The World Federation of Exchanges, the global trade body for exchanges and clearing houses (The WFE), has published a paper analysing whether Financial Transactions Taxes (FTTs) inflict harm on economies.
The paper shows how FTTs create numerous distortions, harm investor outcomes, prevent companies from raising capital, particularly from listing, and make hedging against risk more costly. Additionally, The WFE demonstrates how implementing an FTT is a poor way to regulate financial markets as the effect FTTs have on trading patterns is, at best, unproven and, at worst, completely counterproductive. The 250 market infrastructures that comprise our membership see the impact of these taxes on the trades going through their order books, which can be taken as a proxy for the general health, confidence and buoyancy of the broader market and economy.
The paper explains the reasons why FTTs are defective, namely due to their impact on:
- Increased Transaction Costs: FTTs raise the costs associated with trading financial assets, which can reduce net returns for investors and discourage both short-term and long-term investments.
- Market Liquidity and Efficiency: FTTs can reduce trading volume and market liquidity, leading to wider bid-ask spreads, slower price discovery, and increased market volatility, which negatively impacts overall market efficiency.
- Distorted Investment Behaviour: FTTs incentivise investors to alter their strategies to avoid taxed assets, potentially leading to suboptimal investment choices and a shift towards riskier or less regulated markets.
- Corporate Financing: FTTs indirectly increase the cost of capital for companies, making it more expensive to finance new projects, which can stifle innovation and economic growth.
- Global Investment Shifts: The implementation of FTTs can cause investors to move their capital to jurisdictions with lower or no transaction taxes, reducing investment in regions with higher taxes.
- Reducing Risk: It is the stifling of trading that is dangerous and counterproductive, allowing uncontrollable pressures to build up, as clearly demonstrated by the failure of fixed exchange rates in the later twentieth century. Encouraging trading, on the other hand, ensures that asset prices remain fresh, thereby reducing the risk of bubble, including those fuelled by cheap credit in the banking system. It also ensures that liquidity is maximised for those who wish to change the composition of their portfolios from time to time.
Nandini Sukumar, CEO of the World Federation of Exchanges, commented, “The logic that, by raising transaction costs, an FTT curbs supposedly harmful trading and reduces volatility and asset mispricing is severely misguided. In fact, it has the reverse effect by discouraging informed traders, meaning there are fewer buyers and sellers to trade at the ideal price. This makes plain the counterintuitive nature of this tax. Regulators should learn from the US example, where the stock commission deregulation and consequent decline in transaction costs led to decreased price volatility. The effect of regulation can spread from the financial market to the broader economy, so this must be addressed for the benefit of investors and businesses too. Removing FTTs will lead to growth and lower volatility.”
Richard Metcalfe, Head of Regulatory Affairs at the World Federation of Exchanges, commented, “It is dangerous to experiment with FTTs, as history has shown. To see this, you only need to look at how Swedish equity traders and issuers voted with their feet in response to a series of FTT introductions and rises in the 1980s, and then returned and surged once they were repealed. Policymakers must take heed of the significant economic drawbacks these taxes impose, especially since existing taxes (notably on income and capital gains) already raise revenue from financial businesses, on the same basis as other economic activity, while allowing the economy to continuously price assets and risks, to the benefit of business managers and investors.”
Read the full paper here.
