Anti-price discovery tax

This week saw the publication of the European Parliament’s amendments to the EU Financial Transaction Tax (FTT). As reported in the press, lower rates (until 2017) for sovereign debt and pension funds have found their way into the proposal. Unfortunately, some very unpleasant surprises crept in as well. According to the Parliament, firms engaging in high frequency trading have to pay FTT not only on successful execution transactions, but also on order cancellations! Regulators might argue that this is necessary to protect markets from harmful speculation, but taxing order cancellation is tantamount to an anti-price discovery tax. In order for firms to contribute to price discovery, they must be allowed to revise their opinions. As John Maynard Keynes put it: “When my information changes, I alter my conclusions. What do you do, sir?”

But apart from the impact of the tax, the scope is dangerously far-reaching. The definition of high frequency trading strategies in the FTT is very similar to the Parliament’s proposal for MiFID II. (I highlighted some of the potential difficulties of this in a previous blog.) Any liquidity provider using modern trading technology is potentially in scope. Furthermore, the new exemption for market making only extends to illiquid bonds and shares (no mention of derivatives) while excluding any transactions done as part of an HFT strategy.

The potential negative impact for European markets cannot be underestimated. Electronic market makers are an important stabilising component for many asset classes, providing liquidity and transparent pricing. But they could now be significantly constrained in providing their services to the public and that increases the risk that, one day, price discovery will be something only done outside of Europe.

Comments
One Response to “Anti-price discovery tax”
  1. C Furlong says:

    Taxing cancellations is a sound political idea, it sounds right doesn’t it? Firms that cancel 99% of their orders get penalised. Although isn’t that strangely the opposite of a Transaction Tax? The idea of a 500 millisecond minimum resting time for orders on a market rings right to a politician’s ears, the idea that computers should not be in charge sounds right, and that super-fast computing power must be neutralised or at the very least slowed. The idea that off-exchange trading must be limited sounds right to the public or retail investors who may not knowingly have access to dark pools and a firm’s best prices. All these policies are designed to sound like measures that create a “fair” market and to slow things down and remove the noise and take trading out of the dark and onto exchange. These policies are also proposed to appease a very angry taxpayer who doesn’t support the idea that trading has any economic benefit at all.

    Unfortunately what plays well as politics in this case could be cataclysmic at least for the markets we have today. If any of these changes come in or indeed, heaven forbid, all of these measures do not get washed out of the final regulation, we are looking at one hell of a bun fight trying to work out what the market actually does and doesn’t do in the future. No one can say for sure if things will be better or worse but the blatant unknown is nearly always a very difficult place to go. If you think MiFID had a big impact on market structure in Europe, MiFID2 has the potential to change not only trading behavior but trading fundamentally. It is also likely to have a major detrimental effect on the EU as a place to participate in financial markets.

    It is perhaps time to really push to take the politics out of regulation and focus on forming good regulation that makes the market efficient, free and fair. Unfortunately the political will for revenge on the market is strong. We should bear in mind that the equity and bond markets did not cause the credit crunch and the recession. Their crime is that they judged the policies of governments and central banks cruelly in difficult times and electronic trading might just be lined up to take a good kicking for the team.

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