Financial Transaction Taxes: Developing a Strategic Response Point of View

02 12 15 25 February 2013 Point of view we observe in the for responseWhat How PwC can helpAframework industry

Financial Transaction Taxes: Developing a strategic response Point of view

Financial transaction taxes February 2013 PwC 2 continued to consider the introduction of an EU significantly changed the tax landscape for financial “FTTs will fundamentally change the wide FTT. institutions. tax landscape for financial In September 2011, the EU released a draft institutions…The EU Commission has Is this an issue for non-EU institutions? Directive for an EU FTT, with a planned start date estimated that the EU FTT will raise of 1 January 2014. This represented the first In short, the answer is yes. FTTs may be charged by €31 billion” attempt to introduce a common FTT regime across reference to the location of the issuer of taxable all EU countries. securities, regardless of where the parties to the Financial Transaction Taxes (“FTTs”) will transaction are located (this is the model for the Since then, various countries have sought to ‘front French FTT, for example). fundamentally change the tax landscape for run’ the EU FTT developments by introducing their financial institutions. These taxes will have wide- own, domestic FTTs. An alternative model (which was incorporated in reaching implications for the business models of the September 2011 draft EU Directive) taxes a all financial institutions, regardless of where Why have FTTs come to favour? financial institution based on where it, or the institutions are located and where they transact. At a time of high fiscal deficits in most western counterparty to the transaction, is located. Under In the past 18 months a number of countries have countries (see figure 1), FTTs are highly attractive this model, an institution outside of the FTT either introduced or announced an intention to politically as a revenue raising tool. Indeed, the EU jurisdiction can be subject to the tax by trading introduce domestic FTTs at a local country level. In Commission has estimated that the EU FTT will with a counterparty resident in the FTT addition, a proposal to introduce a FTT in a subset raise €31 billion, which would be a considerable jurisdiction. of the European Union (“EU”) has been approved. cost to financial services institutions and their clients. So, what are FTTs and where did they come from? Figure 1: individual country deficits, as Moreover, the support for FTTs is representative of published on 9 February 2013 What are Financial Transaction Taxes? a number of trends in taxation, including: FTTs are a form of indirect tax levied on specific • the use of taxes to change the behaviour of financial transactions, such as purchases of financial institutions equity securities. Country Budget balance • increased use of indirect taxes rather than as % of GDP A number of countries have long had domestic direct taxes FTTs, including the UK, Hong Kong and United States -7.0 • increased taxes levied on the financial sector Switzerland. Japan -9.8 For all of these reasons, in our view, financial Why are new FTTs being introduced? transactions taxes will be a feature of the tax Britain -7.9 landscape for many years to come. The development of FTTs in recent years has its France -4.5 roots in a request by the G20 to the IMF to find Who is impacted by FTTs? ways of ensuring the financial services sector Germany +0.1 In summary, any financial institutions involved makes a ‘fair and substantial contribution’ towards Greece -7.0 the costs of the financial crisis. in securities business are likely to be directly impacted by new FTT regimes. In particular, banks, Italy -3.0 1 Although the IMF report ultimately concluded that brokers, asset managers, insurers, and custodians Netherlands -4.1 a FTT was not its favoured option, the EU all need to be developing a response to these developments. For these reasons, FTTs have Spain -7.4

