Inge Heinrichsen of Ernst & Young examines
some of the effects and challenges that the asset management
industry may have to face in relation to the proposed EU
In September 2011, the European Commission proposed a draft
directive on a broad financial transaction tax (FTT) across all
member states, the overall objective being to increase the
financial sector's contribution to the EU's common finances. An
estimate for revenue was in the area of €30 billion to
€35 billion. In 2011, the European Fund and Asset
Management Association (EFAMA) estimated the revenue on the
investment funds alone at €38 billion.
The proposal reached a deadlock situation due to
disagreement on the tax's implementation among member states.
However, a number of states wished to continue the FTT work and
further details were passed through the Commission in February
2013, scoping a broader FTT.
On May 6 2014, the finance ministers of Austria, Belgium,
Estonia, France, Germany, Greece, Italy, Portugal, Slovakia,
Slovenia and Spain issued a joint statement on their aim to
create a harmonised FTT regime within the EU. The 11 countries
intend to implement the FTT on a step-by-step basis with an
initial focus on shares and some derivatives, with the initial
steps to be implemented by January 1 2016 at the latest.
There have been recent political developments in respect of
EU FTT indicating greater urgency to complete negotiation.
Some EU member states have already implemented local FTTS -
so called early adopters.
France introduced a FTT on French equities on August 1 2012,
together with a tax on high-frequency trading and naked
sovereign credit default swaps. The French FTT applies a 0.2%
tax on the purchase price of equities (or American depositary
receipts, global depositary receipts or Crest depository
interest) of French publicly-traded companies with a market
value over €1 billion on December 1 preceding the year of
taxation. French FTT does not apply to debt securities.
Italy has also introduced a FTT, which came into effect on
March 1 2013 for cash equities and September 1 2013 for equity
derivatives and structured notes. For over-the-counter
transactions in cash equities, the rate applied is 0.22% for
2013 and 0.20% in 2014. For on-exchange transactions in cash
equities, the rates applied are 0.12% and 0.10% for 2013 and
2014, respectively. The amount of Italian FTT on derivatives is
determined by reference to the type of financial instrument
involved and the relevant notional value – which is a
maximum of €200 on derivatives, payable by both
counterparties to the transaction. The amount of FTT on
derivatives is reduced to 1/5th for transactions that are
Portugal and Spain
Both Spain and Portugal propose local rules, but the
proposals were put on hold awaiting the outcome of the EU FTT.
Neither country has suggested they will react to the delay on
EU FTT by resurrecting these proposals.
What is the EU FTT?
It is proposed that the EU FTT is levied on secondary market
security transactions (broadly: buying, selling, and
collateral). In scope, the products are shares, fund units,
bonds and derivatives. Up until the January 2015 statement it
was thought that the 11 EU countries were likely to narrow this
down at least initially to equities and some derivatives.
"Ways of doing
business in the asset management industry would need
rethinking under the FTT"
Financial institutions in the 11 EU countries are liable, as
are outside financial institutions doing transactions with the
11 countries. Financial institutions are broadly defined, and
no exemptions are contemplated for pension funds or life
Every transaction triggers taxation, with a cascade effect
(subject to a limited market maker exemption). No netting
principles are applicable, and rates are 0.1% for equities and
0.01% for derivatives (stated as minimum rates where states may
The asset management industry has raised concerns regarding
technical aspects of the FTT, such as how it will impact the
product range, as well as the compliance and administrative
burdens it implies.
Will the FTT change the product range?
The commercial scope and ways of doing business in the asset
management industry would need rethinking under the FTT, not
only in terms of investment and hedging strategies for large
institutional investors, but whole business methodologies would
need to be adjusted to minimise the impact of the FTT. The
whole concept of fund structures, investment strategies for
fund and trading patterns and distribution models will have to
The residence principle in the EU FTT implies that wherever
there is a financial institution with so-called nexus within
the 11 EU states, tax is levied. What this would entail for the
asset management industry is business potentially moving
outside the relevant EU zones, and increased interest in non-EU
securities simply for tax reasons, thus creating huge
inefficiencies in trading and investment patterns in the
industry. Domestic fund structures in the 11 countries will
become much less attractive for investment from outside. It is
notable that the traditional asset management centres of
Luxembourg and Ireland are not part of the 11. Changes in
trading patterns may lead to less frequent trading, as was one
intention of the FTT's political agenda, but this may not
necessarily be of benefit in a sound and healthy financial
services environment. Frequent trading is often necessary for
prudent financial management of funds, and the high-frequency
trading of underlying assets is a key factor in various asset
management strategies. The FTT may lead to tax –
rather than commerciality – being the key driver,
therefore creating tax lock-up effects.
Some fund types may be affected by the FTT more than others.
