A proposed EU financial transaction tax could disproportionately hurt small and medium-sized companies rather than the banks and hedge funds it is aimed at, who are expected to shift business elsewhere. The tax aims to ensure the financial sector contributes more to the cost of the euro zone crisis while also addressing risky behaviour in some areas of financial markets.
However, many of the largest potential contributors to any tax revenue - hedge funds, high-frequency traders, banks and larger companies - may be better placed to dodge the tax by relocating than are smaller, often locally-rooted, businesses. If the UK were excluded from the tax - as it has insisted - larger institutions could relocate to London.
"My fear is that a financial transaction tax would have a negative impact on the real economy as companies and consumers will ultimately bear the costs," said Bernard Sinniah, global head of corporate FX sales at Citi. The draft proposal for the tax - dubbed the "Tobin tax" - would not be applied to spot foreign exchange transactions but it would include derivatives, where trades would be taxed at a rate of 0.01 percent.
Although the proposal states the lending and borrowing of enterprises and households would be ring-fenced, including foreign exchange derivatives would impact companies using options for hedging purposes. "It is highly likely that banks will pass these extra charges on to small businesses," said Patrick Gibbels, representative of the Brussels-based European Small Business Alliance.
A Tobin tax may discourage companies from using options, which can be useful when heightened uncertainty causes volatile currency moves, such as those witnessed during the euro crisis. "We are seeing a growing number of companies starting to use options as a hedging tool, particularly given the current volatility," said Alex Lawson, senior broker at Moneycorp, which specialises in FX transactions and hedging for companies.
"If they go ahead with a Tobin tax there may well be unwanted ramifications. There would be an impact on the SME business and it would eventually be passed on to consumers." The ESBA's Gibbels was also concerned the tax would limit already squeezed bank lending.
"SME bank lending is already endangered severely," he said, adding: "We should be helping SMEs do business, not putting obstacles in their way." A 2010 survey by the Bank for International Settlements showed the spot market made up more than a third of the $4 trillion a day FX market, with options accounting for just 5 percent and currency swaps for just 1 percent. Outright forwards and FX swaps accounted for more than half.
Non-bank institutions such as hedge funds have driven FX options growth and account for more than half of these transactions. A Tobin tax could make strategies hedge funds favour, like high-frequency trading, uneconomic. "A tax to be paid not on the overall profit but on the notionals would kill the possibility of doing anything to do with high-frequency trading," said Lorenzo Ravagli, quant strategist at Societe Generale.
Banking sources and analysts believe hedge funds would relocate rather than change their behaviour - as the EU proposal intend - by switching from high-volume, low-margin trades towards lower-volume trades with larger margins. Excluding London would exempt the world's biggest financial centre for foreign exchange and many European-based institutions would simply move there or possibly to Switzerland.
"If on the other hand other regulations or changes in tax levels, bonus levels etc are implemented in the UK then more business will move to Asia (including the Middle East)," said Robert Celsing, global head of FX trading at Swedish bank SEB. The BIS survey showed London accounted for more than a third of FX turnover, more than double that of New York, the second biggest centre. All other EU countries accounted for only 14 percent of the market. Switzerland had around 5 percent.
"The impact of a transaction tax on the FX market will be at the most marginal in terms of the overall flows, but could be quite significant on where those flows are executed," said Justyn Trenner, CEO and principal of FX industry advisers ClientKnowledge. Even if these players did not relocate, analysts said a Tobin tax would dampen FX volumes and therefore tax revenue. The European Commission estimated the tax could raise 57 billion euros, which many consider optimistic. "The Tobin tax is wishful thinking that it will accomplish anything of great significance, except taxing those people who have to undertake real transactions on behalf of real manufacturers and real investors," Trenner said.