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Over the last couple of years, a great deal of effort has been spent in Europe to try and collect on a transaction tax. This so-called "Tobin tax" is different from what one is used to paying when investing. It is not to be levied on any capital gains, instead, it's to be levied on any amounts bought or sold.

Although in its presently proposed form some trading is exempted, such as daytrading or new (primary market issuance), this tax still has the potential to wreak havoc with many market segments. As of today, there is an attempt to apply this tax worldwide, taking into account the residence of the trader. The tax is supposed to be 0.1% of stock and bond trades or 0.01% of the notional amount on derivative trades.

My personal example, regarding forex

It would seem that 0.01% is a very minor tax and traders would be able to pay it without thinking. But it's not so simple. This applies to every trade, be it a winner or a loser. And in some instances, like forex or derivatives, leverage can amplify the tax impact.

Take for instance my own case. Since I launched my automatic forex trading systems, these have produced a return of +168% over 1 year and a couple of months. The systems produced this by trading mostly EUR/USD but also GBP/USD and USD/JPY. To achieve such a return, the systems made 2396 trades, 753 of which were winners, 883 losers. The winners made 24.5 pips on average; the losers lost 16.51 pips on average. What this means is that over 2,396 trades, the average gain per trade on average has been just 1.61 pips.

Now remember, this new tax is supposed to be 0.01% of every transaction. EUR/USD trades at 1.3340 right now, 0.01% of that is 1.33 pips. If every transaction incurred an additional cost of 1.33 pips, this would wipe out 83% of the returns I have made.

This is huge

Much like with my example in forex, any stock or bond trader which trades frequently will be exposed to the same dynamics. Large returns get wiped out; small returns turn into large losses. Although the U.S. might refuse to apply such rules, many of the brokers based in the U.S. have a significant number of European customers, so this is a net negative if it ever comes to fruition.

This is especially negative for brokers catering to forex traders, such as FXCM (NYSE:FXCM) or GAIN Capital Holdings (NYSE:GCAP), but also for discount brokers catering to derivatives or high-frequency traders, such as Interactive Brokers Group (NASDAQ:IBKR), E*TRADE (NASDAQ:ETFC) or TD Ameritrade (NYSE:AMTD).

Where does the impact come from?

As I explained with my own case, the transaction is supposed to be levied on the notional value of every transaction. Any strategy which involves a significant number of trades or significant leverage will thus be very impacted. The brokers above are exposed to both of these dynamics - forex is usually leveraged, derivatives also include leverage and these are brokers whose customer base trades frequently, thus compounding the problem.

Furthermore, if frequent traders are driven off from the market, every other investor and trader will be impacted through lower liquidity and wider spreads. This in turn will probably mean even lower turnover than the simple removal of frequent traders would dictate.

Conclusion

I hope that sanity prevails and no such tax gets imposed, because although the rates being put forward seem low, when mixed with leverage and high-frequency trading they become monstrous. Such a tax, if implemented, would probably drain a lot of liquidity from the markets, first affecting the brokers most exposed to the higher frequency trading, but ultimately affecting every broker and every market participant due to lower liquidity.

The main impact from this measure would take place in brokers catering to European customers (assuming the U.S. does not accept the measure for its own citizens).

Source: The Worldwide Transaction Tax Can Be A Huge Killer