(April 3, 2013) — ATP has spoken out against the impending European Financial Transaction Tax (FTT), decrying it for damaging illiquidity in the markets and for doing the “exact opposite” of what its introduction is trying to achieve.
ATP’s co-CIO Anders Hjælmsø Svennesen told aiCIOATP has been approached by the Danish Ministry for Tax Authority to ask for its opinion on the forthcoming tax, which is due to come into force on January 2014.
The move will put a 0.1% tax on stock and bond trades but just a 0.01% tax on derivatives transactions involving one financial institution with its headquarters in the tax area, or trading on behalf of a client based in the tax area.
This means that even if an investor’s home nation opts out of enforcing the FTT, they can still be hit by the tax if the bond or equity is based in a state that does enforce it.
Pension funds are being forced to consider ramping up their use of derivatives as a result of this tax – including ATP.
Svennesen told aiCIO: “We are looking into using derivatives in this way. The FTT does the opposite of its original intentions and 10 basis points tax on cash bonds will make it extremely expensive.
“We have a large amount of cash bond holdings to act as a hedge against inflation and interest rate risk – this is a tax on hedging your liabilities.”
Svennesen added that ATP was also considering investing in areas outside of the FTT adopters. Currently 11 nations have signed up to the tax, including Germany, France and Estonia.
“We’ll have to look at what’s best for our members – risk adjusted returns, after tax,” he said.
ATP’s remarks arrive on the back of a report from the London Economics consultancy, published on April 3, which warned the FTT would result in investors turning away from debt and bonds as they become more expensive, and instead seeking returns from derivative instruments.
Pension schemes currently tend to use derivatives largely to hedge liabilities and, thereby, reduce risk, but the report suggests schemes may opt to use the instruments more often to replicate bond-like returns, saving them money from the forthcoming tax.
One such instrument cited in the report was a total return swap (TRS), which replicates the cash flows of a bond; if financial institutions were to buy an entire bond issuance and undertake TRS transactions with all counterparties, the minimisation of bond trading and maximisation of trading in derivatives of the bond would result in the investors paying less through FTT.
Even if TRSs were to fall under the FTT rules, fund managers would likely begin to create other instruments, according to the report.
One key issue to consider is that this instrument substitution would result in a significant redistribution of counterparty risk.
Several of Europe’s major economies, including the UK, Luxembourg, and Sweden oppose it.
The European Fund and Asset Management Association has also loudly opposed it, warning a FTT would reduce the attractiveness of savings and the supply of long-term financing in Europe.
If applied at the start of 2011, EFAMA estimated the annual total cost of the FTT would have reached €13 billion (€7.3 billion attributed to the FTT-zone and € 5.7 billion attributed to countries outside the FTT-zone).
The matter is concerning investors in the States as well – the Financial Times reported on April 3 that a coalition of US business groups had written to the European Commission opposing “the unilateral imposition of a global financial transaction tax”.
The US Treasury has also objected to a tax that would “harm US investors in the US and elsewhere who have purchased affected securities”.
The London Economics report also found the introduction of the FTT is likely to have negative impacts on the investor per transaction, specifically:
The impact is greater for returns for corporate bonds from non-participating member states than participating member states by at least 10 basis points.
Bonds with longer maturity fare better than shorter duration bonds – For example, for corporate bonds with maturity of 8-10 years, the impact of the FTT is 6.4% per transaction, while for bonds with maturity of 0-2 years, it is 13.6%.
Sovereign bond returns will be hit harder than corporate bond returns – For example, for bonds with maturity between 4-6 years, the impact of the FTT on corporate debt is 6.8% per transaction, whereas for sovereign debt, it is 11.6%.
You can read the full report here http://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Pages/default.aspx
Related content: Interview with Svennsen in aiCIO‘s Forty Under Forty 2012