University of New South Wales Faculty of Law Research Series
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Last Updated: 22 December 2011
A Financial Transactions Tax: Inefficient or Needed Systemic Reform?
Ross P Buckley, University of New
South Wales*
Gill North, University of New South Wales**
Citation
This article is to be published in Georgetown International Law Journal (forthcoming). This paper may also be referenced as [2011] UNSWLRS 53.
Abstract
The European Commission has included a Eurozone financial transaction tax in its long-term budget, as a first step towards a global tax. This move was taken despite negative European Commission and International Monetary Fund staff reports, which concluded that a tax would reduce the efficiency of capital markets, and raise the cost of capital. The efficiency frameworks used in the staff reviews were unduly narrow. Markets work best when there are strong links between market trading and real economic activity. Of late, these links have become increasingly tenuous and latent market and financial system risks are mounting. Carefully calibrated legal and tax responses are required to change market behaviour. Such a tax as part of an integrated policy framework would reduce short-term momentum trading and promote longer-term investment that would better reflect underlying economic fundamentals. So we argue the European Commission is correct in proposing to adopt such a tax.
TABLE OF CONTENTS
A. A Fair And Substantial Contribution By The Financial Sector: IMF Staff Final Report For The G-20
I. INTRODUCTION
The global financial crisis (GFC) sparked vigorous
debate on the role of financial institutions and capital markets, and the extent
to which financial institutions and other capital market participants should
contribute to the broader economy. Much of this debate
has centred on the
appropriate mechanisms to enable governments to recoup taxpayer monies used to
bail out failing institutions and
appropriate tax regimes going forward.
Proposals considered at an international level have included financial
institution levies
(such as a financial stability contribution), a financial
activities tax (FAT) and a financial transaction tax (FTT) (sometimes referred
to as a securities transaction tax). France, Germany, the United Kingdom (UK)
and other countries have already imposed levies on
their financial industries to
recoup bailout funds provided in the GFC, boost government revenues, and build a
fund to help meet
the cost of future
crises.[1] This article focuses on a
FTT as a needed addition, or alternative to, bank
levies.[2]
Critics of a FTT
argue that a tax would have distorting effects on the function of the market and
would harm its efficiency due to
reduced liquidity, higher volatility, and
increased capital costs.[3] Those who
support an FTT argue that by reducing trading volumes it would enhance the
ability of markets to allocate resources efficiently,
and allow important
financial and human capital to be redeployed into more socially productive
areas. Experts generally agree that
collection of the tax through clearinghouses
would be straightforward and cheap, and that tax avoidance can be minimised by
applying
the tax to a broad range of transactions across all
jurisdictions.[4]
Staff of
the European Commission (EC) and the International Monetary Fund (IMF)
considered a FTT in 2010. Both of these reports rejected
the tax in favour of
other revenue raising schemes. The EC report indicated that
“[e]ssentially, the debate on financial transaction
taxes boils down to
the question of the influence of transaction costs on trade volume and price
volatility, and whether they can
serve as a corrective device to reduce the
number of allegedly harmful short-term
traders.”[5] Although the IMF
report was more comprehensive in scope, it also focused primarily on short-term
trading, liquidity, price discovery,
volatility and cost of capital effects.
The article outlines and discusses the EC and IMF staff reports. We
argue that the frameworks used to assess the efficiency, economic
and other
effects of a FTT are unduly narrow. The primary argument in the reports is that
increased trading leads to enhanced liquidity
and lower transactions costs,
which leads to lower costs of capital and improved economic outcomes (the
trading cost of capital model).
This argument is repeated like a mantra.
However, the empirical research referenced in the reports is generally limited
to microstructure
studies, with the crucial links from the short-term price
effects to long-term economic and community outcomes assumed rather than
established. The critical bigger picture issues are glossed over in the belief
that first, there is no evidence that the dramatic
increase in market trading
levels of recent years has been inefficient; and second, there is no decisive
evidence that the way capital
markets operate had anything to do with the
crisis. We question both of these assumptions.
The main lesson to be
learned from the GFC is that policy analysis founded on efficiency or economic
outcomes must adopt a broad perspective
and measure the impact of the policy
upon the real economy over a long time frame. Policy assessment of efficiency
and economic effects
must extend beyond short-term financial variable effects to
the likely longer-term economic impacts and public interest factors.
Prior to
the GFC many claims were made about the effective risk management, efficiency,
and innovativeness of the mortgage market
and securistisation processes in the
US. Few commentators stepped back from day-to-day events to think about the
soundness and sustainability
of the housing, mortgage, and securitisation
trends.
Similarly, a farsighted, arms length, and pragmatic review is
required of recent developments in capital market trading. Large institutions
are driving ever increasing global securities trading levels. This is
understandable as market participants have strong incentives
in markets to try
to outplay the next party. What is less clear, but crucial to understand, is why
many policy makers and scholars
are once again actively advocating and
supporting market trading developments on efficiency, risk enhancement, and
innovation grounds.
Capital markets remain the best available mechanism to
determine security prices and allocate financial resources efficiently. However,
the net efficiency and economic gains from increasing trading activity are
uncertain. Indeed, we argue that the trading cost of capital
model is flawed
– the asserted economic benefits are largely illusory and the trading
environment poses significant long-term
risks to the real economy.
The market patterns of high frequency trading, computer generated
activity and short-termism are now well entrenched, so behaviour
will be
difficult to change. A serious response will require a range of carefully
calibrated legal and tax policies. We support the
introduction of a low level
FTT as part of this overall framework to promote greater alignment between
capital market and economic
activity. A transactions tax would discourage
short-term speculative and technical trading and promote more stable and patient
investment
aligned with fundamental valuations. In contrast, a bank levy and FAT
as proposed by the IMF will raise funds but will not reorient
market trading
behaviour. For this reason, a FTT is to be preferred over a
FAT.
Despite the negative EC and IMF reviews,
discussion on a proposed FTT continues at a European and global level. Nicolas
Sarkozy, the
French President, and Angela Merkel, the German Chancellor, support
the tax.[6] The EC notes that
“[i]ntroduction of a tax on financial transactions ought to be as broadly
based as possible or, failing that,
the financial transaction tax should be
introduced as a first step at European Union (EU)
level.”[7] On this basis,
President Barroso, Taxation Commissioner Šemeta and Budget Commissioner
Lewandowski publicly support a European
based tax. In June 2011 the EC included
a EU wide FTT as part of the funding in its long-term budget
(2014-2020).[8] The EC will present
the required regulations to the European Council and European Parliament by the
end of 2011.[9]
At a global
level, the communique from the G20 finance official meetings in October 2011
indicated that options for innovative financing
and a range of different
financial taxes were discussed.[10]
The subsequent G20 summit communique acknowledged the initiatives in some
countries “to tax the financial sector for various
purposes, including a
financial transaction
tax.”[11] This vague
commentary reflects the significant political divisions among the G20
countries towards a FTT.
Wolfgang Schaeuble, the German Finance
Minister argues that even though there is no consensus on a global based FTT,
the tax is needed
in Europe, and it will be implemented with great
energy.[12] He suggests that if
‘we go ahead with a FTT a lot of other parts of the world economy will
follow us’.[13] Sarkozy told a
news conference at the end of the G20 leaders’ summit that “I remain
convinced [the tax] is possible ...
that it’s indispensable financially
given the crisis and that morally it is absolutely
necessary”.[14]
Given
the high levels of public debt in Europe, US and elsewhere, the risks associated
with sudden changes in trading activity, and
the fragile state of international
markets, we continue to call for a global FTT with support from all policymakers
and regulators.[15] An international
FTT would minimise market distortions and the transfer of trading activity to
untaxed jurisdictions.[16] Should
Europe establish a tax limited to the Eurozone, it should be carefully
structured to minimise the relocation of financial
activity and any negative
effects on markets.
The tax should be designed to target trading
issues of most concern and its efficacy should be reviewed after five years. If
a tax
scheme is not introduced, other policy options to alter capital market
structures and trading behaviour should be considered. While
the reforms
included in the Dodd–Frank Wall Street Reform and Consumer Protection Act
(Pub.L. 111-203, H.R. 4173) will assist, in the absence of a FTT, much more will
be needed to ensure capital markets operate in the long-term interests of the
global community.
The article is in eight parts. Part II describes the
market-trading environment. Part III outlines the arguments for an FTT. Part
IV
outlines the EC summary review of the FTT, while Part V discusses the more
comprehensive IMF reviews of the FTT option. Part VI
considers the
administrative feasibility of a FTT. Part VII reviews recent developments. The
final part provides our summary critique
and conclusion.
The key market
trends and general principles and concerns that underpin the need for a FTT are
outlined initially. To properly assess
the EC and IMF arguments and findings, an
understanding of capital market developments is needed.
II. FINANCIAL MARKET TRADING – THE FACTS
Over the last twenty years there has been rapid growth in the levels of global market activity, well above those of the economy.[17] The ratio of the volume of financial transactions relative to nominal world gross domestic product (GDP) in 2007 was seventy-five point three, compared to fifteen point three in 1990.[18] The increase in volumes was driven by derivative trading,[19] as spot transactions of stocks, bonds and foreign exchange grew roughly in line with nominal world GDP.[20] Eighty eight percent of the transactions in 2007 were derivative based[21] and 64 percent were fixed income security derivatives.[22]
An increasing proportion of market trades are short-term and technically driven. In 2009, algorithmic[23] or computer-driven trading accounted for at least 60 percent of equity market trading volume in the US and 30-40 percent of European and Japanese equity trading.[24] Similarly, 40 percent of the futures trading volumes in the US, 10-20 percent of the foreign exchange trading volume, and 20 percent of the options trading volume, were algorithmically driven.[25]
Many transactions involve “high frequency trading” (HFT) aimed at exploiting minor price fluctuations.[26] HFT typically involves the generation of massive numbers of orders for very short periods (often less than a second), many of which are subsequently cancelled to mask the true intent of the trader.[27] Estimates of the proportion of trading classed as HFT vary depending on the definition used but generally fall within the 50-75 percent range.[28]
HFT is founded on an ability to transact rapidly. To enable faster processing
speeds, market participants are locating their systems
beside or within the
building of the relevant exchange. This co-location process reduces the latency
time: the period it takes for
the trading data to transact across the electronic
trading systems. French hedge funds moved their trading computers to London
because
the time it took electronic messages to travel from Paris was placing
them at a disadvantage. Similarly, Goldman Sachs moved its
computers beside
those of NASDAQ because each millisecond gained, by their calculations, added
more than US$100 million to company
profits.[29] In January 2010, a
project was discussed to build an optical cable through the Arctic Sea between
the financial centres in London
and Tokyo at a cost of US$1.3 billion to cut
latency times for data transmission from 140 to eighty eight
milliseconds.[30]
An increasing
portion of market activity is being driven by hedge funds. Global assets under
management in hedge funds have grown
rapidly over the last decade to between
$2-3 trillion in assets.[31] Kapoor
indicates that
hedge funds dominate trading activity in equity markets, account for more than 50% of the volume in certain kinds of [over-the-counter] (OTC)] derivatives, are by far the biggest players (by volume) in certain fixed income markets, are fast increasing their market share in foreign exchange markets and are prominent actors in commodity markets.[32]
Hedge funds already account for 90 percent of the volume in
convertible bonds, between 55-60 percent of the transactions in leveraged
loans,
almost 90 percent of the trading in distressed debt, and more than 60 percent of
the volume in the credit default
market.[33] Nevertheless, the share
of market trading by hedge funds is likely to rise further as regulatory reforms
such as the Volcker Rule
in the
US[34] and more stringent global
capital rules constrain banks from engaging in proprietary trading or owning
hedge funds.
The benefits and risks posed by the hedge fund industry
continue to be hotly debated. No evidence has been found suggesting that hedge
fund activity directly contributed to the GFC. However, each financial crisis
raises questions about the role played by hedge funds
in financial
markets.[35] Hedge funds were
implicated in the 1992 currency crisis in Europe. There were also allegations of
large hedge fund transactions in
various Asian currency markets in the lead up
to, and in the wake of, the Asian financial crisis in 1997. These concerns were
compounded
by the potential insolvency of the major US hedge fund, Long-Term
Capital Management in 1998.[36]
The International Organization of Securities Commissions confirms that
hedge funds play an important role in global capital markets.
Trading by hedge
funds can enhance price efficiency, market liquidity, product innovation and
investor asset diversification.[37]
At the same time, however, the activities of hedge funds pose risks to market
integrity, investor protection, and financial
stability.[38] The amount of trading
and the share of global securities transactions by hedge funds continue to
grow.[39] Many hedge funds trade
primarily in derivative instruments, which “compounds ... [the] problems
of information and evaluation
for bank management, [other investors] and
supervisors alike.”[40] These
risks are magnified when financial markets are suffering from stress or
instability, particularly when the hedge funds are
large or highly leveraged.
During periods of market volatility or reduced liquidity, the unwinding of
concentrated or leveraged positions
can cause major market dislocation and
disorderly pricing.[41]
The
sustainability of the ever-increasing levels of securities trading, in the form
of derivative instruments with ultra-short holding
periods by the largest
financial institutions including hedge funds is questionable. However, it will
not be easy to alter the entrenched
patterns of trading, as the operations of
capital markets are complex. To do so will require a range of substantive
polices including
changes to market infrastructure. The introduction of a
low-level FTT as part of this process would promote greater alignment between
capital market and economic activity.
III. PROPONENTS OF A FINANCIAL TRANSACTION TAX
The FTT debate to date has centred on efficiency and
economic goals and effects. Keynes was one of the earliest proponents of a
securities
transaction tax to curb speculative bubbles. He suggested in 1936
that the “introduction of a substantial government transfer
tax on all
transactions might prove the most serviceable reform available, with a view to
mitigating the predominance of speculation
over enterprises in the
US.”[42] He argued that
when:
[T]he capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield cannot be claimed as one of the outstanding triumphs of laissez faire capitalism – which is not surprising if I am right in thinking that the best brains of Wall Street have in fact been directed towards a different object.[43]
Similarly, Joseph Stiglitz indicated in 1989 that:
If, one thinks as I do, that the most important function (from the social view) of the stock market is raising new equity capital, one cannot but be struck by how, under current circumstances, it seems to do so little of this at great cost ... most of these resources are not spent in raising new funds but in rearranging ownership claims on society’s resources ... Resources devoted to gambling – and to short-term speculation in the stock market – could be devoted to more productive uses.[44]
In the
wake of the GFC, these long-standing arguments about speculative trading have
intensified. The base of FTT supporters has expanded
to include highly respected
policy makers, academics, and practitioners. For example, the advisory committee
of Redefine, a policy
think tank actively campaigning for the tax, includes
leading investment banking executives, policy makers, and
scholars.[45] Warren Buffett and
George Soros, who have made their fortunes in financial markets, also believe
the tax would improve the operations
of
markets.[46] These parties are
concerned about excessive trading levels, speculative trading, a pervasive
culture of short-termism in markets,
and the dislocation between capital markets
and the real economy.
