France passes Financial Transactions Tax; other nations unlikely to follow

In what may be ultimately seen as a major blow to France’s trading markets in favor of international venues, the French National Assembly has adopted the much-discussed Financial Transactions Tax. The tax will impose a 0.1% fee on trading French stocks with a market valuation of over Eur 1 billion and and 0.01% tax on CDS and some “speculative” automated trading. The tax is expected to hit securities lending and repo transactions as well. The question is: is this an invitation for a huge piece of regulatory arbitrage, or is it a sound piece of legislation that will ultimately be adopted worldwide? Our vote is the former.

Our critique of this law is based on several factors. First, this is a pass-through tax; it will be added on to trades done by clients and leave banks relatively unscathed, except that it will slightly decrease their overall revenues by increasing the frictional costs of trading for their clients. If the government wanted to impose a moral or payback tax on banks it should have gone for their profits, not their clients.

Second, this was a unilateral move by France’s government; many other nations including the UK and Sweden (and presumably Ireland and Luxembourg) are not following their lead. This opens up a massive hole for regulatory arbitrage by every financial participant who can engage in it. Right now, a French stock traded on the NYSE by a US citizen would not see the tax. The NYSE and French companies would have incentives to move their listing, although the French government will certainly impose a political cost on those who try. While some members of the European Commission would like to expand the reach of the tax to avoid just this type of regulatory arbitrage, it is very unlikely to happen.

Third, France is on the road towards final approval of the tax based on its own internal tax revenue estimates; it presumes that it will be revenue-neutral on the tax (the new tax will raise revenues while the VAT will go down). This is a strong presumption, figuring as it does that existing trading revenues will stay constant or shrink only slightly with the new tax.

Fourth, does no one remember why the massive Contracts for Differences market exists? The UK’s stamp tax of 0.5% gave rise to the CFD market starting in 1995. CFD trades account for anywhere between 30% and 50% of the volume on the London Stock Exchange. The CFDs were designed as a hedging strategy but others quickly saw the potential of the contract as a taxed advantaged swap. The first major wave of CFD use coincided with the original internet boom in the late 90’s: London’s nascent hedge fund scene snapped up the derivatives for their leveraged trading benefits while online platforms popularized CFDs for individuals. The difficulty for France, like just for the UK, is that financial markets are diverse and global; a tax has to be made effective everywhere to work, otherwise it just hurts one economy or product in favor of another one. Markets take the path of least resistance.

Lastly, French government officials have spoken publicly about their desire to intrude in the markets. This is not a casual statement – they aim to intervene. This type of intrusion is seen as doing much more harm than good. Markets that are being disrupted will seek easier climates especially when so many of them exist close-by (relatively speaking, by Internet).

France’s unilateral action raises more eyebrows than makes for effective change. We don’t see good things happening for French financial transactions here.