Source: The Economist, February 9th 2013 1. See http://ec.europa.eu/taxation_customs/resources/documents/taxation/other_taxes/financial_sector/com(2011)594_en.pdf Financial transaction taxes February 2013 PwC 3 Notwithstanding the attractiveness of FTTs to Figure 2: Impacts of UK stamp tax 1 “FTTs have a significant adverse governments, research and experience from the impact at an economic level. FTTs can introduction of FTTs has suggested that FTTs have result in increased costs to companies a significant impact at an economic level. issuing securities…and present a risk There have been a number of studies into the • Reduction in the share prices of of relocation of activities economic impact of introducing FTTs. UK companies In the context of the UK’s stamp tax regime, • Increased cost of equity for UK companies For a very broad-based EU FTT research has suggested this has had a number of ...implementation costs of $15 – 20 economic effects on the UK economy as well as UK • Reduced liquidity in UK shares in the million would seem likely for large companies (see Figure 2). secondary markets financial services organisations with When a financial transaction tax was introduced in • Reduced UK GDP and tax receipts a European footprint” Sweden in the 1980s on the purchase and sale of domestic equities and stock options, this had a 1. See Stamp Duty : its impact and the benefits of its abolition by significant effect on the Swedish markets Oxera, May 2007. (including the migration of an estimated 50% of trading activity from Sweden to the UK). The economic impact of any new FTT will depend Compliance and implementation costs on the precise nature of the regime. One key aspect is whether tax is levied by reference to the location Our experience with the French FTT, and to some of the issuer of the securities (as with UK Stamp extent the Italian FTT, gives us an indication of Duty Reserve Tax (“SDRT”) which broadly applies what the implementation costs are likely to be for to transfers of equities issued by UK companies) or financial institutions. by reference to the location of the parties to the For the individual country FTTs, the transaction. implementation costs for financial institutions were The first model could be expected to result in estimated to be $2-3 million per country. The increased costs to companies issuing securities, and implementation costs of an EU wide FTT are add cost to parties trading those instruments. therefore likely to be significant. The second model provides a greater risk of Although it would be hoped that some economies relocation of activities as institutions which are of scale could be achieved, for a very broad-based located outside of the FTT zone and who do not EU FTT (along the lines of the current EU trade with counterparties inside the zone will not Commission proposal) and based on recent be subject to the tax. experience of individual country FTT These points are not simply of academic interest. implementation, total implementation costs of $15 They can be used to inform institutions’ – 20 million would seem likely for large financial engagement with governments, specifically around services organisations with a European footprint. the practical issues and the shape any proposed regime should take. They will also be highly relevant to assessing the impact of a new regime at an institutional level. These points are discussed in further detail later in this document. Financial transaction taxes February 2013 PwC 4 The EU FTT is now coming into force across a The EU Commission released a new draft of the “The EU FTT is now coming into subset of EU countries. So, how did this come Directive on 14 February 2013. The details of the force” about, what happened to the planned EU wide revised proposal are set out in the Appendix. FTT, and where does this regime stand? The next steps in the process are as follows: From the outset, this topic has been highly political with a range of views expressed by different • The precise provisions of the Directive will be governments. France and Germany in particular debated. All EU Member States will be present have been very strongly in support of the proposal, at these debates. whilst the UK and certain other countries have • Once the technical debate has concluded, the been strongly against it. process will move to the political level. The original intention was for the FTT to apply to Only the (currently 11) Member States, which have all EU Member States. Once it became clear that formally requested to the Commission to join the this could not be achieved given the opposition of Enhanced Cooperation on FTT, have the right to certain countries, a number of countries moved for participate in the final vote on the FTT regime at the introduction of an EU FTT in those countries the Council political level. The vote requires Figure 3: Countries joining the EU FTT only through a process known as the Enhanced unanimity to pass. via the Enhanced Cooperation Procedure Cooperation Procedure (“ECP”). This procedure Throughout the ECP process, Member States can allows a subset of at least 9 Member States to send a formal request to the Commission to join the proceed with introducing progressive EU law core group of 11 Member States in favour of the EU within those supporting States only. FTT. Based on the current draft Directive, once an On 22 January 2013, a vote was passed (with four EU FTT is enacted those countries signed up to the countries abstaining) to allow the 11 countries in FTT will not be able to retain existing, domestic € favour of the EU FTT to proceed with the FTTs. introduction of the tax. The Netherlands may join In summary, in what continues to be a process of the ECP, but this is subject to certain conditions on € close consultation with governments, the EU FTT is €+ the nature of the final regime (see Figure 3). €+ likely to become a reality. Although the €+ Commission's proposal forms a formal basis for € € what are complex talks between Member States, € €+ 11 Countries Joining the ECP € € the current proposal may still be considerably € Potentially joining the diluted. The key issues to be determined in the € € 1 Country ECP, subject to conditions €+ coming months are the precise shape of the EU € € 10 Countries Opposed to an EU wide FTT FTT and when it will come into force. We €+ Undecided: not formally understand however that it is increasingly 5 countries € € € opposed, and/or expressed concerns uncertain whether a compromise can be reached

Euro currency before the German elections in September 2013. € € €+ Euro Plus Pact € zone This means that the proposed timeline may shift.

Financial transaction taxes February 2013 PwC 5 Over the coming months, there are a number of The events of the next 12-18 months will therefore “The events of the next 12 – 18 months key events both with respect to the EU FTT and be key in shaping the FTT landscape. For this will be key in shaping the FTT domestic FTTs. reason, institutions need to start planning for these landscape. Institutions need to start For the EU FTT, we will now see the start of events now. The timeline below sets out the key planning for these events now.” negotiations on the precise form of the EU FTT events on the EU FTT and domestic FTTs as the following the release of the revised Commission position currently stands, together with some key proposal on 14 February 2013. In parallel, domestic developments from recent months. FTTs will be coming into force (and it remains possible that more countries will seek to introduce FTTs locally, especially if the EU timetable were to be extended).