The debate has also broadened to encompass
discussion on the role of the finance industry in society. An increasing number
of commentators
question the social usefulness of the growth of transactions
that boost the relative and absolute size of the finance industry. Financial
services have become such a significant part of the total economy in some
countries that it is suggested that too many of the best-educated
individuals in
these countries are trading paper assets rather than creating real
wealth.[47] The Report of the
Commission of Experts of the President of the United Nations General Assembly on
Reforms of the International Monetary
and Financial System highlights that
the:
measure of success of financial policy should not be the rate of growth or the size of the financial sector as a share of GDP. Indeed, an excessively large financial sector relative to the GDP of a medium to large economy should be a cause of concern to those interested in long-term economic growth because financial crises are often associated with unsustainable growth of the financial sector.[48]
Similarly,
Lord Turner, Chairman of the United Kingdom’s Financial Services Agency,
argues that the City of London has grown
“beyond a reasonable size. He
describes much of the current market trading as “socially useless
activity,”[49] and suggests
that:
[P]arts of the financial services industries need to reflect deeply on their role in the economy, and to recommit to a focus on their essential and economic functions ... not all financial innovation is valuable, not all trading plays a useful role, and ... a bigger financial system is not necessarily a better one ... parts of the financial services industry have a unique ability to attract to themselves unnecessarily high returns and create instability which harms the rest of society ...[50]
Whilst
the comments by Stiglitz and Lord Turner are profound, arguably they raise more
questions than they answer. The underlying
issues that remain largely unresolved
include the following:
• What are the important connections and links from capital market activity to sustainable economic growth?
• What are the benefits and risks to society from fair/unfair and efficient/inefficient capital markets?
• To what extent is financial services and trading activity in markets zero sum (that is, it merely alters the distribution of wealth among market participants without adding to economic and society outcomes)?
• How are the net economic benefits created from market activity distributed? What proportion of the wealth created from market activity is simply redistributed to the finance industry in the form of higher salaries or profits?
• What types of financial innovations provide long-term value to the global community beyond the profits or wealth generated for the product creators?
• To what extent are short-term economic gains generated from financial
sector activity during boom times mitigated or lost
during subsequent crises or
economic downturns?
Some of these “bigger picture issues”
are being debated in various fora. For example, in April 2011, 1000 economists
signed
a letter to the G20 urging them to accept a
FTT.[51] The letter states that the
“financial crisis has shown us the dangers of unregulated finance, and the
link between the financial
sector and society has been broken ... It is time to
fix this link and for the financial sector to give something back to society
...
this tax is technically feasible. It is morally
right.”[52]
Much of
the policy and scholarly debate relating to capital markets continues to be
narrowly framed by short-term price efficiency
goals and an assumption that
capital markets work most efficiently when left alone. Such a framework is
reflected in the EC and IMF
reports that considered options to raise money from
the finance sector in the wake of the GFC. The EC and IMF reports reject a FTT
as an option on “efficiency” grounds and argue that most parties
including consumers would be harmed by the tax. Both
reports imply that the real
economy and the public are benefiting from increased market trading levels due
to enhanced liquidity
and price discovery, which in turn, reduces costs of
capital. This core argument is presented as a fact that has been scientifically
verified. However, the adopted theoretical and empirical frameworks to support
the cost of capital arguments are not explained, the
crucial connections to
long-term economic outcomes are generally assumed, and any effects beyond
efficiency factors are largely ignored.
The EC report (the Report)
analysis is presented in a summary format. The IMF reported in two stages. A
staff report in June 2010
provided summary arguments and conclusions. A later
working paper by Matheson reviewed the issues more comprehensively. Most of our
critique deals with the detailed analysis in the Matheson paper.
IV. EUROPEAN COMMISSION REPORT
In March 2010, the European Parliament adopted a
resolution requesting the EC to assess a FTT in comparison to other revenue
raising
options. This process took place as part of the international debate,
including by the G-20, on new sources of finance to: support
fiscal
consolidation; recoup the costs of bail-outs; fund future crisis intervention
measures; and finance global development and
climate change
measures.[53]
The criteria
used by the EC for assessing innovative sources were:
The
Report ultimately rejects the argument by proponents of the FTT that “the
tax would reduce noise and technical trade, thereby
linking trade more closely
to the underlying fundamental economic market conditions and make financial
markets less volatile.”[55] It
questions the assumption that most short-term trading is highly speculative or
based on technical trading, and suggests the time
horizon of an investment is
not a good predictor for the degree of speculation. It notes that short-term
transactions are often related
to trade or other commercial transactions and
“it has proven to be extremely difficult to make a meaningful and
operational
distinction between speculative and non-speculative
transactions.”[56]
The
Report argues that a FTT poses a risk of increasing the cost of capital for
businesses and the cost of financial risk distribution.
Further, the tax would
increase the hedging cost for all companies and the use of derivatives as
insurance devices could be seriously
affected.[57] It even suggests the
tax could increase financial costs for governments because they might have to
pay higher interest rates.[58] The
Report highlights that there is no empirical data to support the argument that
the tax would be of a progressive nature, and
expresses concern that it would
burden pension funds that manage the savings of middle and low-income
earners.[59] It stresses the need to
properly define the scope of the tax, including the tax base and other
administrative design features.[60]
Overall, the Report conclusions are strongly negative. The Report
suggests the tax could have adverse effects on investment and economic
activity
and highlights the risk of potential loss of whole market segments if the tax is
not comprehensive in geographical and product
scope.[61] It raises potential legal
issues around the free movement of capital and payments between Member
States.[62] It also highlights the
asymmetric revenue allocations, with most of the revenue collected in countries
with significant financial
centres. It points to the need for
international solutions, and questions whether an agreement to share the
revenues internationally could be
reached.[63]
The Report
findings are myopic and overstated. The arguments concerning potential risk or
adverse consequences arising from the trading
environment are dismissed on the
grounds that there is no evidence that the GFC was triggered by excess
transactions and it is not
possible to prove that ultra high frequency trading
is speculative.[64] The factors the
Report identifies as resulting in the crisis are limited to excess leverage and
the taking of undue risk by financial
institutions.[65] Put simply, the
Report indicates there is no evidence of any issues arising from capital market
activity and therefore no basis for
any form of interference that may distort
market functions. Yet the Report simultaneously makes unsubstantiated claims
that: the
tax poses a risk of increasing “the cost of capital for business
and the cost of financial risk
allocation”;[66] the use of
derivatives for genuine hedging purposes would be seriously affected;
governments may have to pay higher interest charges;
the tax would have adverse
effects on investment and economic activity; and pension funds would be
burdened.[67]
As previously
outlined, discussion on a proposed FTT continues despite the negative Report
findings. In June 2011, the EC included
a EU wide FTT as part of the funding in
its long-term budget
(2014-2020).[68] The EC will put
forward a legislative proposal for the tax before the end of 2011.
The
EC indicates that a FTT is likely to be introduced in the EU by January 1, 2018
at the latest.[69] The tax will
apply to shares, bonds, and derivatives on shares and bonds. The proposed tax
rates are 0.1 percent on shares and bonds
and 0.01 percent on the derivatives of
shares and bonds. The tax base applying to derivatives is the nominal value of
the underlying
assets. The proposed tax will be levied according to the fiscal
residence of the seller of an asset (country of origin principle).
The tax is
expected to raise more than thirty billion euros by
2020[70] and up to fifty billion
euros should currency transactions be included. The revenues from the tax are to
go to the general EU budget.[71] The
proposal requires ratification by all member state to become effective. A
unanimous decision would have to be taken on the final
form of the 2014-2020 EU
budget by the Council after consulting the European Parliament. As the UK
remains firmly opposed to the
tax, it is only likely to be implemented across
the twenty-seven EC countries after a long tussle between national governments,
the
EC, and the European
Parliament.[72]
The
G-20 discussed a FTT when it considered options in 2009 to ensure the financial
sector makes a fair and substantial contribution
towards government revenues.
The summit asked the IMF to prepare a report for their meeting in June 2010.
V. IMF REPORTS
As indicated earlier, the IMF reported in two stages. A staff report in June 2010 provided summary arguments and conclusions. A later working paper by Matheson reviewed the issues more comprehensively. The staff report notes that “[e]xpecting taxpayers to support the [financial] sector during bad times while allowing owners, managers and/or creditors of financial institutions to enjoy the full gains of good times misallocates resources and undermines long-term growth.”[73] They acknowledge that many of the developed nations owed trillions of dollars in debt and funds had to be raised from the finance industry to build up reserves.
A. A Fair And Substantial Contribution By The Financial Sector: IMF Staff Final Report For The G-20
The IMF staff comprehensively reject the FTT
option and conclude that it “does not appear well suited to the specific
purposes
set out in the mandate from G-20
leaders.”[74] They indicate
that a FTT is not the best instrument because:
The
staff indicate that a FTT would not target the acknowledged attributes of
systemic risk - institution size, interconnectedness,
and
substitutability.[76] They conclude
that:
They suggest it is not obvious that the incidence would fall
mainly on either the better off or financial sector
rents.[78] A large part of the tax
burden may well be passed on to the users of financial services in the form of
reduced return to savings,
higher costs of borrowing and/or increases in final
commodity prices. They indicate that the tax incidence depends on the price
elasticities
of demand and supply, and wider competitive conditions, in the
different markets in which the tax would operate. They suggest these
relevant
elasticities are not readily observable and mostly not available for G-20
countries.[79]
The staff
argue that a weakness of the FTT is that it taxes transactions between
businesses, and as a tax levied on transactions at
one stage, it cascades into
prices at all further stages of
production.[80] They highlight
avoidance difficulties and issues associated with
swaps.[81] They conclude that
“care should be taken in assessing the potential efficiency of an FTT in
raising revenue.”[82]
The staff ultimately recommend two levies; a Financial Stability Contribution to be levied on assets and accumulated to fund future bail-outs; and a Financial Activities Tax (FAT) to be levied on financial institution’s profits and staff remuneration. They suggest a FAT be set at levels from 0.2 percent to 0.4 percent of a nation’s GDP annually.[83] They indicate that a FAT would approximate a tax on rents in the financial sector if the base included only high levels of remuneration and the profit component excludes a normal return to capital.[84] They suggest a structure that taxes excess returns would mitigate excessive risk-taking and would tend to reduce the size of the financial sector with more certainty on its impact on the structure of financial markets than an FTT.[85]
As indicated previously, some countries, including France, Germany and the
UK, have implemented levy or activity charges on their
financial sectors. The
revenue estimates for these charges are considerably less than for a global
FTT.[86] More critically, these
charges will not alter market-trading behaviour.
B. IMF Working Paper: Taxing Financial Transactions: Issues and Evidence
Matheson of the Fiscal Affairs Department at the IMF
provides more detailed discussion on the efficiency and economic effects of a
tax on traded securities.[87] He
reviews the literature on transaction costs and the potential effects on
security valuations, costs of capital, market turnover,
liquidity, price
discovery, volatility, and waste, but concedes that many efficiency factors
within capital markets and links to
economic outcomes remain largely unexplored.
We argue that the base of information from which the EC and IMF
conclusions are formulated is too narrow for real world policy decision-making.
The conclusions are generally restricted to short-term price effects evidenced
in microstructure studies by finance, economic and
accounting scholars. However,
the limitations of these studies, the theoretical and practical assumptions
underpinning them, and
their links to broader macroeconomic studies are not
explained. Moreover, the crucial links from the short-term price effects to
long-term economic and community outcomes are assumed, without acknowledgment of
the complexities around efficiency measures and
effects in markets.
Nobody denies the importance of capital costs to economic outcomes.
However, there are many uncertainties around cost of capital measures
because
they involve forward-looking analysis of “expected returns and pricing of
risk”.[88] Furthermore, there
is “no well-accepted analytical model for relating trading liquidity with
cost of equity.”[89]
1. Asset Valuation and Cost of Capital
Matheson indicates that in accordance with economic
theory, a steep decline in transaction costs over the past thirty five years has
produced an increase in financial transactions relative to real
activity.[90] He suggests that in
line with theory, the lower transaction costs have encouraged primarily
short-term trading.[91] He confirms
that most of the growth in securities trading has been concentrated in
derivative markets because these instruments typically
have lower transaction
costs relative to notional values than spot
markets.[92] Matheson concedes that
the explosion of derivatives trading, particularly for short-term security
trading, raises concerns. He admits
that the growth in derivatives trading
“implies a corresponding growth in leverage, which increases liquidity and
default risk,
and may promote asset
bubbles.”[93] He also notes
that the increasing dominance of computer generated trading poses technical and
systemic risks, particularly when these
trades are correlated or are subject to
herding behaviour, because this can potentially exacerbate price trends that are
not fundamentally
based. Matheson agrees that a tax that decreased short-term
trading could reduce these
risks.[94]
Nevertheless,
Matheson indicates that theoretical models generally confirm that higher
transaction costs, including those imposed
by transaction taxes, are associated
with lower asset prices.[95] He
suggests that investors bid prices down to compensate for the higher cost to
acquire or dispose of a security. In turn, the higher
transaction costs raise
the costs of capital for companies raising funds through taxed
securities.[96] He notes the impact
of an FTT on securities value and capital costs would be partially countered by
the lengthening of the average
holding period of securities, particularly for
securities with narrow bid-ask spreads such as the stocks of the largest
companies.[97] Accordingly, the
“overall impact of a low rate (five basis points or less) FTT on the
corporate cost of capital is ... likely
to be quite
modest.”[98]
Matheson
suggests the impact of a FTT on a company’s cost of capital depends on the
frequency of the trading in its shares,
with a FTT having far more impact on the
asset prices of securities with higher turnover such as large capitalization
stocks.[99] However, he assumes
rather than establishes the connecting links between short-term trading, asset
valuation, and cost of capital.
