19/10/2011 Author: Will Wainewright

Clear and present danger

Proposals for a tax on financial transactions have been on the periphery of the political agenda for a while. But with renewed support for the tax from the EU President, it may be time for the hedge fund industry to seriously consider the impact of such a measure 

Amid the flood of post-2008 industry regulation, proposals for a new Europe-wide tax on all financial transactions had gone by largely unnoticed until last month. EU president José Manuel Barroso’s speech in support brought the potential levy to wider attention, bringing what had previously been a distant threat considerably closer to becoming a reality. It seems the proposed Financial Transactions Tax (FTT), which will be next discussed when the G20 meets in November, has almost crept up on the industry.

Doug Shaw, BlackRock’s COO for fundamental equity in the EMEA region, has one explanation. “I think the hedge fund industry has been quiet on this issue, possibly because they don’t think it is going to happen,” he says. “But the FTT is a clear and present danger to hedge funds that could cause great harm overall to markets if it is introduced.”
A tax on the trade of shares, bonds and derivatives will obviously impact many areas of finance and hedge funds are no exception. High-frequency trading funds will be most affected and, if you consider that 6% of all high-frequency trading volume comes from hedge funds (according to data from the Tabb Group), the risks for the industry seem real. So-called ‘black-box’ hedge funds, which trade using computer-driven algorithms, will be worst affected. But how would the proposed tax work?

The FTT would, with some exceptions, apply to all financial transactions carried out by EU-based financial institutions. A minimum tax of 10bps (0.1%) would be applied to all bond and share transactions, while derivative products would land a 1bp levy (0.01%). And institutions based outside Europe should not consider themselves safe from the tax – if they engage in transactions with EU institutions they will be liable.

The seriousness of the potential change can be gauged by the response of the trade bodies, with both the Managed Funds Association (MFA) and the Alternative Investment Management Association (Aima) opposing the measure. “The tax would only exacerbate the difficulties of the countries, individuals and investors that continue to confront the complexities of a fragile global economy,” MFA president Richard H Baker told HFMWeek.com last week.

Aima set out its opposition in April, saying that the FTT could lead to funds re-domiciling to outside the EU unless it is applied globally. What sort of impact could it have on a granular level? At BlackRock, Shaw says, some equity mutual funds are expecting a hit of 35-40bps – a big piece of the 200bps targeted outperformance of benchmarks. He adds that he has done research into fixed income strategies, several of which could “cease to be viable.”

High-frequency funds would be worst hit though. “There is a clear and present danger that high-frequency funds in European securities would instantly lose validity,” claims one market participant. Black-box hedge funds approached by HFMWeek declined to comment on the proposals “until more was known.”

Backers of the proposals in Brussels claim that it would pull in €57bn ($78bn) a year, a fair contribution, they argue, after financial institutions received aid and guarantees to the tune of €4.6trn ($6.3trn) during the financial crisis. However, its opponents point out that punishing hedge funds for a crisis not of their making, in which they received no state bail-outs, hardly seems fair. What’s more, it is investors, pension funds and others who would end up footing the bill.

MFA’s Baker adds: “It would impair those investors, pensioners, issuers and countries who desperately seek efficient, liquid and well-functioning financial markets.” The spectre of further regulation may be the last thing the industry wants as it continues to digest the implications of the AIFM Directive and Dodd-Frank. If Barroso and others get their way, however, it may have to brace itself.