Exchange Traded Funds (ETFs) are likely to be more heavily
impacted as the first issue will typically be to a large
financial institution and therefore not qualify for the issuer
exemption. Each further transaction on the exchange will then
trigger further transaction taxes.
Money Market Funds will not generally benefit from the
issuer exemption, as they tend to buy short term. As the
margins in the money market are low, high trade turnover is
part of the earnings strategy triggering multiple times
Funds investing in asset classes that are not a typical
high-frequency trading security may not be affected as
seriously as the typical investment fund with listed shares or
listed bonds or similar types of securities.
Funds investing in real estate assets or infrastructure
assets are typically more illiquid in nature, closed-ended,
with a smaller number of institutional investors. Or, in some
cases, the funds themselves may be listed, such as real estate
companies where the sale and purchase of shares in the company
itself may be subject to FTT. As the FTT comes into effect,
funds with traditional securities in shares and bonds for
example, will become more expensive and therefore less
attractive to investors – institutional and retail
Fund-of-funds may be affected differently, depending on
their structure and investment area.
Pension fund concerns
Pension funds across Europe manage their assets using
various investment strategies and approaches according to
different asset classes. Since the FTT does not hold any
exemptions for pension funds, they would be subject to the FTT
on every transaction of FTT-liable securities. Considering the
large amounts of securities in the portfolios of pension funds,
the impact will be considerable.
A pension fund would directly hold large portfolios of
equities, debt instruments, financial instruments and various
other asset classes. It would also actively manage this large
investment portfolio of securities and trade to generate yields
for the benefit of pension holders. Various strategies on how
to generate and optimise returns on these portfolios would now
entail the tax element of the FTT and need to factor this in
the pension fund investment strategy.
burden and cost of FTT administration could pose a
significant burden on custodians"
The impact of the FTT would not only relate to the
investment portfolio securities themselves but also to the
hedging strategies, as financial instruments are also within
the scope of the FTT. Pension funds use financial instruments
in various ways, such as covering investment portfolio risks or
hedging their liabilities.
In some instances, a pension fund would hold certain types
of assets in an entity managed by an external investment
manager. In this case, the pension fund would bear the cost of
the FTT in the same manner as other investors in investment
funds: it would lack any specific exemption for investment
funds wholly owned by pension funds or even general exemptions
for pension funds.
The overall objective of a pension fund's management of the
investment portfolio is to increase the returns and pension
yield for the benefit of the pension holders – so
ultimately, the pension holders will bear the cost of the
|Potential effects of the EU
- Potential destabilisation of the single European
market, as only a subset of the 28 EU member states
will implement the tax.
- Significant shift in asset class appetite (some
sources cite a reduction of up to 90% in relation to
derivatives volumes) exacerbated by the inclusion of
so-called issuance principles.
- Curbing of high-frequency trading.
- Changes to legal entity models and location
strategies by firms seeking to reduce their exposure
to the tax.
- Exposure to different credit risks as
counterparties change their legal entity models.
- Significant impact on funds as costs are passed
on to end users.
- Reduction in liquidity.
- Increased cost of managing risk (such as using
derivatives to hedge).
- Increased complexity of operations, resulting in
lower rates of straight through processing and
therefore higher cost per trade (even before
application of the tax).
- Front-to-back changes to applications and their
business rules to be able to compute and reflect the
EU FTT throughout the transaction life cycle from
order management through to settlement and
- Dependency on data quality, particularly
counterparty reference data and instrument
Administrative and compliance issues
Where the FTT cannot be avoided, it will have an economic
impact, and in some cases a significant one. The compliance
burden and cost of the FTT administration could pose a
significant burden on custodians, administrators and other
market participants. In the end, the costs would be priced
within the products and there will be just one payer –
the unit holder in case of an investment fund or pension holder
in case of a pension fund investor for example. This will make
savings products less affordable for savers and reduce the
attractiveness of long-term saving products.
The operational challenges with regard to the administration
of the EU FTT are also burdensome. Each financial institution
will need to deal with the mapping of transactions, systems
implementation, legal framework, collection and reporting
Depending on the scope of the EU FTT, examples of its
effects could include:
Tax Partner, Head of FS Tax, Nordic Management Team, FS
Ernst & Young P/S
Osvald Helmuths Vej 4,
D: + 45 73233761
M: + 45 25293761
The EU proposal does not provide further guidance on the
mechanisms of collection.
An independent report by Ernst and Young for the European
Commission (October 2014) provides insight on existing
collection mechanisms and considers the challenges the EU FTT
poses with regard to collection models and data requirements.
It suggests that a centralised collection mechanism could
perform various functions on collection and reporting. Whilst
the report may well help policy makers in considering the best
methods of tax collection, in the first instance, the EU 11
need to decide what they will tax and how. If the EU 11 reach a
political agreement, and this is far from certain, then asset
managers across Europe will need to urgently assess the likely
effects on their business.