Security valuation is a complex process
that is affected by many variables. The securities of the largest companies are
generally
the most highly traded on a market. Any additional efficiencies
generated from marginal liquidity changes to these already relatively
liquid
securities will reflect the law of diminishing returns. The argument that ever
increasing levels of computer generated trading
for holding periods of less than
a second can infinitely improve a company’s valuation and lower its cost
of capital, is incomplete
and not really credible. These arguments overstate the
importance of marginal liquidity and transaction costs within the security
valuation process. They also downplay the market, valuation, and speculative
risks associated with the increasing churn and decline
in average holding period
of securities.[100]
In
any event, any efficiency benefits that arise from such trading must be weighed
against the longer-term effects and risks, including
the withdrawal of market
participants due to a lack of fairness and confidence in the operations of the
market; the potential for
technology or momentum induced market issues; and the
increasing market and financial system risks due to the increasing scale,
concentration,
interconnectedness and short-term focus of the global trading
environment.[101]
2. Turnover
Matheson concurs with Tobin that the imposition of a
FTT, which increases transaction costs in the form of a widening of the bid-ask
spread, discourages short-term trading in
particular.[102] By raising
transaction costs, a FTT would lengthen the average holding period of
securities, particularly those with narrow bid-ask
spreads.[103] Matheson summarises
the studies that examined the trading volume effects from higher transaction
costs as showing a broad range of
elasticities across
markets.[104]
Matheson
notes that studies on the volume effects vary across asset classes and
jurisdictions, depending largely on the opportunities
for
avoidance.[105] He cites one study
by Schmidt that found relatively low elasticity to transaction costs for trading
in the four largest currencies
(US dollar, euro, sterling and
yen).[106] The Schmidt study
finding is important, as it suggests that potential large dislocative effects
from a FTT can be minimised by applying
the tax broadly to secondary security
trading across all jurisdictions.
3. Liquidity
Matheson then considers the liquidity and price
discovery effects flowing from lower trading volumes. He highlights that a
reduction
in trading volume driven by a FTT also reduces liquidity, defined as
the price impact from a given
trade.[107] He suggests that lower
liquidity can in turn slow the price discovery process that ensures that prices
quickly and accurately reflect
new
information.[108] However,
Matheson notes that other models find the effect of a FTT on liquidity depends
on the market microstructure.[109]
The comment by Matheson that the effects of a tax on liquidity may vary
is not surprising. Liquidity effects are complex and depend
on:
Secondary market trading is essential to maintain
liquidity in traded securities. However, the tax related liquidity arguments
must
reflect real world trading patterns. Most of the increased trading activity
is in the derivatives of securities and not in the spot
markets.[110] In addition, most of
the increased trading is concentrated in the areas of the market that are
traditionally the most liquid segments
of the market, namely, the fixed income
and foreign exchange markets, and the equity securities of the largest
companies.[111] No evidence is
provided in the reports suggesting that the increased activity levels have
materially improved the liquidity of the
securities of smaller listed companies
that tend to attract lower trading levels.
Second, short-term
improvements in specified efficiency proxies may be negated over longer periods
of time. For instance, while trading
on private or inside information may in
some circumstances enhance liquidity, empirical research suggests that any
short-term liquidity
gains arising from such trading may be outweighed over the
long run by reductions in other efficiency measures such as bid-ask
spreads,[112] price accuracy and
capital costs.[113]
Third,
empirical studies indicate that liquidity responds asymmetrically to changes in
asset market values. Liquidity decreases far
more in conditions where market
returns are decreasing than in positive
markets.[114] The most significant
liquidity issues arise following large market declines because the available
collateral of market participants
is reduced and many security holders are
forced to sell, resulting in a lack of liquidity precisely when the market most
needs it.[115]
Fourth,
liquidity issues are subject to contagion. When an increased level of trading is
driven by momentum factors, those trades
are often one sided. For instance, on
May 6 2010 in the US, a large sell order of the Chicago Mercantile Exchange
S&P 500 E-mini
futures contracts and subsequent intense selling pressure
driven by algorithms quickly drained the market of buy orders and led to
a
technology induced crisis (referred to as the “flash
crash”).[116] Sustained
liquidity requires a diversity of views and willingness to trade through all
periods, particularly during negative market
conditions.
Fifth,
sustained liquidity also requires investor confidence in individual securities
and in the markets generally. The most significant
capital availability issues
and negative increases in spreads tend to arise when investor confidence is
lacking, weak or volatile.
These patterns were evident following the 1987
crash[117] and during the GFC, and
investor confidence remains fragile in most markets, suggesting the alleged
liquidity benefits resulting
from high trading levels must be assessed over full
economic cycles. Finally, it is worth highlighting again that there is “no
well-accepted analytical model for relating trading liquidity with cost of
equity.”[118]
4. Price Discovery
The empirical studies that examine the impact of
transaction costs on the price discovery process often investigate changes in
the
autocorrelation of market returns in response to changes in FTT rates. The
studies find the autocorrelation of returns increase (decrease)
with an increase
(decrease) in the rates of a FTT. The study authors infer that the identified
changes in autocorrelation of returns
mean that an FTT would slow the rate at
which new information is incorporated into the security prices by reducing the
level of trades.[119]
The
relevance of these studies to the FTT debate is not clear. Those that argue for
polices on the basis of short-term price formation
or price efficiency goals
generally assume automatic links to long-term economic gains. However, such
links are only established
when the allegedly “inefficient” prices
impact significantly on the cost of new capital. If information is not
incorporated
into a security price for a millisecond or even a few minutes or
hours, this may alter the distribution of profits between market
participants,
but is unlikely to affect the ability of a company to raise capital or its
long-term cost of capital.
5. Volatility
A FTT may affect short-term price volatility and
long-term asset price swings that potentially develop into bubbles and crashes.
Matheson
suggests that while both of these types of volatility are of concern
because they distort fundamental price signals, the long-term
mispricing is of
more concern because it can result in serious macroeconomic
externalities.[120] We agree.
i. Short-term Volatility
The theoretical models on the relationship between a
FTT and short-term price volatility are
ambiguous.[121] The empirical
investigations that consider the short-term price volatility effects of taxes
show either no effect on volatility or
a positive
effect.[122]
Most of the
cited studies assess volatility by measuring the transaction to transaction
price changes. However, the drivers of short-term
volatility are difficult to
isolate. For instance, French and Roll found that market volatility between
Tuesdays and Thursdays was
halved when the market was closed during
Wednesdays.[123] In addition,
there is some evidence that trading activity itself generates short-term price
volatility,[124] and on this
basis, a transaction tax that dampens trading activity may reduce price
volatility.
In any event, the key question for policy makers is the
exent to which volatility measures impact on the ability and cost of raising
new
capital over full economic
cycles.[125] The volatility of
most concern relates to significant momentum
overshoots[126] that contribute or
lead to sustained price swings driven by factors not related to the underlying
economic values.[127]
ii. Longer-Term Volatility
There is a dearth of research on the relationship
between transaction costs and long-term price volatility. Economic literature
generally
links bubbles and crashes to excesses in the leverage
cycle.[128] There is a growing
body of literature on measures to combat excessive leverage as a way to prevent
bubbles.[129] Matheson concedes
that a FTT may have a side effect of reducing leveraged trades, but suggests
that a more direct means to discourage
leveraged purchases would be to increase
margin requirements or
collateralisation.[130]
Nevertheless, he suggests that transaction costs are merely one factor in
determining market cycles, and not a decisive one. Indeed,
he argues that while
a FTT might slow the asset cycle swings, it could also slow corrections back to
fundamental equilibrium. While
there is empirical evidence that short-term
trading tends to focus on technical trading, a practice associated with
“noise
trading”[131]
and irrational herding
behaviour,[132] some technical
trading uses contrarian strategies and arbitrages price
movements.[133]
6. Waste
All parties seem to accept that securities trading
is a zero-sum game across a market. Some suggest that increased trading can add
value if it permits more efficient allocation of risks among
transactors.[134] However, it is
difficult to see how very short-term trades contribute to better risk
allocation. Notably it was argued leading up
to the GFC that securitization was
enhancing risk allocation, when in fact the risks were growing as they became
increasingly concentrated
within the largest financial
institutions.[135] Much of the
risk was hidden or latent which made tracking and analysis of the institutional
and systemic risk difficult.[136]
Securities trades are now transacted across many exchanges, electronic
communication networks, and broker dealers. The number of “orders
executed
in non-public trading venues such as dark pools and internalizing
broker-dealers” is
increasing.[137] The prevalence of
HFT makes it difficult and time consuming for regulators to identify the trades
and traders involved. Further,
the scale, complexity and sophistication of the
growing derivative trading and algorithmic transactions present investors with
significant
disclosure and security valuation
issues.[138] The reporting of
trading activity even within the US “often has format, compatibility and
clock-synchronization
differences.”[139] These
difficulties are compounded when trying to determine global exposures. Global
regulators are improving their systems and audit
trails in an endeavour to
better monitor trading activity and market
developments,[140] but continuing
rises in the level and complexity of trading activity make this an ongoing
challenge.
There is no doubt that secondary market
trading is essential to maintain liquidity in listed securities. However, at
some point the
level of market trading becomes inefficient from a societal
perspective because there are costs and effects associated with all
trading.[141] Many parties
highlight the decline in the cost of individual
trades.[142] However, total
revenue earned by global exchanges continues to increase, suggesting that total
transaction costs have
increased.[143] If this is the
case, social waste arises when the increased trading is not generating marginal
wealth over the full economic cycle
equivalent to the additional trading costs.
It is important from the public perspective to know which parties are bearing
the additional
trading costs and where the wealth created is flowing,
particularly if the trading developments ultimately result in systemic crises
or
losses that require taxpayer funding or that adversely impact retirement
incomes.
Global empirical studies on performance confirm that very few
individuals or institutions are able to persistently outperform the
market.[144] Consequently, some
economists describe the secondary trading process as a “quest for
rent” rather than activity that
provides returns to society on productive
assets.[145] That is, it
determines how the pie is divided rather than increasing the size of the
pie.[146] The largest financial
institutions are increasing their activity levels to potentially augment trading
profits, and their policy
advocacy of the trading cost of capital model is
aligned to this end. The recent trading patterns serve the interests of the
largest
players by enhancing their relative position and enabling them to profit
from trades with the other participants. Parties do not
trade in capital markets
primarily to enhance efficiency or the public good. Policy debates on efficiency
in markets must therefore
differentiate between the efficiencies and wealth
created for specific market participants, individual nations, and society. The
real question is the extent to which the increasing transactions are resulting
in improved long-term economic outcomes or benefits
to the broader
community.[147]
Given the
complexities of the markets and the difficulties in controlling and measuring
endogenous efficiency effects across markets
and economies, it is not possible
for empirical studies to draw a line in the sand as to the optimal level of
market trading. While
policy decision-making should be supported by empirical
evidence where possible, the limitations of controlled empirical studies
means
that many efficiency or economic effects cannot be tested or verified. Moreover,
as discussed in other fora, empirical evidence
on efficiency effects should be
cited with care.[148] Empirical
studies require defined assumptions and proxies, and the credibility and
relevance of individual studies depend on the
accuracy and relevance of the
selected models and assumptions.
The definition of the dependent
variable used in a regression model is critical to the outcome. Empirical
research efficiency proxies
are highly interdependent. Improvement in one proxy
in specified circumstances may be negated by reductions in other efficiency
measures.
As discussed earlier, studies are cited to support the argument that
the tax may impede price
discovery.[149] However, the links
from the price discovery argument to sustainable cost of capital reductions and
economic gains are not explained
or established. The purpose of most capital
market trading is to profit from information (whether obtained on a private or
public
basis) in advance of other traders. It is unlikely that
“investments made with a horizon of hours [or seconds or milliseconds]
reveal much socially beneficial information to the market
place.”[150] As previously
highlighted, if information is not incorporated into a security price for a
millisecond or even a few minutes or hours,
the distribution of profits between
market participants may change, but there is generally minimal or no impact on
the allocation
and cost of real capital.
The time period over which
efficiency is measured is also
critical.[151] Policy makers
should be most concerned with long-term effects on security prices, markets and
economies. Short-term improvements
in specified efficiency proxies may be
negated over longer periods of time. The return effects observed in studies on
transaction
costs may reflect fundamentally based market responses or over or
under reactions that are later mitigated or reversed. Event studies
use a
variety of time periods, but many are restricted to a few days or months after a
specified event. As indicated previously,
trading on private or inside
information may in some circumstances enhance short-term price accuracy and
liquidity. However, studies
suggest any efficiency gains arising from such
trading are outweighed over the long run by increases in market
volatility[152] and reductions in
other efficiency measures such as bid ask spreads, liquidity, price accuracy,
and capital costs due to reduced
transparency and lower investor confidence and
trust levels.[153]
Consequently, the efficiency and cost of capital effects need to be
assessed over a lengthy period. Over the long run, the “integrity
of our
financial markets and the public’s trust in those markets are essential to
the economic well-being of ... [a]
nation.”[154] This
proposition is starkly evident in the present environment. If the nature of a
market and the trading patterns result in the
essential “equity market
structure break[ing] down – if [the market] fails ... to provide the
necessary fairness, stability,
and efficiency – investors and companies
may [and do] pull back, raising [capital] costs and reducing
growth.”[155]
As
previously discussed, market conditions are critical to efficiency measures.
Policy makers should be most concerned by the large
negative economic and other
effects that arise during bust periods of an economic cycle. Some scholars argue
these effects are more
severe when linked to a financial
crisis.[156] The dire condition of
much of the developed world today provides compelling evidence to support these
theories and arguments.
Further study is required to assess the costs
and benefits of short-term trading and the long-term impact of such trading on
market
function, asset prices and investor confidence. Future research should
consider the following issues:
• Why is most securities trading in the form of derivative instruments rather than through the spot markets? What are the latent risks when 90 percent of global securities trading is derivative based? And are the empirical studies that examine efficiency effects in equity markets generalisable to equity derivatives and to trading in fixed income and currency markets?
• Do market participants that value and trade securities on a fundamental basis capitalise higher transaction costs into their valuations as trading levels increase? And do participants that turnover their portfolio once a year value equivalent securities significantly lower than parties who trade multiple times over a year, a week or a day? If so, is there a limit on these valuation differentials?
• Are listed companies and governments achieving sustainable improvements in capital costs because of increased turnover of the securities in the form of derivatives? And can market participants permanently increase the value of all types of traded securities because of increased trading in the form of derivatives? If so, is there a limit on such improvements?
• To what extent are securities valuations and primary issuance costs
impacted by changes in investor confidence and trust?
