Eurobond 50th Anniversary Shows Tobin Tax Risks: Euro CreditJohn Glover
Half a century after a U.S. tax on bond purchases spawned the $3.7 trillion-a-year Eurobond market, Europe’s plan to impose a levy on financial transactions risks triggering a similar flight.
Against the objections of nations including the U.K. and Luxembourg, European Union finance ministers agreed Jan. 22 that interested member states may design a broad-based tax that would cover trades in stocks, bonds, derivatives and other securities. The EU estimates the proposal would allow France, Germany and nine other countries to raise as much as $47 billion a year.
“What’ll happen is what has always happened,” said Jim Kean, founder of investment advisory firm Bayesic Asset Management Ltd. in London, who started as a bond trader in 1986, a year before Margaret Thatcher’s “Big Bang” deregulation of the U.K. ushered in liberalized financial markets. “If you can transact without transaction costs, you will. There’ll be a market in Singapore or somewhere else.”
Europe’s plans have been dubbed a Tobin tax after U.S. economist James Tobin, who in 1972 suggested taking a cut of foreign-exchange trades to limit currency speculation. History is littered with government attempts to extract revenue from financial transactions, not all of which were successful and most of which had unintended consequences.
The Eurobond market, now the largest forum for corporate fixed-income transactions, came into being after President John F. Kennedy imposed a so-called interest-equalization tax in 1963 to make investing in foreign securities less alluring to U.S. investors and ease a balance of payments deficit.
Italy’s Autostrade per l’Italia SpA issued the first Eurobond in July 1963, a $15 million issue managed by S.G. Warburg, according to “The Eurobond Diaries,” a market history published in 1994. The U.S. move drove bond trading to London, where an unregulated market arose. So-called Belgian dentists, shorthand for wealthy entrepreneurs whose customers paid in cash, bought corporate debt and rode the “coupon train” to Luxembourg to collect interest, according to Mint Partners Ltd. bond broker Bill Blain, who joined Morgan Stanley in 1985.
“It was all driven by tax,” he said. “Who would have thought Europe would be so stupid as to actually do this now?”
An unintended consequence of the U.K.’s attempt to impose a stamp duty on colonies in the Americas was the Boston Tea Party and the War of Independence. The levy, among the oldest financial taxes that still exists, was introduced in 1694 during the reign of William III and Mary II, modeled on a tax in the Netherlands that originated 70 years earlier, according to a Leicester City Council pamphlet.
EU Tax Commissioner Algirdas Semeta is expected to propose plans for implementing the levy in mid-February, said Anne Powell, a London-based tax specialist at law firm Allen & Overy. A tax of 10 basis points on stock and bond transactions and 1 basis point on derivatives is possible. A basis point is 0.01 percentage point.
In contrast to Tobin’s proposal, the “main rationale” behind the EU plan is to generate revenue, according to Andreas Johnson, an economist at Stockholm-based SEB AB.
Sweden’s experience with the financial-transactions levy that was in place from 1984 to 1991 -- first on equities and then on bonds -- showed that it’s difficult to get money to stay in the country.
“Transactions simply moved abroad,” Johnson said. “Tax revenues were much smaller than expected.”
Bond trading fell by more than 80 percent and the options market died, he said. The tax take was 80 million kronor ($12.7 million) rather than the expected 1.5 billion kronor, according to Johnson.
A French levy on trading in shares of the country’s largest companies reduced volumes of those covered by as much as 15 percent more than those excluded from the list, according to Euronext in Paris. Investors have escaped paying it by either buying so-called contracts for difference, derivatives that aren’t covered by the levy, or by purchasing similar stocks in other European markets, according to Euronext.
“I doubt the EU will raise the revenue they expect,” said Powell at Allen & Overy. “It’ll be very interesting to see how they get around the collection and enforcement issues. And then there’s the relocation risk. People might just move out of the euro zone.”
Avoiding regulation was what drove the development of the Euromarket, said Alec Chrystal, professor emeritus of money and banking at Cass Business School in London.
“The whole point was that you set up offshore and you were outside jurisdictions at the time,” he said. “There isn’t much the authorities can do about that. Unless there’s international agreement, the tax won’t have a big impact.”
The EU is seeking to extend its reach as far as possible, proposing that any transaction involving an institution from one of the participating countries will attract the levy. So too will deals involving securities issued in one of the 11 nations.
The nations that have signed on to the plan are Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia.
A transactions tax would hurt the economy, according to opponents such as the industry lobby group, the Association for Financial Markets in Europe.
A tax would be “regrettable and likely serve as another brake on economic growth,” said Richard Middleton, a managing director at the Association in London. “Europe needs to focus on rebuilding its economies and fostering recovery.”
The tax risks reducing liquidity and returns in the affected markets, raising the cost of capital for companies, and increasing the incentives for financiers to design ways to avoid the expense, according to Johnson.
The effects of the tax may not be as far-reaching as opponents fear, said Alan Brown, chief investment officer at Schroders Plc in London.
“It won’t be cost-free, it never is,” he said. “My first thought was ‘over my dead body,’ but given the way it’s designed I’m now less exercised about it than I was.”
One clear casualty will be computer-driven high-frequency trading, which involves buying and selling stocks in split-second intervals, Brown said.
“It will have a very significant impact on that,” he said. “No one, though, is going to weep about the loss of high-frequency trading.”