This is a link to an article in Risk Magazine which discusses the impact of the proposed financial transaction tax (FTT) on the clearing of OTC derivatives in Europe.
Broadly, the FTT will apply to financial transactions:
- in relation to which at least one party is a financial institution established in an EU Member State; or
- entered into for the benefit of a financial institution established in an EU Member State.
The article refers to a leaked EU Commission discussion document which confirms that the proposed FTT of 0.01% of a contract’s notional value would be payable by each counterparty and levied on all legs of a cleared transaction. In a chain of back-to-back principal trades, as forms the basis of the clearing model in Europe, this would mean that the FTT would apply, at least, to:
- the original trade between two counterparties; and
- each leg of the trade once given up to a clearing member.
Fortunately, the FTT Directive does not apply directly to CCPs, with the result that the back-to-back trades executed between clearing members and CCP would be exempt from the FTT. In addition, an exemption applies under Article 9(2) of the FTT Directive, which states that “[w]here a financial institution acts in the name or for the account of another financial institution only that other financial institution shall be liable to pay FTT”. However, the article notes that this is only relevant where a financial institution acts as agent, and not where a chain of back-to-back principal trades occurs. The net result is that the operation of the FTT in a normal clearing environment could give rise to six instances of payment of the FTT, increasing to ten payments with respect to indirect clearing arrangements, creating the situation where a cleared transaction could be subject to up to 5 times the tax of an uncleared transaction.
The article also notes Article 9(3) of FTT Directive which states that each party to a transaction, including persons other than financial institutions, is jointly and severally liable for the payment of the FTT. Worryingly, the EU Commission has confirmed that a CCP would be liable in circumstances where one of its counterparties fails to pay. Given the amount of transactions which will be channelled through CCPs under EMIR, this could create a huge potential liability. The situation of CCPs could be made yet worse if another risk, not referred to in the Risk article, materialises. Under the EU Parliament’s recently proposed amendments, the non-payment of the FTT would render the transaction itself legally unenforceable. If this amendment were to find its way into the final FTT Directive, it would make the process of maintaining a flat book on the part of any CCP virtually impossible, seriously threatening the development of clearing in Europe.