7. Matheson Conclusions
Matheson summarises the empirical research on FTTs as follows:
Matheson
suggests that if the impact of a FTT of two basis points reduced turnover on the
S&P 500 to the average level of 2005
(0.8 years), it would lower stock
values by 1 percent and raise the cost of capital by three basis points. He
concedes the effect
on the bond market would be lower as holding periods on
bonds are typically longer.[158]
Matheson describes the effects of a FTT beyond a reduction in trading
levels as lowering financials sector profits. He suggests that
financial firms
would likely pass the cost onto clients, imposing higher costs on financial
institutions, institutional investors,
publicly listed companies and companies
involved in cross-border trade and finance. He assumes the tax would cascade
through financial
activities and its cumulative impact on certain activities
could be substantial.[159]
Matheson concludes that while FTTs appear to “conform to the tax
policy precept of levying a low rate on a broad base, they
conflict with the
precept that, because gross transaction taxes distort production, they should
therefore be avoided when more efficient
tax instruments are
available.”[160]
8. Our Response to the Report Findings
Many of the EC and IMF arguments on the likely
impacts of the tax lack a sense of proportion. Matheson’s conclusions do
not
flow naturally from his preceding analysis and are not fully consistent with
his prior comments. As noted, long-term rather than
short-term volatility is the
primary concern related to momentum over swings and asset bubbles. In addition,
trading volume effects
show a broad range of elasticities. A small transaction
tax would not deter the use of derivative trading for genuine hedging purposes
as these transactions tend to be one-off or irregular transactions. A tax levied
against the value of the underlying asset places
most of the burden on traders
with a short time horizon rather than on pension funds. Many institutional
pension and mutual funds
aim to limit the turnover of their portfolios.
Accordingly, the impact of the tax on these investors is likely to be minimal.
As
noted earlier, reductions in security transaction costs since the 1970s have
resulted in large increases in trading activity, predominantly
in short-term
trading. Conversely a FTT would discourage this short-term trading. The smaller
the spread between the buy and sell
prices of a transaction, the higher the
impact of the tax on expected profits. As such, the tax has a more pronounced
effect on derivative
trading. Further, a tax based on the notional value of the
transaction and the cash position would discourage highly leveraged
transactions.
The reports do not explain what is meant by financial
service “production.” These arguments seem to assume that most of
the growing institutional trading is transacted on behalf of clients rather than
on a proprietary basis. However, data on the extent
of client versus proprietary
trading is not provided. Further, the alleged cascading or cumulative impacts of
a FTT are not clear.
Companies generally determine client charges based largely
on “what the market will bear” and whether existing or future
competition allows them to pass on costs. Whilst the competitive environments of
financial institutions vary markedly across the
globe, the likelihood that an
individual institution will pass on the cost of a tax or levy would depend on
the level of competition
rather than the form of the policy impost. To the
extent that institutions are unable to pass on the tax, or that the trading is
for the institution’s own account: the reported profits at the taxed
institutions would fall, the lower profit levels would
result in lower corporate
tax, and the reduced profits may result in lower employee remuneration and
employee levels[161] and a lower
payout level to investors. Nevertheless, the tax is expected to provide
significant net additional revenue.
VI. THE ADMINISTRATIVE FEASIBILITY OF A FTT
In August 2011 the IMF considered the administrative feasibility of levying a FTT.[162] It concludes that a FTT “is no more difficult and, in some respects easier, to administer than other taxes.”[163] Nevertheless, there are structural and implementation issues that require careful consideration.[164] For the tax to be technically feasible, the following issues must be determined:
1. Territorial Scope
The risk that traders will transfer their
transactions to non-taxing jurisdictions would be significantly reduced by the
introduction
of a tax across all major financial centres in a uniform
manner.[165] In the event the tax
is implemented in individual countries or zones, these territories should
consider provisions to dampen potential
offshore migration of transactions.
Measures to reduce avoidance of the tax include: applying the tax broadly to
ensure that possible
substitutes are subject to the tax; adopting a low tax
rate; conditioning the legal standing of a transaction on the payment of the
tax; and imposing a higher rate when the transactions exit a domestic
market.[166] A broadly based tax
would include “the purchase or sale of a financial instrument, an
agreement that establishes a right or
obligation to purchase or sell a financial
instrument, or an exchange of payments based on a financial instrument, rate,
index, or
an
event.”[167]
2. Taxable Event
The timing of the taxable event could be assessed on
a cash or accrual basis, or a hybrid system that combines these two methods.
Under the accrual rule, the tax applies when a person enters into a transaction.
This methodology would be appropriate for instruments
where the transaction
price is agreed (or is required to be agreed) in the
contract.[168] The cash rule
applies the tax when a transaction is settled. This approach should be used
where the transaction price is not known
until after the contract is entered
into.
3. Tax Base
The measure of the tax base could be either the
consideration exchanged or the underlying notional value of the
transaction.[169] The amount of
consideration paid for spot trades is the spot price. The appropriate tax base
for other types of transactions is more
controversial. It is possible to limit
the tax payable to the premium paid or strike price of an instrument such as a
swap, option,
futures or OTC contract. However, this option would strongly
favour and promote even greater trading of derivative and highly leveraged
instruments. If this were to occur, the potential financial system, market and
trading risks would inherently increase. It is therefore
critical that the FTT
be applied to the full notional value of derivative instruments.
4. Taxable Person
The taxable person is the party legally liable for
paying the tax. The splitting of the tax liability between counterparties is
beneficial
because this allows the relevant tax agencies to crosscheck payment
by both parties.[170] When the
trading is not executed or settled through exchanges or clearing houses, the
person taxed could be the buyer or seller,
or the broker dealer and market
participant, each of who would be liable for paying half the tax. Alternatively,
the tax could be
applied proportionately to the resident
participant.[171]
5. Assessment & Collection of the Tax
Experts agree the tax should be assessed and
collected on exchange-traded instruments through the exchanges or their
clearinghouses.[172] While the
administrative issues are more challenging when dealing with OTC instruments,
there are countries that already apply a
tax to some OTC
transactions.[173] Where OTC
instruments are not centrally cleared, the tax liability could be self-assessed,
collected and payable by the market participants
such as securities dealers and
large traders. Compliance with the tax liability could be enhanced by linking
the legal standing and
enforceability of the contract rights under the OTC
instruments to payment of the
tax.[174]
VII. RECENT FTT DEVELOPMENTS
As previously outlined, the G20 finance ministers
met for a series of meetings in Paris on October 14-15, 2011. Point four of the
Paris communique stated that:
[w]e are more determined than ever to reform the financial sector to better serve the needs of our economies. We reaffirm our commitment to implement fully, consistent and in a non-discriminatory way agreed reforms on OTC derivatives, all Basel agreements on banking regulation within agreed timelines and reducing overreliance on credit ratings. We endorsed a comprehensive framework to reduce the risks posed by [systemically important financial institutions], including strengthened supervision ...[175]
The
affirmed policy commitments are important responses within a global environment
still devastated by the impacts of financial crises.
However, the commentary on
potential financing plans is vague. Point seven of the communique indicated that
we “debated options
for innovative financing, as well as a range of
different financial taxes”. Similarly, the subsequent G20 summit
communique
simply acknowledged the initiatives in some countries “to tax
the financial sector for various purposes, including a financial
transaction
tax.”[176]
Wolfgang
Schaeuble, the German Finance Minister, stated in mid October 2011 that it was
clear there was no chance of global agreement
on the implementation of a
FTT.[177] An unnamed G20 source
indicated that opponents of a global tax included the US, the UK, Canada, India,
and Australia.[178] A
representative of the Obama Administration confirmed that the US “will
pursue levies on the financial system ‘in their
own way’, rather
than through a common global tax
plan”.[179] The UK
government has warned that it will use its veto to block the tax unless it is
levied globally. Commentators in the UK criticise
the FTT as a “tax on the
City of London”.[180] The
British finance minister George Osborne claims that there “is not a single
banker in this world that is going to pay this
tax ... The people who will pay
this tax are
pensioners”.[181] Canada
argues that its banks did not require bailing out and a FTT would be
counterproductive “by reducing banks’ ability
to lend during times
of weak economic
growth.”[182] A senior
Indian Finance Ministry official indicated that India opposes a FTT because it
would put an additional burden on the domestic
banking system. China also
suggested the tax would burden its local
banks.[183]
Within the
Eurozone, some countries have expressed concerns that the FTT may raise the
interest rates on government
loans.[184] The largest financial
industry associations claim the tax would “reap major damage to the
financial sector, resulting in an
outflow of derivatives trades from Europe
while also hitting the real
economy.”[185]
Resistance to a global tax is therefore centred on: potential adverse
impacts on financial institutions; higher government debt and
bank loan costs;
increased charges to pensioners; and negative effects on economic growth derived
from financial activity. The argument
that banks would be adversely affected or
burdened by the FTT, and as a consequence less likely to lend, is difficult to
comprehend.
The connections between the introduction of a FTT, an additional
burden on banks, and the banks’ proclivity to lend, are not
clear. The tax
would apply to secondary trading of securities and not to mortgages, bank loans
or primary capital issues.[186]
The claim that the main burden of the tax would fall on pensioners assumes that
pension fund managers are initiating most of the
short-term trades. While global
data on trading participants is limited, it is highly unlikely that managers of
long-term pension
funds are generating most of the securities transactions and
would pay a large share of the tax paid. To the extent that pension
managers are
involved in consistently high levels of short-term derivative trading, critics
might consider whether this is sound
public policy. Pensioner beneficiaries are
ultimately more likely to derive a net benefit from a FTT that encourages a
longer-term
investment horizon.
As previously discussed in B1 of Part
V of the article, the argument that increases in the level of secondary
securities trading result
in lower capital costs to primary issuers (including
governments) on an ad infinitum basis is incomplete and not fully
credible. Trading in most government securities is already highly liquid. The
key factors impacting
on governmental debt costs are the state of a
government’s finances, the ability to repay the debt, and investor
confidence
in the global and individual country environments. Any possible
benefits obtained from increased trading levels in government securities
must be
weighed against the risks of the massive capital flows moving on a millisecond
and speculative basis by means of derivative
trading, the increasing
concentration and interconnectness of these flows, and the potential loss of
investor and public confidence
in the markets.
Many parties
claim that continued increases in market and financial activity are inherently
beneficial to the local economy and in
the public interest. Such claims are
often wielded as powerful weapons to deflect policy interference or changes to
capital market
structures and trading patterns. In the post GFC environment, it
is vital that these “economic” and “public good”
assertions are tested and critiqued in their totality, particularly when made by
vested interests. Assessment of the national and
public interest effects flowing
from increased activity levels must use a wide-angled and long-sighted lens that
considers all associated
costs, including longer-term economic and other costs,
as well as the opportunity costs.
Only a portion of the value created
from the growth in global market and financial activity during the 1980s and 90s
flowed into the
real economy. Market participants such as exchanges,
clearinghouses, financial institutions, financial intermediaries, and company
registries benefited directly (and continue to benefit) from growth in
securities trading levels.[187]
These entities employed staff and advisors and paid taxes and dividends,
creating direct and indirect economic and other benefits
for the relevant
countries. Over this period, the finance industry contribution to the economic
output of many of the developed nations
grew to a significant
share.[188]
At the same
time, however, some of the value created from higher activity levels was
absorbed within the entities in the form of higher
compensation to managers,
directors and employees. For instance, rapid growth in the average compensation
paid to employees in the
financial sector in the US from the mid-2000s added
significantly to a dramatic widening of income distribution that began in the
1980s.[189]
Furthermore,
much of the contributed economic value prior to the GFC was subsequently lost in
the wake of the crisis, as direct support
to financial institutions, and as
indirect costs borne by individual countries, their taxpayers, and the broader
global community.[190] Some
parties suggest that excessive trading did not cause the
GFC.[191] However, the creation of
complex OTC derivatives, the growing levels of institutional trading on a
proprietary basis, and the willingness
of parties to leverage their trading
positions, were all interconnected factors that formed part of the crisis
framework.
Finally, it is essential to the future well being of
developed nations that policy makers consider whether the expanding capital and
other resources required to generate the increases in financial and market
activity could, and should, be applied to more productive
business
opportunities.
To summarize, those opposed to the FTT on efficiency or
economic grounds need to ask themselves: whether growth based on the rapid
turnover of derivative assets is real and in the public interest; whether the
alleged efficiency, economic and public interest benefits
are sustainable over
the long run; what longer-term costs and issues are likely to arise if the
developing market trends are allowed
to continue; and whether there are
alternate projects that would provide a better return on capital and that would
be more clearly
in the national interest? These parties should also indicate
their preferred financing options for countries or zones burdened with
excess
public debt.
The German Chancellor, Angela Merkel, has openly
criticised Barack Obama, the President of the
US,[192] and David Cameron, the
leader of the Coalition in the UK, for opposing the EU proposals for a FTT. She
indicated that it
cannot be that those outside the eurozone who press us again and again for comprehensive action are, at the same time, comprehensively working together to prevent the introduction of a financial transaction tax ... This is out of order. We must ensure that financial market actors share in the costs of fighting the crisis. I will push for this until it happens, at least in Europe but preferably worldwide.[193]
Schaeuble
confirmed that ‘[w]e have to do this in Europe and we will do this with
great energy.’[194] The EC
has publicly suggested that if Europe goes ahead with the tax, they expect other
countries will follow their lead and introduce
the
tax.[195]
Pressure on
the UK from the rest of Europe is building. Some EC representatives have
suggested a FTT should be introduced as a value
added tax, which could be
imposed without Commission ratification and the right to veto the
bill.[196] Such a move would be
strongly opposed by the UK. Should the EC ultimately fail in its attempt to
introduce a mandatory tax regime
across the twenty-seven Eurozone members, the
tax may be implemented initially in the seventeen countries that use the euro
currency.[197]
VIII. CONCLUSION
The EC and IMF staff reports imply that global
economies and the public are benefiting from increased trading levels due to
enhanced
liquidity and price discovery, which in turn leads to improved costs of
capital. This core argument is presented as a well-accepted
and soundly based
theory that accurately reflects the real world, and explains the links and
interconnections between short-term
financial variables and long-term economic
and other outcomes. However, the theoretical and empirical frameworks adopted to
support
the cost of capital model are not supported by evidence or outlined
comprehensively; the limitations of microstructure empirical
studies are not
discussed; and the crucial links and connections from the cited studies to
long-term global outcomes are assumed,
not established.
The data,
analysis, and assumptions underpinning the EC and IMF reports are too narrowly
constructed as a basis for meaningful real
world analysis. The conclusions are
based on a limited set of possible short-term financial variable effects without
sufficient understanding
or thought given to the interconnections from the
microstructure elements to the real economy outcomes as well as the public
interest
factors. The asserted positive effects from increased short-term
trading are overstated, while the potential negative impacts of
the capital
market developments are understated or ignored on the basis that there is no
empirical research confirming any adverse
long-term consequences. The adopted
analytical frameworks appear to be consistent with: a fundamental belief in the
ability of markets
to regulate themselves; a view that external regulation of
markets should be kept to a minimum; and an emphasis on short-term efficiency
or
economic factors.
