Financial services sector fears impact of Financial Transaction Tax on trading, liquidity, and active management

Tax return

The possible introduction of a financial transaction tax (FTT) in the US and Europe to make up for lower tax revenues resulting from the Covid-19 pandemic, is raising concern from investors and advisers, shows new data from Greenwich Associates.

Several European nations are reconsidering use of a financial transaction tax (FTT), and in the US, as the presidential election approaches, the debate around an FTT has been resurrected, worrying financial professionals, investors and retirement beneficiaries. 

FTT supporters say that adding a small charge to financial transactions can help the government raise funds for a raft of social programs. Past FTT efforts have failed to raise the funds projected and having unexpected consequences, such as shrinking trading volume, falling market share and migrating of capital market activities to other market centres. 

Across financial services, 72 per cent of market professionals surveyed expect an FTT will harm retail trading and retail traders, with one quarter saying it will eliminate the benefit of zero commissions.

Active managers also stand to lose out, with an overwhelming 84 per cent believing an FTT will accelerate the move to passive investment.

Greenwich Associates interviewed 58 professionals, including retail brokers, wealth managers, asset managers, regulators, banks, hedge funds, broker dealers and consultants, on the potential impacts of an FTT. The majority of respondents were based in the US with responses also coming from EMEA and APAC.

Nearly 70 per cent of respondents said they anticipate a real-world reduction in their firm’s trading, and a further 65 per cent believe it will negatively impact their personal 401(k) or other retirement portfolios.

Senior analyst Shane Swanson in the Market Structure and Technology Group at Greenwich Associates, the report’s author, says: “The rational economic response to the increase in costs will be a reduction in the amount of trading. According to a majority of respondents, the clear view is that FTTs haven’t succeeded in the past, as the negative effects are broad-based and the marginal potential benefits are far outweighed by the true costs.” 

Liquidity is another worry, with 66 per cent saying there will be less liquidity available at the best bid and offer, with 64 per cent expecting spreads to widen as a result of decreased liquidity. 64 per cent also believe costs of capital will go up for issuers, with 57 per cent saying borrowing costs will go up for the public and private sectors.  

Swanson says: “Although the US markets are the envy of the world, an FTT could damage that machinery, resulting in spreads widening, liquidity dropping, stock prices falling, and the possibility of volatility increasing.”