December-January 2014

BACK OFFICE VIEW: Rising to FTT challenge

D OrrockThe election results in Germany have now put the much discussed roll-out of an EU Financial Transaction Tax (FTT) in Europe firmly back on the EU agenda, says Denis Orrock of GBST Capital Markets. Germany is one of 11 eurozone countries that originally pledged its support for the controversial financial transaction tax (FTT), a levy designed to reduce the amount of excessive short term trading that, arguably, contributed to the financial crisis. With its many complicated rules, rates and exemptions, the tax is something investment managers must monitor carefully. For the investment management community, the tax will generate a large workload for the operations teams: in terms of capturing the trades and relevant data; sifting through this data to determine those trades that are exempt; performing the tax calculations and generating the appropriate messaging to the relevant authorities. Under the current legislation, fund managers, where involved, are ultimately responsible for the payment of transaction taxes. If they use a broker, then the broker is responsible for the transaction and trading aspects. But most fund managers will, of course, wish to ensure that the tax payments are correct. There will still remain many incidences, however, where instrument movements may not go through the brokerage houses. In such circumstances, the fund management company will be liable for posting the appropriate declaration – either direct or through their custodian. The problem for many asset managers wishing to build an FTT solution is the return on investment against the in-scope FTT volumes being processed. While brokers are trading the bulk of your trades, and then reporting these on your behalf, how many trades will you be responsible for on a monthly basis (assuming that you do not want to reconcile all trade calculations provided by your brokers)?   The obvious solution is that the pressure on the asset management houses should be diverted onto the custodians, their counterparties and brokers – asking them to handle the FTT applicable trades. This means them not just assisting with the regulatory reporting but also providing a solution to the problem that will help the asset manager dilute the risk – through validation, netting, rebating and online authorisation. Custodians have the requisite scale and already manage many similar responsibilities and activities. From an asset manager’s perspective, a further consideration surrounds the structure of a fund. The structure of funds may change as, for instance, asset managers could say avoid “Total” in a fund and buy “BP” instead. This change would avoid an FTT. If the market capitalisation tax threshold is €1 billion, a fund manager might also choose a company that is just under the threshold. Asset allocation will therefore change, as the Asset Allocation Committee’s stance on blacklisting countries and specific securities to minimise tax begins to evolve. If we consider a “what if” analysis, what asset managers require is the knowledge of which instruments are in scope. In this way, if a fund manager went ahead with a certain trade, he/she would understand the tax implication for his/her fund. This kind of pre-trade analysis for the asset management community will be invaluable. The operational challenge, the relationship with their custodians and the structuring of funds are just three items on the asset manager’s FTT to-do list. And while there is still much uncertainty surrounding the EU FTT, with Italy live and Germany throwing its hat into the ring, I can only see the tax going ahead. The question is: how prepared is your operations team to meet the challenge? ©2014 funds europe

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