We need to step back and ask whether current
financial market trading is so beneficial to global economies that we dare do
nothing
for fear it may distort market functions. Prior to the GFC, many
financiers and scholars argued that securitization processes and
the use and
trading of derivative instruments improved “efficiency” by enhancing
risk allocations among
investors.[198] However, these
efficiency arguments were shown to be incomplete and inaccurate, with
devastating economic consequences. As Erskine
suggests, the operations of the
financial sector were generally dealt with as an unpacked “black
box” within academic,
policy-making, and regulatory
circles.[199] The GFC
“showed a considerable information deficit and lack of understanding of
the economics of securities markets and the
interconnections with the broader
finance sector and the
economy.”[200] The adopted
models were constructed on narrow historical patterns without sufficient
consideration of the underlying fundamental
trends, systemic risk, and the
occurrence of significant dislocative events and
crises.[201] Whilst a review of
empirical research as part of the policy decision-making process is to be
applauded, the credibility of such analysis
is undermined when the sources are
narrowly selected, and the study’s assumptions, relevance and
uncertainties are not carefully
outlined and explained.
The real world is
far more complex than the cited microstructure studies and the trading cost of
capital model suggest. It is time
for all parties to acknowledge the immense
uncertainties and risks posed by modern financial markets and capital flows.
Efficiency
proxies as measured within a narrowly defined study may or may not
affect both the efficiency across an entire market and the efficient
allocation
of real capital.[202] Furthermore,
the marginal gains from improvements in efficiency may prove tiny compared to
the losses caused or enhanced by the emerging
capital market structures and
trading patterns.
The interconnections between human behaviour, capital
markets, economies and the global community are too uncertain, complex and
dynamic
to be fully represented in empirical or computer
models.[203] We have to use our
experience and judgment to unpack black boxes, to better understand the links
and connections to long-term real
world outcomes, and to assess systemic
financial, economic and other risks. In the real world, there are very few
perfect black box
solutions; only frameworks that may result in less flawed
outcomes than others.
Matheson acknowledges:
1. the leverage risks associated with increased derivative trading;[204]
2. the technical and systemic risks posed by computer generated trading, particularly when these trades are correlated and or subject to herding patterns; [205]
3. that long-term volatility and mispricing are of more concern than short-term effects because long-term volatility can lead to serious macroeconomic externalities;[206] and that
4. securities trading is ultimately a zero sum game and it is difficult to see how very short-term trades contribute to enhanced risk allocation.[207]
He suggests that the explosion of derivatives trading, particularly that
of short-term securities raises concerns. He notes that growth
in derivatives
trading “implies a corresponding growth in leverage, which increases
liquidity and default risk, and may promote
asset
bubbles.”[208] He admits
that the increasing dominance of computer generated trading poses technical and
systemic risks, particularly when these
trades are correlated or are subject to
herding behaviour, because this can potentially exacerbate price trends that are
not fundamentally
based. A tax that decreases short-term trading could reduce
these risks and may reduce the level of leveraged trades as a secondary
effect.
Yet these significant risks, and the potential for a FTT to mitigate these
risks, do not appear to have been taken into account
in his final conclusions on
the expected impacts of the tax.
Large financial institutions are
driving most of the growing derivative, algorithmic, and high frequency trading.
As these players
become increasingly dominant, the operations of markets are
becoming more concentrated and global in nature. Even if one accepts
the
arguments that the recent trading developments improve short-term efficiency and
market function, these benefits must be weighed
against the building systemic
risks resulting from the increasingly concentrated and interconnected trading
and capital flow exposures
within financial markets and the global
economy.[209] These significant
risks and issues cannot simply be put into a “to be researched”
basket or justified by reference to
alleged marginal liquidity and transaction
cost benefits.
The notion that “finance is an industry that exists
to serve the real economy rather than the other way
around”[210] has been
forgotten.[211] Many of the
claimed efficiency and economic benefits derived from ever increasing
transaction volumes are likely to prove largely
illusory. Arguably the trading
data provides loud warning
signals.[212] As the US Financial
Stability Oversight Council warns in its 2011 annual report, “rapid growth
in products and activities untested
by time and adversity necessarily entails
challenges and requires more care and
attention.”[213]
All
parties need to reflect more deeply on the credibility of the proposition that
capital market trading, at levels greater than
one hundred times GDP, for
holding periods of less than a second, with much of the trading driven by
computer algorithms, is benefiting
the long-term interests of the global
community. Policy makers need to ask themselves:
• Which parties are effectively controlling financial and market policy development;
• What is the primary function of such markets and who is primarily benefiting from the trading; and
• Will large sections of the population that rely on the markets for
their retirement pensions trust such markets over the long-term
or the
intermediaries that are managing their money in such environments?
Discussion around market integrity and fairness issues is notably absent
in the EC and IMF review reports. Yet the “integrity
of our financial
markets and the public’s trust in those markets are essential to the
economic well-being of ... [a]
nation.”[214] As Ronald
Arculli, Chairman of the Hong Kong Exchange suggests,
[d]evelopments that strengthen our markets and make them more effective and efficient are to be welcomed. But those that can intensify systemic risk or disadvantage a certain segment of investors to the benefit of others raise concerns ... perhaps it is time to return to basics and remind ourselves of the true function of financial markets. Computer-generated liquidity is already affecting real liquidity and altering trading activity. We run the risk of having it all just being a mathematical playground for the few to the detriment of many. A piecemeal approach seems inadequate to these vast changes. Perhaps a more fundamental reassessment of how to achieve the right balance between humans and technology in the financial field is called for. We need to focus on what really adds economic value and how to ensure market integrity and fairness.[215]
Geithner
highlights the need for the right balance between rules that protect consumers
and investors and the economy, without stifling
the competition and innovation
that drives economic growth.[216]
While few parties would disagree with this aspiration, maintaining such a
balance over entire economic cycles is notoriously difficult.
The temptation for
us all is to focus on short-term economic gains and to largely ignore the
longer-term risks and the consequences
of inaction.
Leading up to the
GFC, the Federal Reserve Governors (the Fed) saw the growth in the US subprime
market as a natural and positive
development that was allowing millions of
people to own their own homes. As late as May 2007, Chairman Bernanke indicated
that:
we believe that the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system ...
Credit market innovations have expanded opportunities for many households. Markets can overshoot, but ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit.[217]
Thus
even as evidence of abuses in the housing and mortgage sectors grew, the Fed
determined that the greater economic good or the
“net societal
benefit” was being served by allowing the subprime lending to
continue.[218] This
determination focused narrowly on the potential short-term economic gains
and significantly underestimated the longer-term risks and
costs.
Similarly, the continuing competition by developed nations to attract
financial services activity means that policy makers are strongly
tempted to
implement and support polices that promote short-term domestic economic growth,
without full consideration of the longer-term
adverse economic and other
consequences at a global
level.[219] Even if it were
possible to show that all countries would be better off by introducing a FTT,
individual countries may remain reluctant
to introduce a tax when others are
not, for fear that business will be lost to the untaxed jurisdictions.
Policymakers may prefer to rely on narrowly constructed efficiency arguments
for many reasons in making their decisions. It is all
too easy to claim there is
no evidence that market trading contributed to the GFC and no empirical evidence
of any substantive risks
flowing from the new trading environment. However, we
should all consider how few parties warned of the impending issues leading
up to
the GFC and provided hard evidence of the increasing systemic risks.
Furthermore, capital markets are constantly evolving,
and to be effective,
policy responses must adapt to changing conditions and market innovation.
Regulatory structures and reforms
will only be meaningful if they deter or
mitigate the fallout from the next financial crisis, which will almost certainly
centre
on different circumstances and factors than those leading up to the GFC.
Opponents of the tax may well argue that resolution of the debt crises
in Europe is the top priority for the G20. However, there are
no quick fix or
easy solutions to resolve the Eurozone problems. Moreover, even assuming
successful resolution of the short-term
issues. Europe and other developed
countries with high levels of public debt will still need to establish
sustainable financing mechanisms
to significantly reduce their debt ratios over
the medium to longer term.
The recent protests around the world, which
started as the “Occupy Wall Street” movement, provide a compelling
backdrop
for policy makers considering market and financial reforms, including
the introduction of a FTT.[220] On
October 17, Ban Ki-Moon the United Nations Secretary-General urged G20 leaders
to take action to “restore confidence and
trust from the people [and] from
the market”.[221] He
indicated that global leaders must look beyond domestic issues in order to
tackle the international financial crisis. We agree.
Implementation of
a global FTT would satisfy multiple policy objectives. An appropriately
structured global FTT would improve market
function and reduce system risks by
dampening or discouraging ultra short-term trading and trading of non-commercial
derivatives
and leveraged instruments. The tax could also meaningfully reduce
the sovereign debt levels and associated risk crippling many developed
nations,
and would ensure a fairer contribution from the finance industry to the public
purse.
We need to reweight our markets in favour of longer-term
investment and away from rewarding short-term
speculation.[222] A FTT:
The FTT base should be as broad as possible to
minimise avoidance issues and distortions across security classes and markets.
The
FTT should apply to all traded securities including equity, debt, currency,
and commodities. The taxed securities should include
spot and derivative
transactions through exchanges and over the counter. However, the tax should not
apply to new security issuances
or offerings or financial services provided by
financial institutions to customers.
The tax should be implemented at a low rate initially, with an agreed review period of five years. The tax should be a small impost of between 0.005 percent and 0.05 percent. Differential rates should be applied to instruments or asset classes to reflect the varying transaction costs and the extent to which the tax is intended to discourage trading in particular instruments or classes. The tax should be calculated on the notional values of the underlying security and should be adjusted for the term of the security.
The tax should be collected where possible by the relevant exchange or
central clearing house. Its collection should be designed as
a required part of
the clearing process to minimise
avoidance.[224] The cost of the
tax should be shared between the buyer and
seller.[225]
In an ideal
world, the tax would be implemented across all jurisdictions. While the
asymmetry of revenue across individual countries
may be an
issue,[226] the potential benefits
of more stable, efficient and fair global markets and financial systems provide
compelling drivers for the
successful negotiation and implementation of this
tax.
The reforms contained in the Dodd-Frank
Act,[227] comprehensive as they
are, will not fundamentally redirect market trading
behaviour.[228] The Dodd-Frank
reforms are a useful, but not sufficient, basis upon which to build markets that
promote sound capital investment
decisions and financial stability rather than
the sort of devastating volatility we have seen recently.
We urge
policy makers and regulators to act now to change the tide of capital market
behaviour, because the longer the current trends
continue, the more difficult it
will become to restore the links between markets and society, and to ensure that
capital markets
are supporting rather than destabilising world economies. Rapid
growth in the level of securities transactions has resulted in
“staggeringly
large” capital
flows[229] and the associated
market and financial system risks are mounting. “Carefully calibrated
legal and tax
infrastructure”[230] should
be established now to ensure that policy makers are not required to react at the
last minute to harmful capital
flows.[231] The introduction of a
low level global FTT as part of an integrated policy framework would promote
greater alignment between capital
market and economic activity to the real
benefit of entire economies and the people who live in them.
* Professor of International Finance Law, Faculty of Law, University of New
South Wales; Fellow, Asian Institute of International
Financial Law, University
of Hong Kong.
** Visiting Professorial Fellow, Faculty of Law, University of
New South Wales. The authors would like to thank the Australian Research
Council
for the Discovery Grant that funded some of the research, Martin North for his
invaluable feedback and Anita Wise for her
excellent research assistance. All
responsibility rests with the authors.
1 For details, see
INTERNATIONAL MONETARY FUND, FINANCIAL SECTOR TAXATION: THE IMF’S REPORT
TO THE G-20 AND BACKGROUND MATERIAL
11 Annex Table 1, Appendix 2 (2010).
[2] Many countries previously had
a financial transaction tax and a few continue to do so. See Thornton Matheson,
International Monetary Fund, Taxing Financial Transactions: Issues and
Evidence 7-8 (Working Paper WP/11/54, March
2011).
[3] As noted later in the
article, critics of the tax also highlight potential revenue asymmetries across
countries.
[4] INTERNATIONAL
MONETARY FUND, A FAIR AND SUBSTANTIAL CONTRIBUTION BY THE FINANCIAL SECTOR FINAL
REPORT FOR THE G-20 19 (June 2010),
http://www.imf.org/external/np/g20/pdf/062710b.pdf;
European Commission, Innovative Financing at a Global Level 25 (Working
Paper, SEC, 2010). Recent and ongoing regulatory reforms are likely to drive a
significant portion of market trading
previously transacted in the over-the
counter markets through formal exchanges and clearing
systems.
[5] European Commission,
supra note 4, at 23.
[6]
Jeff Salway, Banks Facing Demand for 20 bn [pd] From Robin Hood Tax
Campaign, THE SCOTSMAN, June 7, 2011,
http://thescotsman.scotsman.com/business/Banks-facing-demand-for-20bn.6780717.jp.
[7]
EUROPEAN PARLIAMENT, MEPS PUSH FORWARD PLANS FOR FINANCIAL TRANSACTIONS TAX (EN
Press Service 20110131STO12855),
http://www.europarl.europa.eu/en/headlines/content/20110131STO12855/html/MEPs-push-forward-plans-for-financial-transaction-tax.
[8]
EUROPEAN COMMISSION, THE MULTIANNUAL FINANCIAL FRAMEWORK 2014-2020: A BUDGET FOR
EUROPE 2020 (June 29, 2011), http://ec.europa.eu/commission_2010-2014/lewandowski/library/documents/pressConf_MFF_presentation_20110629_en.ppt.
See also Ralitsa Kovacheva, Pros and Cons of a European Tax on Financial
Sector, EUINSIDE.EU, November 11, 2011. Many charitable and public policy
organisations, such as Oxfam and the Gates Foundation, advocate
a global FTT in
order to raise funds for global poverty, developing country initiatives and/or
climate change programmes. The revenue
from the proposed EU tax is
included as a resource in the European budget that will reduce
Member States’ contributions. Use of some of the revenue for fighting
climate change or as development aid is under
consideration.
[9] EUROPEAN COMMISSION, PROPOSAL
FOR A COUNCIL DECISION ON THE SYSTEM OF OWN RESOURCES OF THE EUROPEAN UNION 5
(EN Press Service 2011/0183
(CNS) June 29, 2011). See also CIDSE, Analysis of
the European Commission Proposal for an EU0-Wide Financial Transaction Tax
(Briefing
Report, June 30, 2011),
http://www.cidse.org/uploadedFiles/Publications/Publication_repository/Background%20briefing%20on%20EU%20FTT%20in%20EC%202014-2020%20budget%20proposal_CIDSE_30%20June%202011.pdf;
Ian Traynor, EU Calls for “Tobin” Tax In a Move To Raise Direct
Revenue, THE GUARDIAN, June 29, 2011, http://www.guardian.co.uk/world/2011/jun/29/ec-proposes-tobin-style-taxes.
