France warns on use of derivatives to evade new transaction tax
The French government has warned it could take action if derivatives are used to evade its new tax on cash equity transactions.
Market participants report volumes in the cash market have shrunk 10-15% since the tax was introduced – therefore reducing receipts – while volumes in exempt derivatives instruments, such as contracts for difference (CFDs), have increased.
“We will be very careful on the risk of bypassing and tax evasion through synthetic instruments and take appropriate measures where needed,” says Laurent Martel, tax adviser to Pierre Moscovici, the French finance minister, in an email to Risk.
The taxe sur les transactions financières applies to the equity instruments of companies headquartered in France with a market capitalisation greater than €1 billion – currently 109 stocks. Originally set at 0.1% of each transaction’s value, it had doubled to 0.2% by the time the law was adopted by the French parliament on February 29. Transactions became taxable as of August 1 and the French Treasury began collecting proceeds in November.
The tax has reportedly proved a boon for derivatives desks at some dealers. They are said to be seeing an increase in clients looking to trade equity swaps or CFDs, which allow leveraged, synthetic exposure to movements in the underlying French equities without having to pay the tax.
“What appears to be happening is that the hedge fund and prop trading segment of the market is increasingly looking to CFDs as an alternative. One client estimated there’s been about a 20-25% increase in CFD volumes,” says Tony Freeman, executive director for industry relations at post-trade software vendor Omgeo in London.
For many, the tax isn’t causing waves precisely because it’s so easy to shift trading to futures or – if there is not enough liquidity – to over-the-counter derivatives. “We haven’t seen a huge behavioural shift in the markets, as market participants can just switch to derivatives, either through their brokers or directly on the listed markets,” says Dominique Ceolin, chief executive of ABC Arbitrage, a Paris-based systematic hedge fund.
Institutional investors in France are said to be more wary of circumventing the tax via derivatives, but there is anecdotal evidence that some firms are reducing their turnover in the affected names or substituting French stocks for other European securities with similar characteristics.
“Many institutional investors have been frank on this. For them, whether they trade France Telecom or Deutsche Telekom it’s almost the same in portfolio allocation terms. They now prefer to replace French names with other eurozone securities from the same sector,” says Laurent Fournier, head of business analysis and statistics for European cash markets executions at NYSE Euronext in Paris.
The French tax has been crafted to minimise the impact on volumes. Eligible transactions are subject to the tax wherever they’re traded, which removes the incentive to simply shift trading to foreign exchanges. It also offers nine exemptions, including for primary market activity, securities lending and a broad market-making exemption. On intraday trades, the tax is levied on the net buying position at the end of day, reducing the impact on hedge funds with rapid-fire trading strategies.
August is traditionally a quiet month for trading volumes, especially in France, so the effect of the tax has not been easy to discern amid the seasonal trading slump. However, NYSE Euronext estimates the introduction of the tax has had a significant impact in its first few months.
“In terms of volumes, we saw an incremental drop compared to market trends of about 15% across the market. In September and October, the incremental impact compared to the trend is more like negative 10%,” says Fournier.
Across Europe, 11 member states have written to the European Commission (EC) stating they would like to participate in plans for a common financial transaction tax (FTT), namely Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain. In December, the Council of the European Union is expected to instruct the EC to advance plans for an FTT under ‘enhanced cooperation’ – a legislative procedure allowing a coalition of member states to forge ahead with a shared law that does not have the support of all 27 member states.
In September 2011, the EC released a proposal for an FTT that would include both listed and OTC derivatives – a prospect some dealers privately said at the time would kill the OTC market. In an interview with Risk earlier this year, Michael Spencer, chief executive of interdealer broker Icap, said his company would relocate to another financial centre if a new transaction tax was introduced in the UK.
Those threats will carry rather less weight in other countries, and as France contemplates avoidance of its own tax, lessons learned in Paris may filter through into the design of the EC’s proposals.
“This has to be dealt with in accordance with other European member states, in the framework of enhanced cooperation,” adds Martel, the adviser to the French finance minister.
This article was first published on Risk