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. 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.