[10]
TEXT – G20 Finance Chiefs’ Communique, THOMSON REUTERS
ONLINE, October 15, 2011.
[11]
G20 Leaders Summit in Cannes: Final Communique, TELEGRAPH.CO.UK, November
6, 2011; Lesley Wroughton, G20 Fails to Endorse Financial Transaction
Tax, REUTERS.COM, November 5, 2011.
[12] Rainier Buergin,
Scaeuble Sees No Chance for Global Financial Transactions Tax, Bloomberg
online, October 15, 2011.
[13]
Parochialism Stopping Financial Transactions Tax – Schaeuble, DOW
JONES NEWSWIRES, October 17, 2011 foxbusiness.com
[14] Wroughton, supra
note 11.
[15] See Peter Martin,
New Global Financial Crisis Alert, SYDNEY MORNING HERALD, June 27,
2011,
http://www.smh.com.au/business/new-global-financial-crisis-alert-20110626-1glud.html.
[16]
See RICHARD MIDDLETON & GERRY CROSS, ASSOCIATION FOR FINANCIAL MARKETS IN
EUROPE, COMMISSION CONSULTATION ION TAXATION OF THE
FINANCIAL SECTOR
(Members’ Briefing Call, July 27, 2011). The briefing highlights an EU
comment in October 2010 that “a
financial transaction tax could be
considered at the EU level only. However, it must be borne in mind that the
financial industry
is a global and interconnected one. Financial activities are
concentrated in a small number of financial centres both inside and
outside the
EU which must compete on the world
stage.”
[17] Matheson,
supra note 2, at 19.
[18]
Stephan Schulmeister, A General Financial Transactions Tax: A Short Cut of
the Pros, the Cons and a Proposal 6 (Austrian Institute of Economic Research
Working Paper No. 344, October 2009). The volume of financial transactions in
Europe and
the US is closer to 100 times nominal gross domestic product (GDP).
[19] A derivative is a financial
instrument whose value depends on underlying
variables.
[20] Schulmeister,
supra note 18, at 5.
[21]
Zsolt Darvas & Jakob von Weizsacker, Financial Transaction Tax: Small is
Beautiful 4 (Economic and Scientific Policies, European
Parliament Working
Paper, February 2010).
[22]
Darvas & Weizsacker, supra note 21, at 5. See Timothy Canova,
Financial Market Failure as a Crisis in the Rule of Law: From Market
Fundamentalism to a New Keynesian Regulatory Model 3 HARV. L. &
POL’Y REV. 369, 388 (2009). See also, Paul Farrell, Derivatives the New
“Ticking Bomb”: Buffett and Gross Warn: $516 Trillion Bubble is a
Disaster Waiting to Happen, MARKET WATCH, March 10, 2008,
http://www.marketwatch.com/story/derivatives-are-the-new-ticking-time-bomb.
[23]
Algorithmic trading uses high-speed computer programs to generate, route and
execute orders. The Australian Securities and Investments
Commission define
algorithmic trading as “computer-generated trading activity where trading
parameters are determined by strict
adherence to a predetermined set of rules,
aimed at delivering specific execution outcomes”: AUSTRALIAN SECURITIES
AND INVESTMENTS
COMMISSION, MARKET ASSESSMENT REPORT: ASX GROUP 23
(Report 222 – November 2010). See also SECURITIES AND EXCHANGE COMMISSION,
CONCEPT RELEASE ON
EQUITY MARKET STRUCTURE 45 (17 CFR Part 242, Jan. 14, 2010);
Australian Securities and Investments Commission, Australian Equity Market
Structure ProposalS 21 (Consultation Paper 145, November 2010).
[24] Matheson, supra note
2, at 19. See also Sony Kapoor, Re-Define, Financial Transaction Taxes: Tools
for Progressive Taxation and Improving Market
Behaviour, 6 (February 2010),
http://www.oekosozial.at/uploads/tx_osfopage/ReDefine_FTTs_as_tools_for_progressive_taxation_and_improv....pdf
[hereinafter ‘Kapoor, Financial Transaction Taxes’]; Sony Kapoor,
Re-Define, The Financial Crisis – Causes and
Cures, 96 (2010),
http://re-define.org/sites/default/files/Re-Define%20Book%20The%20Financial%20Crisis%20-%20Causes%20and%20Cures%20by%20Sony%20Kapoor(1).pdf.
Kapoor highlights that a review of trading in Vodafone shares showed 90 trades
and 72 changes to the price each minute of each day
with most of this trading
generated by automatic algorithms.
[25] Matheson, supra note
2, at 19.
[26] Matheson,
supra note 2, at 19.
[27]
Some parties estimate the cancellation rate at more than 90 percent: James
Brigagliano, Co-Acting Director, Division of Trading and
Markets U.S. Securities
and Exchange Commission (SEC), Address at the Trader Forum Fall Workshop, (Oct.
8, 2009), in U.S. SECURITIES AND EXCHANGE COMMISSION, October 2009,
http://www.sec.gov./news/speech/2009/spch100809jab.htm.
[28]
Brigagliano, supra note 27. See also INTERNATIONAL ORGANIZATION OF
SECURITIES COMMISSIONS (IOSCO), REGULATORY ISSUES RAISED BY THE IMPACT OF
TECHNOLOGICAL
CHANGES ON MARKET INTEGRITY AND EFFICIENCY CONSULTATION REPORT
(July 2011).
[29] T. Williams, Oh
dear! I’m Queued! It’s Latency! (October 29, 2008),
http://www.mondovisione.com/exchanges/handbook-articles/oh-dear-im-queued-its-latency/#_ftn1.
[30]
Darvas & Weizsacker, supra note 21, at 9.
[31] Kapoor, Financial
Transaction Taxes, supra note 24, at 12. A large portion of the funding
of global hedge funds is from wealthy individuals and families. Institutions are
also
increasingly investing in hedge funds as an alternative asset class.
[32] Kapoor, Financial
Transaction Taxes, supra note 24, at
6.
[33] Kapoor, Financial
Transaction Taxes, supra note 24, at
6.
[34] Dodd–Frank Wall
Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 619, 124
Stat. 1376, 1620–1631
(2010).
[35] See BARRY
EICHENGREEN AND DONALD MATHIESON, INTERNATIONAL MONETARY FUND, HEDGE FUNDS: WHAT
DO WE REALLY KNOW? (Economic Issues No.
19, September 1999).
[36] FINANCIAL CRISIS INQUIRY
COMMISSION, REPORT 47 (January 2011). Long-term Capital Management (LTCM) was a
large hedge fund that amassed
more than $1 trillion in the notional amount of
OTC derivatives and $125 billion of securities on $4.8 billion of capital
without
the knowledge of its major derivatives counter parties or federal
regulators. Greenspan testified to Congress that LTCM’s failure
would
potentially have had systemic effects; a default by LTCM would not only have had
a significant distorting impact on market
price but also in the process could
have produced large losses, or worse, for a number of creditors and counter
parties, and for
other market participants who were not directly involved with
LTCM.
[37] IOSCO,
‘METHODOLOGY FOR ASSESSING IMPLEMENTATION OF THE IOSCO OBJECTIVES AND
PRINCIPLES OF SECURITIES REGULATION 138 (September
2011). See also IOSCO, HEDGE
FUND OVERSIGHT, CONSULTATION REPORT (March 2009); IOSCO, HEDGE FUND OVERSIGHT,
FINAL REPORT (March
2009).
[38] IOSCO, supra note
37, at 138.
[39] Kapoor,
Financial Transaction Taxes, supra note 24, at 6.
[40] Eichengreen et al,
supra note 35.
[41]
IOSCO, supra note 37, at
138.
[42] JOHN MAYNARD KEYNES,
THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY 156 (1936). Many believe
that James Tobin, an economist
who proposed a small tax on foreign currency
transactions to reduce the level of trading and volatility in exchange rate
markets,
was the initial proponent of a FTT. While there are similarities
between Tobin’s aims and arguments to alter trading behaviour
in foreign
exchange markets and those that apply to a financial transaction tax, there are
also major differences in the content
and effects of the two taxes: James Tobin,
A Proposal for International Monetary Reform, 4 EAST. ECON. J.
153 (1978).
[43] KEYNES,
supra note 42, at 156.
[44] Joseph Stiglitz, Using
Tax Policy to Curb Speculative Short-Term Trading, 3 J. FIN. SERV. RESEARCH
101, 109 (1989). See also Lawrence Summers & Victoria Summers, When
Financial Markets Work Too Well: A Cautious Case For a Securities Transaction
Tax, 3 J. FIN. SERV. RESEARCH 261, 263 (1989). Summers & Summers express
concerns about excessive volatility in markets caused by
destabilising
speculation, the diversion of human and capital resources away from more
socially profitable pursuits into the financial
sphere, and the impact of rapid
financial turnover on the way in which corporate investment decisions are made.
[45] Re-Define describes itself
as a non-partisan international Think Tank that advises key policy-makers on
reforming the financial system,
formulating economic policy, improving
governance and driving sustainable development. The Re-Define Advisory and
Expert Committee
includes: Sony Kapoor; Vinash Persaud, former Managing Director
State Street Bank, head of Research UBS, Chairman of Intelligence
Capital;
Henrik Enderlien, Prof Political Economy and Assoc Dean at the Hertie School of
Governance; John Fullerton, President Capital
Institute and ex Managing
Director, JP Morgan; Stephen Spratt, Research Fellow, IDS Sussex; Perry Mehling,
Prof of Economics, Barnard
College, Columbia University; Amit Seru, Asst Prof of
Finance, University of Chicago; Sebastian Dullien, Co-Director, Centre for
Excellence on Money, HTW Berlin; Simon Pak, Assoc Prof of Finance, Penn State
University; Thorsten Beck, Prof Economics, University
of Tilburg; Michael
Hoffman, former Director General, German Development Ministry, currently
Executive Director World Bank; Rob Johnson,
former Managing Director, Soros Fund
Management, and Chief Economist Senate Banking Committee; Damon Silvers, Member,
Congressional
Oversight Panel on TARP and Head of Policy, AFL-CIO; Chris Rose,
former Vice President Goldman Sachs and COO of several Hedge Funds;
Jose Antonio
Ocampo, former Under Secretary General of the UN, currently Professor Columbia
University; Stephanie Griffiths Jones,
Director Institute for Policy Dialogue,
Columbia University; Meenoo Kapoor, former Director of Finance & Financial
Controller
at several MNCs operating in India; Patrick Diamond, Research Fellow
University of Oxford; Richard Werner, Chair Empirical Macroeconomics,
Goethe
University Frankfurt; Mike Masters, Managing Member Masters Capital and Founder
Better Markets; Robert Wade, Professor of
Development Studies, London School of
Economics; David Webb, Head of the Finance Department, London School of
Economics, available at:
http://www.re-define.org/about-us.
[46]
See Center for Economic and Policy Research, Support for A Financial
Transactions Tax (FTT), (Jan. 2010),
http://www.cepr.net/documents/ftt-support.pdf.
[47]
Stiglitz, supra note 44, at 109; Summers & Summers, supra note
44, at 270; Dean Baker, Center for Economic and Policy Research, The Benefits
of a Financial Transaction Tax (Dec. 2008),
http://www.cepr.net/documents/publications/financial-transactions-tax-2008-12.pdf;
Margaret Blair, Financial Innovation and the Distribution of Wealth and
Income 29 (Vanderbilt University Law School, Working Paper 10-32, June
2010); FINANCIAL CRISIS INQUIRY COMMISSION, supra note 36, at 64-65.
[48] COMMISSION OF EXPERTS OF
THE PRESIDENT OF THE UN GENERAL ASSEMBLY ON REFORM OF THE INTERNATIONAL MONETARY
AND FINANCIAL SYSTEM, REPORT
OF THE COMMISSION 47 (September 21, 2009).
[49] Angela Monaghan, Tax
“Socially Useless” Banks, Says FSA Chief Lord Turner, THE
TELEGRAPH, August 27, 2009,
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6097420/Tax-socially-useless-banks-says-FSA-chief-Lord-Turner.html.
[50]
Adair Turner, Address at the City Banquet, The Mansion House, London (September
22, 2009).
[51] Heather Stewart,
World Economists Urge G20 Ministers to Accept Robin Hood Tax, GUARDIAN,
April 13, 2001,
http://www.guardian.co.uk/business/2011/apr/13/world-economists-robin-hood-tax.
The signatories are available
at
http://www.scribd.com/fullscreen/52919705.
[52]
The letter is available at
http://www.guardian.co.uk/business/2011/apr/13/robin-hood-tax-economists-letter.
[53]
See, eg, International Monetary Fund, supra note 4; European Commission,
supra note 4. See also Financial Services Authority, The Turner
Review: A Regulatory Response To The Global Banking Crisis (March 2009)
<http://www.fsa.gov.uk/pubs/other/turner_review.pdf>
.
[54]
European Commission, supra note 4, at
15-16.
[55] European Commission,
supra note 4, at 23. The European Commission Report notes that the
effects of a decline in transactions and liquidity remain subject to
debate and
suggests these effects may depend on the microstructure of markets. It cites the
following studies: Katiuscia Mannaro
et. al., Using an Artificial Financial
Market for Assessing the Impact of Tobin-like Transaction Taxes, 67 J. ECON.
BEHAV. & ORG. 445 (2008); Paolo Pellizzari & Frank Westerhoff, Some
Effects of Transaction Taxes under Different Microstructures (Quantitative
Finance Research Centre Research Paper 212, University of Technology Sydney,
December 2007).
[56] European
Commission, supra note 4, at
23.
[57] European Commission,
supra note 4, at 24.
[58]
European Commission, supra note 4, at
24.
[59] European Commission,
supra note 4, at 25.
[60]
European Commission, supra note 4, at
25-26.
[61] European Commission,
supra note 4, at 24.
[62]
European Commission, supra note 4, at 26.
[63] European Commission,
supra note 4, at 22.
[64]
European Commission, supra note 4, at
24.
[65] European Commission,
supra note 4, at 24.
[66]
European Commission, supra note 4, at
24.
[67] European Commission,
supra note 4, at 24.
[68]
EUROPEAN COMMISSION, supra note 8.
[69] EUROPEAN COMMISSION,
supra note 9, at 5.
[70]
EUROPEAN COMMISSION, supra note 9, at
5.
[71] EUROPEAN COMMISSION,
supra note 9, at 5.
[72]
Quentin Peel & Gerritt Wiesmann, Schauble Calls for EU Lead on Tobin
Tax, FT.COM, October 31, 2011; Robert Preston, How Scary is a Financial
Transaction Tax?, BBC News, BBC.CO.UK, October 10, 2011. The German Finance
Minister, Wolfgang Schauble, has indicated that if agreement cannot be
reached
between the 27 eurozone countries, the EC will consider introducing it initially
in some member states.
[73]
INTERNATIONAL MONETARY FUND, supra note 4, at 9.
[74] INTERNATIONAL MONETARY
FUND, supra note 4, at
19.
[75] INTERNATIONAL MONETARY
FUND, supra note 4, at
19-20.
[76] INTERNATIONAL
MONETARY FUND, supra note 4, at
19.
[77] INTERNATIONAL MONETARY
FUND, supra note 4, at
20.
[78] INTERNATIONAL MONETARY
FUND, supra note 4, at
20-21.
[79] INTERNATIONAL
MONETARY FUND, supra note 4, at
58.
[80] INTERNATIONAL MONETARY
FUND, supra note 4, at
21.
[81] INTERNATIONAL MONETARY
FUND, supra note 4, at
21.
[82] INTERNATIONAL MONETARY
FUND, supra note 4, at
21.
[83] INTERNATIONAL MONETARY
FUND, supra note 4, at 5,
14.
[84] INTERNATIONAL MONETARY
FUND, supra note 4, at 4,
22.
[85] INTERNATIONAL MONETARY
FUND, supra note 4, at
23.
[86] Matheson, supra
note 2, at 10-11.
[87]
Matheson, supra note 2. Matheson defines a financial transaction tax on
page 5 as a “securities transaction tax that applies to all or certain
types of securities (equity, debt and their
derivatives).”
[88] SHANNON
PRATT & ROGER GRABOWSKI, COST OF CAPITAL: APPLICATIONS AND EXAMPLES 4
(4th ed. 2010).
[89]
MICHAEL EHRHARDT, THE SEARCH FOR VALUE MEASURING THE COMPANY’S COST OF
CAPITAL 126 (1994).
[90]
Matheson, supra note 2, at 19.
[91] Matheson does not explain
the economic theory he refers to.
[92] Matheson, supra note
2, at 19.
[93] Matheson,
supra note 2, at 20.
[94]
Matheson, supra note 2, at
19-20.
[95] Matheson,
supra note 2, at 14-15. Matheson cites the following studies: JULIAN
MCCRAE, THE IMPACT OF STAMP DUTY ON THE COST OF CAPITAL (Institute
for Fiscal
Studies mimeo, 2002); Steven Umlauf, Transaction Taxes and the Behaviour of
the Swedish Stock Market, 33 J. FIN. ECON. 227 (1993) (Umlauf found the
Swedish market declined by 5.3 percent in the 30 days prior to the imposition of
a
one percent tax on equity trades tax in 1983); Shing-yang Hu, The Effects
of the Stock Transaction Tax on the Stock Market – Experience from Asian
Markets, 6 PAC. BASIN FIN. J. 347 (1998)(Hu found a 23 percent
increase in transaction costs across various Asian markets caused a one percent
decline in daily market returns); OXERA, STAMP DUTY: ITS IMPACT AND THE BENEFITS
OF ITS ABOLITION (May 2007)(Oxera estimates that
the abolition of the 0.5
percent stamp duty in the UK would increase share prices by 7.2 percent and
reduce the cost of capital by
66-80 basis points); G. William Schwert & Paul
Seguin, Securities Transaction Taxes: An Overview of Costs, Benefits and
Unresolved Questions, 49 FIN. ANAL. J. 27 (1993)(Schwert and Seguin estimate
that a 0.5 percent FTT in the US, a tax 10 times higher than the one commonly
considered, would increase cost of capital by 10-180 basis points).
[96] Matheson, supra note
2, at 14. Matheson notes that investors place a valuation premium of 20-25% on
publicly traded firms in comparison to illiquid
privately held companies. This
example is the most extreme possible in terms of the comparative liquidity of
securities.
[97] Matheson,
supra note 2, at 14. In 2009, the average holding period for stocks in
the Standard and Poors 500 stock index was three and a half months,
down from 20
months in 1990.
[98] Matheson,
supra note 2, at 115-16.
[99] Matheson, supra note
2, at 15. Matheson cites the following studies: Steve Bond et al., Stamp Duty
on Shares and its Effect on Share Price (Institute for Fiscal Studies,
London Working Paper WP04/11, 2004)(by Bond et al that found that a 50 percent
cut in stamp duty in
the United Kingdom in 1986 resulted in higher price
increases in the shares with higher turnover); G. AUTEN & T. MATHESON, THE
MARKET IMPACT AND INCIDENCE OF A SECURITIES TRANSACTION TAX: THE CASE OF THE
U.S. SEC LEVY (2010) (Auten and Matheson found evidence
that a low rate
transaction tax levied by the United States (US) Securities and Exchange
Commission reduced trading in only the largest,
most liquid US Equities).
Matheson suggests these study results support the finding by Amihud and
Mendelson’s that investors
specialise in trading assets suited to their
time horizons: Yakov Amihud & Haim Mendelson, Asset Pricing and the
Bid-Ask Spread, 17 J. FIN. ECON. 223 (1986).
[100] John Pender,
Incentive Structures Still Favour Risk-Taking, FT.COM, October 25, 2011.
Pender points out that most fund managers are subject to three-moth performance
measures encouraging them
to resort to herding and momentum trading to minimise
their own business and career risks.
[101] See, e.g. STAFFS OF
THE CFTC AND SEC TO THE JOINT ADVISORY COMMITTEE ON EMERGING REGULATORY ISSUES,
FINDINGS REGARDING THE MARKET
EVENTS OF MAY 6, 2010 (September 30,
2010).
[102] Matheson,
supra note 2, at 13.
[103] Matheson, supra
note 2, at 13-14.
[104]
Matheson, supra note 2, at 17-18. The studies calculate elasticities
relating to changes in taxes, bid-ask spreads and total transaction costs.
[105] Matheson, supra
note 2, at 18.
[106] RODNEY
SCHMIDT, THE CURRENCY TRANSACTION TAX: RATE AND REVENUE ESTIMATES (Oct. 2007).
In contrast, studies on the FTT in Sweden found
a massive shift in trading
volumes because of the high tax rate and narrow base of the Swedish market:
Umlauf, supra note 95.
[107] Matheson, supra
note 2, at 16, citing Amihud & Mendelson, supra note 99; Paul
Kupiec, Noise Traders, Excess Volatility, and a Securities Transaction
Tax, 10 J. FIN. SERV. RESEARCH 115
(1996).
[108] Matheson,
supra note 2, at 16, citing Kenneth Froot & Andre Perold, New
Trading Practices and Short-Run Market Efficiency, 15 J. FUTURES MARKETS 731
(1995); Alex Frino & Andrew West, The Impact of Transaction Costs on
Price Discovery: Evidence from Cross-Listed Stock Index Futures Contracts,
11 PAC. BASIN FIN. J 139
(2003).
[109] Matheson,
supra note 2, at 16, citing Avanidhur Subrahmanyam, Transaction Taxes
and Financial Market Equilibrium, 71 J. BUS. 81 (1998); Dominique Dupont
& Gabriel Lee, Effects of Securities Transaction Taxes on Depth and
Bid-Ask Spreads (2007) 31 ECON. THEORY
393.
[110] Schulmeister,
supra note 18, at 5; Matheson, supra note 2, at 19.
[111] See, eg, Darvas &
Weizsacker, supra note 21, at 5; Matheson, supra note 2, at
15-16.
[112] The bid-ask spread
is the amount by which the ask price exceeds the bid. More specifically, it is
the difference in price between
the highest price that a buyer is willing to pay
for an asset and the lowest price for which a seller is willing to sell it.
[113] Bradford Cornell &
Erik Sirri, The Reaction of Investors and Stock Prices to Insider
Trading, 47 J. FIN. 1031, 1055 (1992); Raymond Fishe & Michael
Robe, The Impact of Illegal Insider Trading in Dealer and Specialist Markets:
Evidence From a Natural Experiment, 71 J. FIN. ECON. 461, 461-462, 481
(2004).
[114] Allaudeen Hameed
et al., Stock Market Declines and Liquidity, 65 J. FIN. 257, 291
(2010).
[115] Hameed et al.,
supra note 114, at
291.
[116] STAFFS OF THE CFTC
AND SEC TO THE JOINT ADVISORY COMMITTEE ON EMERGING REGULATORY ISSUES, FINDINGS
REGARDING THE MARKET EVENTS OF
MAY 6, 2010, supra note 101.
[117] Summers & Summers,
supra note 44, at
274.
[118] EHRHARDT,
supra note 89, at
126.
[119] Matheson,
supra note 2, at 18, citing Shinhua Liu, Securities Transaction Tax
and Market Efficiency: Evidence from the Japanese Experience, 32 J. FIN.
SERV. RESEARCH 161 (2007); Badi Baltagi et al., Transaction Tax and Stock
Market Behaviour: Evidence from an Emerging Market, 31 EMPIRICAL ECONOMICS
393 (2006).
[120] Matheson,
supra note 2, at 20.
[121] Matheson, supra
note 2, at 20. Matheson cites J Bradford De Long et al., Noise Trader Risk in
Financial Markets, 98 J. POL. ECON. 703 (1990); Kenneth Froot et al.,
Herd on the Street: Informational Inefficiencies in a Market with Short-Term
Speculation, 47 J. FIN. 1461 (1992); Frank Song & Junxi Zhang,
Securities Transaction Tax and Market Volatility, 115 ECON. J 1103
(2005); Pellizzari & Westerhoff, supra note 55.
[122] Matheson, supra
note 2, at 21. Matheson cites Richard Roll, Price Volatility, International
Market Links, and Their Implications for Regulatory Policies, 3 J. FIN.
SERV. RESEARCH 211 (1989) (Roll found no consistent relationship between
transaction costs and volatility across 23 countries);
Baltagi et al.,
supra note 119 (Baltagi and others found that a FTT in China had no
impact on volatility); Charles Jones & Paul Seguin, Transaction
Costs and Price Volatility: Evidence from Commission Deregulation, 87 AM.
ECON. REV. 728 (1997) (Jones and Seguin found that stock commission deregulation
in the US led to a decline in transaction costs and decreased price
volatility);
Harold Hau, The Role of Transaction Costs for Financial Volatility: Evidence
from the Paris Bourse, 4 J. EUR. ECON. ASS’N 862 (2006) (Hau found
that a reduction in the tick price lead to a fall in volatility); Christopher
Green et al., Regulatory Lessons for Emerging Stock Markets from a Century of
Evidence on Transaction Costs and Share Price Volatility in the London
Stock Exchange, 24 J. BANKING & FIN. 577 (2000) (Green and others found
that increases in stamp duty in the UK generally led to higher short-term
price
volatility).
[123]
Kenneth French & Richard Roll, Stock Return Variances, 17 J. FIN.
ECON. 5 (1986).
[124] Matheson,
supra note 2, at 21. Matheson cites French et al., supra note 123.
[125] When there is extensive
short-term trading, a change in a security price from 99 to 100 may involve many
trades at minute
increments.
[126] Kapoor,
Financial Transaction Taxes, supra note
24.
[127] Robert Pollin et al.,
Securities Transaction Taxes for U.S. Financial Markets, 29 EASTERN ECON.
J. 527, 533 (2003). Pollin et al argue that market volatility is influenced by
three partially independent influences:
the underlying behaviour of the
nonfinancial economy; the herd behaviour of financial market participants; and
the attempt by participants
to dig out of financial crises once they have
already occurred. They suggest that a FTT should moderate the first two sources
of
volatility through a decline in liquidity, while the third source would be
exacerbated by a decline in liquidity.
[128] See, eg, Franklin Allen
& Douglas Gale, Bubbles and Crises, 110 ECON. J. 236 (2000);
Gadi Barlevy, A Leverage-based Model of Speculative Bubbles (Federal
Reserve Bank of Chicago, Working Paper No. 2008-01, Aug. 28, 2009).
[129] Matheson, supra
note 2, at 21. Matheson cites Allen & Gale, supra note 128; CARMEN
REINHART & KENNETH ROGOFF, THIS TIME IS DIFFERENT: EIGHT CENTURIES OF
FINANCIAL FOLLY (2009); GEORGE AKERLOF
& ROBERT SHILLER, ANIMAL SPIRITS: HOW
HUMAN PSYCHOLOGY DRIVES THE ECONOMY, AND WHY IT MATTERS FOR GLOBAL CAPITALISM
(2008); Tobias
Adrian & Hyun Song Shin, The Shadow Banking System:
Implications for Financial Regulation, 13 FIN. STABILITY REV. 1 (2009);
Barlevy, supra note 128; John Geankoplos, Solving the Present Crisis
and Managing the Leverage Cycle (Cowles Foundation Discussion Paper No 1751,
Yale University, January 2010).
[130] Matheson, supra
note 2, at 22.
[131] Matheson,
supra note 2, at 22. Matheson cites Thomas Gehrig & Lukas Menkhoff,
Extended Evidence on the Use of Technical Analysis in Foreign Exchange,
11 INT’L J. FIN. ECON. 327 (2007).
[132] Matheson, supra
note 2, at 22. Matheson cites Froot et al., supra note 121.
[133] Matheson, supra
note 2, at 22.
[134] See
Matheson, supra note 2.
[135] See, e.g. FINANCIAL
CRISIS INQUIRY COMMISSION, supra note 36.
[136] FINANCIAL CRISIS INQUIRY
COMMISSION, supra note 36, at
xxi.
[137] Mary Schapiro,
“US Equity Market Structure” 11 (Testimony Before the Subcommittee
On Securities, Insurance, and Investment
of the United States Senate Committee
on Banking, Housing, and Urban Affairs and the United States Senate Permanent
Subcommittee
on Investigations, December 8 2010); Australian Securities and
Investments Commission, Australian Equity Market Structure Report 215 91
(November 2010).
[138]
EICHENGREEN & MATHIESON, supra note
35.
[139] Schapiro,
supra note 137, at
7.
[140] See, eg, IOSCO, REPORT
ON OTC DERIVATIVES DATA REPORTING AND AGGREGATION REQUIREMENTS CONSULTATIVE
REPORT 26 (August 2011); Schapiro,
supra note 137. The IOSCO Report
confirms at page 26 that there is an international effort underway to promote a
consistent international
framework for the regulation of OTC derivatives
transactions, based on cooperation between national authorities. This
framework includes efforts to aggregate OTC derivatives data. Schapiro indicates
that the SEC is focused
on obtaining the tools and resources necessary to better
surveil trading, inspect regulated entities, and enforce the rules in
today’s
highly automated, high speed and high volume markets.
[141] Monaghan, supra
note 49.
[142] See, eg,
Matheson, supra note 2, at 19.
[143] WORLD FEDERATION OF
EXCHANGES, 2009 COST AND REVENUE SURVEY 2 (Oct.
2010).
[144] See, e.g., Mark
Carhart, On Persistence in Mutual Fund Performance, 52 J. FIN. 57 (1997);
Jeffrey Busse et al., Performance and Persistence in Institutional Investment
Management, 65 J. FIN. 765 (2010).
[145] Stiglitz, supra
note 44, at 109.
[146]
Stiglitz, supra note 44, at 103.
[147] Darvas & Weizsacker,
supra note 21, at 5.
[148] Gill North & Ross
Buckley, A Fundamental Re-examination of Efficiency in Capital Markets in
Light of the Global Financial Crisis[2010] UNSWLawJl 30; , 33 UNSW L. J. 714
(2010).
[149] See Part V
section B 4 of the article.
[150] Summers & Summers,
supra note 44, at
272.
[151] Marcel Kahan,
Securities Law and the Social Costs of “Inaccurate” Stock
Prices, 41 DUKE L.J. 977, 981, 987 994-1043 (1992).
[152] Julian Du &
Shang-jin Wei, Does Insider Trading Raise Market Volatility?, 114 ECON.
J. 916, 916, 940, 940
(2004).
[153] Cornell &
Sirri, supra note 113, at 1055; Fishe & Robe, supra note 113,
at 461-462, 481. See also Utpal Bhattacharya et al., The World Price of
Earnings Opacity, 78 ACCOUNTING REV. 641 (2003); Laura Beny,
Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence, 7
AM. L & ECON. REV. 144 (2005); Laura Beny, Insider Trading Law and Stock
Markets Around the World: An Empirical Contribution to Theoretical Law and
Economics Debate, 32 J. CORP. L. 237
(2007).
[154] FINANCIAL CRISIS
INQUIRY COMMISSION, supra note 36, at xxii.
[155] Schapiro, supra
note 137, at 2-3. See also Gill North, Structural Developments in Global
Capital Markets: Promoting Efficiency or A Risky & Unstable Mathematical
Playground? (Working Paper, UNSW, September
2011).
[156] See, e.g. Heather
Stewart, Without a Return to Growth, the Western Economies, SYDNEY
MORNING HERALD, July 4, 2011, at 8. Stewart cites Robert
Shiller.
[157] Matheson,
supra note 2, at 37.
[158] Matheson, supra
note 2, at 38. The assumptions and methodologies underlying these conclusions
are not provided.
[159]
Matheson, supra note 2, at 37.
[160] Matheson, supra
note 2, at 5.
[161] Umlauf,
supra note 95.
[162]
John Brondolo, Taxing Financial Transactions: An Assessment of Administrative
Feasibility (August
2011).
[163] Brondolo, supra
note 162, at 5.
[164]
Brondolo, supra note 162, at 5-6. The IMF paper highlights the challenges
linked to: constant innovation in financial instruments, potentially allowing
opportunities for tax avoidance; the continuing growth in the volume of
financial transactions; and the increasing globalisation
of financial
markets.
[165] Brondolo,
supra note 162, at
45.
[166] Brondolo,
supra note 162, at 18. For example, the UK stamp tax is chargeable on a
transaction carried out either in the UK or overseas. To ensure
some tax is
collected on the international transactions, a higher rate of 1.5 percent is
imposed when shares enter a depositary receipt
issuer arrangement or a clearance
service system.
[167] Brondolo,
supra note 162, at
12.
[168] Brondolo,
supra note 162, at
12-13.
[169] Brondolo, supra
note 162, at 13-14, 27. The notional value is the value of a derivative's
underlying assets at the spot price. For instance, in the
case of an options or
futures contract, it is the number of units of an asset underlying the contract,
multiplied by the spot price
of the
asset.
[170] Brondolo,
supra note 162, at 13-14.
[171] Brondolo, supra
note 162, at 26, 28.
[172]
Brondolo, supra note 162, at
13-14.
[173] For example,
Switzerland levies a stamp transfer tax on financial instruments including some
OTC instruments. This tax is collected
through securities dealers including
broker-dealers, banks and companies with significant security holdings on their
balance sheet.
[174] Brondolo,
supra note 162, at 30.
[175] TEXT – G20
Finance Chiefs’ Communique, supra note
10.
[176] G20 Leaders Summit
in Cannes: Final Communique, supra note 11; Wroughton, supra
note 11.
[177] Mike
Peacock, G20 Discuss Transaction Tax, Little Hope of Progress, THOMSON
REUTERS ONLINE, October 14, 2011. See also Rebecca Christie, US, EU to Pursue
Bank Levies in “Their Own Way,” U.S. Says, BLOOMBERG, November
3, 2011. George Osbourne, the Chancellor of the Exchequer in the United Kingdom,
also confirmed that the necessary
international consensus does not exist to
implement a tax globally.
[178] Peacock, supra
note 177.
[179] Christie,
supra note 177. See also Wroughton, supra note 11. The White House
deputy national security adviser Michael Forman told reporters in Paris that
President Obama shares the
objectives that Chancellor Merkel and President
Sarkozy have in ensuring that the financial sector contributes an appropriate
share
to the resolution of the crisis. However, the Administration has proposed
one approach to that, through the financial crisis responsibility
fee. The
Europeans have another approach. But see Melanie Waddell, Lawmakers Push
Financial Transaction Tax as Deficit Deadline Nears, ADVISORONE, November
11, 2011. Two Democratic representatives in the US, Senator Tom Harkin and
Representative Peter De Fazio, have
introduced a bill (the Wall Street Trading
and Speculators Tax Act introduced November 2, 2011) to impose a financial
transaction
tax. They point out in a letter to the Joint Select Committee on
Deficit Reduction that the tax would raise over $40 billion annually.
[180] Louise Armistad,
European Politicians Plot to Block UK Veto on “Tobin Tax”,
TELEGRAPH.CO.UK, October 6
2011.
[181] Kovacheva, supra
note 8. Osborne indicates that he introduced a bank levy in the United
Kingdom because this is a tax paid by the banks and their shareholders.
However,
as noted in Part V section 8 of this article, the ability of the banks to pass
on the cost of either a levy or tax to their
customers depends on market
conditions and competitive factors.
[182] EU Calls for Global
Tax, Canada Says Can Block It, THOMSON REUTERS, October 5,
2011.
[183] Kavaljit Singh,
Amidst Backdrop of #OWS Protest, Group of 20 (G20) Defers Decision on a
“Global Financial Transaction Tax”
(FTT), GLOBAL RESEARCH.CA,
October 17, 2011.
[184] EU
Calls for Global Tax, Canada Says Can Block It, THOMSON REUTERS,
October 5, 2011
[185] Andrew
Hickey, Industry Urges Osborne to Quash FTT Talk, Global Financial
Strategy, GFSNEWS.COM, October 25,
2011.
[186] Perhaps these
parties are suggesting that the profits gained from proprietary trading are
required to sustain the required capital
base of the commercial banks – a
problematic proposition given the risks inherent in the trading.
[187] These entities will
naturally oppose policy measures that might restrict or reduce future growth and
profits.
[188] See, eg,
FINANCIAL CRISIS INQUIRY COMMISSION, supra note 36, at 64-65. The
Financial Crisis Inquiry Commission Report and scholars highlight that from the
1980s the financial sector
in the US grew much faster than the general economy
– rising from about 5% of gross domestic product to around 8% in 2007.
In
addition, financial sector profits grew from around 15% of corporate profits in
1980 to a peak 33% in 2003 and around 27% in 2006.
[189] FINANCIAL CRISIS INQUIRY
COMMISSION, supra note 36, at 62-63. See also Blair, supra note
47; James Politi, Income of Richest US Households Soars, FT.COM, October
25, 2011. In October 2011, a non-partisan US Congressional Budget Office report
indicated that after-tax household
incomes grew by 275 percent for the richest 1
percent between 1979 and 2007. In contrast, after-tax income rose 65 percent for
the
top 20 percent of Americans, less than 40 percent for the top 60 percent,
and 18 percent for the poorest 20 percent.
[190] See, eg, INTERNATIONAL
MONETARY FUND, supra note 4, at 32-36. The IMF Report outlines the
amounts provided by governments as direct support to the financial sector during
2009.
The Report also estimates the associated economic costs.
[191] European Commission,
supra note 4, at
24.
[192] See, eg, David Gow,
Germany and Spain Hit Back at Critics of Eurozone Debt Strategy,
GUARDIAN.CO.UK, October 14 2011; Mark Schoeff Jr. Financial Transaction Tax
Maybe on Senate’s Agenda, PENSION & INVESTMENTS, October 25, 2011
available at
http://www.pionline.com/article/20111025/REG/111029951/financial-transactions-tax-maybe-on-senate8217s-agenda.
The reasons for the US’s opposition to the FTT are not clear.
[193] Gow, supra note
192. Merkel was speaking at a conference of the engineering trade union IG
Metall in Karlsruhe.
[194]
Buergin, supra note
12.
[195] Parochialism
Stopping Financial Transactions Tax – Schaeuble, DOW JONES NEWSWIRES,
October 17, 2011 foxbusiness.com
[196] Louise Armistad,
European Politicians Plot to Block UK Veto on “Tobin Tax”,
TELEGRAPH.CO.UK, October 6
2011.
[197] Peel et al,
supra note 72; Peacock, supra note 177.
[198] See, e.g. FINANCIAL
CRISIS INQUIRY COMMISSION, supra note 36, at xxi, 52.
[199] Alex Erskine, Australian
Securities and Investments Commission, Rethinking Securities Regulation After
the Crisis: an Economics Perspective 9 (Working Paper, July 9,
2010).
[200] Erskine,
supra note 199, at
4-5.
[201] REINHART &
ROGOFF, supra note 129. The Reinhart and Rogoff book discusses financial
crises over the last four centuries. They award their booby prize to the
theorists who argued prior to the GFC that their models indicated that US
foreign assets were actually far larger than the official
estimates.
[202] Most of the regression
based empirical research, which examines specific efficiency characteristics and
determinants, does not comment
on efficiency effects across an entire market or
economy because of the difficulties or dangers in dong so. The endogeneity of
the
variables means that tests designed to measure efficiency determinants over
the entire market are inherently ambiguous. That is,
the efficiency proxies are
interrelated and it is often not possible to accurately separate out and
“test” for all efficiency
effects across a full market on a
controlled basis.
[203] See
FINANCIAL CRISIS INQUIRY COMMISSION, supra note 36, at 44. The Financial
Crisis Inquiry Commission Report notes that the “increasing dependence on
mathematics let the
quants create more complex products and let their managers
say, and maybe even believe, that they could better manage those product’s
risks ... But models relied on assumptions based on limited historical data...
the models would turn out to be woefully inadequate.
And modelling human
behaviour was different from the problems the quants had addressed in graduate
school.”
[204] Matheson,
supra note 2, at
20.
[205] Matheson,
supra note 2, at
20.
[206] Matheson,
supra note 2, at
20.
[207] See Matheson,
supra note 2, at
20.
[208] Matheson,
supra note 2, at 20.
[209] See, e.g. US FINANCIAL
STABILITY OVERSIGHT COUNCIL, ANNUAL REPORT 91
(2011).
[210] See, e.g.
Lawrence Mitchell, The Morals of the Marketplace: A Cautionary Essay for Our
Time, 20 STAN. L & POL’Y REV. 171, 192
(2009).
[211] Major reviews of
the GFC conclude that the crisis was due to human error and that actions could
have been taken to prevent or to
mitigate the negative effects. See, e.g.
FINANCIAL CRISIS INQUIRY COMMISSION, supra note
36.
[212] FINANCIAL CRISIS
INQUIRY COMMISSION, supra note 36. As Dean Baker said of the years before
the GFC, “[t]here were a lot of things that didn’t require any
investigation
at all; these were totally available in the
data.”
[213] See, e.g. US
FINANCIAL STABILITY OVERSIGHT COUNCIL, supra note 209, at
iv.
[214] FINANCIAL CRISIS
INQUIRY COMMISSION, supra note 36, at xxii.
[215] Ronald Arculli, Chairman
Hong Kong Exchange, The Role of Exchanges in the New Economic Order,
World Federation of Exchanges,
http://www.world-exchanges.org/news-views/views/-role-exchanges-new-economic-order.
[216]
Ian Katz & Rebecca Christie, Volcker Rule Should be Robust, Financial
Oversight Panel Says, BLOOMBERG, Jan. 19, 2011,
http://www.bloomberg.com/news/2011-01-18/volcker-rule-s-implementation-should-be-robust-oversight-council-says.html.
[217]
Ben Bernanke, The Subprime Mortgage Market, Address at the Federal Reserve Bank
of Chicago’s 43rd Annual Conference on Bank Structure and
Competition, Chicago (May 17, 2007).
[218] Edmund Andrews, Fed
and Regulators Shrugged as the Subprime Crisis Worsened, N.Y TIMES, December
18, 2007, at A1.
[219] Most
developed nations continue to aspire to become major centres that attract global
financial transactions. See, e.g. Chancellor George Osborne’s Mansion
House Speech, THE TELEGRAPH, June 15, 2011; Australia On Track As Finance
Hub: Shorten, SYDNEY MORNING HERALD, May 28, 2011.
[220] UN Asks G20 to
Deliver “Bold Solutions” to Popular Protests, MENAFN.COM,
October 26, 2011
[221] Caroline
Copley, G20 Leaders Must Compromise to Solve Crisis – U.N.’s
Ban, THOMSON REUTERS ONLINE, October 17 2011.
[222] The Aspen
Institute, A Call to Action (Sept. 9, 2009),
<http://www.aspeninstitute.org/policy-work/business-society/corporate-programs/cvsg/public-policy>
.
[223] Some countries are
already doing this.
[224]
Pollin et al., supra note 127, at 542.
[225] See European Commission,
supra note 4, at 19. The report indicates that collecting taxes through
central clearing mechanisms is straightforward and cheap.
[226] Schulmeister,
supra note 18. More than ninety seven percent of the EU spot and
derivative transactions currently occur in the UK and Germany. Elsewhere
a large
portion of the trading occurs in the
US.
[227] Dodd–Frank Wall
Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 619, 124
Stat. 1376, 1620–1631
(2010).
[228] Gill North &
Ross Buckley, The Dodd–Frank Wall Street Reform and Consumer Protection
Act: Will Require a Change in Regulatory Culture and Mindset to be
Effective
35(2) MELBOURNE U. L. REV. (forthcoming
2011).
[229] See Martin,
supra note 15.
[230]
Joe Leahy, Don’t Improvise Capital Controls, IMF Says, FINANCIAL
TIMES May 29, 2011,
http://www.ft.com/cms/s/0/5d07acbe-8a1e-11e0-beff-00144feab49a.html#axzz1UzwJ5KLp.
[231]
Leahy, supra note 230.
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