1 January 2013 Hungarian FTT comes into force

1 August 2012 14 February 2013 - Revised 1 July 2013 2013/2014 Potential French FTT comes int0 EU FTT Directive released. Italian FTT on derivatives introduction of force Negotiations amongst ECP comes into force Portuguese FTT countries begin

2012 2013 2014

22 January 2013 2013 – Potential 1 January 2014 ECP vote passed for introduction of Proposed start date for EU FTT Spanish FTT EU FTT

1 January 2013 1 March 2013 Ukrainian FTT comes Italian FTT on equities into force comes into force

Financial transaction taxes February 2013 PwC 6 Financial institutions will need to prepare, Accordingly, until the introduction of the EU FTT “As the negotiation and debate develop strategies for and deal with multiple FTTs financial institutions will be faced with a patchwork around the EU FTT has continued, a implemented by local countries in the short to of local country FTTs, all with different features – a number of countries have either medium term. very difficult situation to manage. introduced, or announced an As the negotiation and debate around the EU FTT As mentioned before, under the terms of the intention to introduce, their own has continued, a number of countries have either current draft EU FTT Directive those countries FTTs” introduced, or announced an intention to signing up to the Directive cannot retain their introduce, their own FTTs. The current status of domestic FTTs. That said, even once the EU FTT is the major countries with an FTT-style tax is set out introduced local implementation may still differ. below. Each of these domestic FTTs has different For example, the Directive will only specify scopes, rates, and exemptions, etc. minimum rates of tax – these could therefore differ at a local country level.

Country Italy France Portugal Spain Hungary Ukraine EU

Scope of Charged on the sale of Acquisition of equity and Secondary market Acquisition of equity Money transfers, OTC transfers of Transactions involving a tax Italian equities and ADRs, similar securities issued by a transactions over and similar securities collections, payments, Ukrainian financial institution, with transactions in Italian French listed company financial instruments, issued by large Spanish cash disbursements, cash securities and OTC a party established in an equity derivatives and high having a market cap in including equities, bonds companies. Tax on transfers, redemptions of transactions over ECP country, over frequency trading of excess of €1bn (and ADRs and fund units, high frequency trading letters of credit and Ukrainian equities, bonds, money taxable instruments over such). Tax on high derivative transactions and certain CDS by cheques, and certain derivatives market instruments, frequency trading and Spanish entities central bank deposits derivatives and UCITS certain CDS by French units entities

Rate of tax 0.1% for equities traded on 0.2% shares, 0.01% for high Up to 0.3% To be confirmed In most cases 0.01%, but 0.1% for listed 0.1% for non derivatives, regulated securities frequency trading and CDS in some cases up to 0.3% securities, 1.5% for 0.01% for derivatives exchanges, 0.2% otherwise depending on the unlisted securities (0.12%/0.22% for 2013). transaction Nominal rates applied to derivatives

Key reliefs Primary market Primary market Issuance of securities, Primary market Various, including Primary market Primary market transactions, market maker transactions, market maker potentially market transactions, market accounts held at the same transactions, transactions; transactions transactions transactions, stock loans, makers (to be maker transactions bank by the same person, transactions over with certain government repos, intra-group determined) cash pooling and government bodies, certain group transactions securities accounts securities restructuring transactions

Expected Equities tax from 1 March Effective from 1 August 2012 2013/2014 Potentially first half of 1 January 2013 1 January 2013 1 January 2014 Start date 2013, derivatives tax from 1 2013 July 2013

Financial transaction taxes February 2013 PwC 7 For some time financial institutions have had to to the extent possible financial institutions should “In developing a strategic response to deal with domestic FTTs. Accordingly, the seek to leverage the experience and lessons learned the introduction of new FTTs, to the introduction of more FTTs that need to be from dealing with these existing FTTs (this theme extent possible financial institutions managed means that financial institutions must of building from experience of existing regimes is should seek to leverage the experience prepare to deal with this dynamic landscape. discussed further later in this document). This is and lessons learned from dealing with The table below sets out the features of some of the particularly true for FTT regimes that tax equity these existing FTTs” main existing FTT regimes. In developing a transactions, since this forms the basis for most strategic response to the introduction of new FTTs, FTT regimes already in existence.

Country Hong Kong Ireland South Africa Switzerland United Kingdom

Scope of Charged on the transfer of stock Charged the on transfer of stock in Securities transfer tax applies on Securities transfer tax applies to Agreements to the transfer of UK tax which is registered in Hong Kong Irish incorporated companies the transfer of South African transfers of qualifying securities, equities and certain UK securities by way of sale and purchase securities or listed securities wherever issued, involving Swiss with equity-like features parties

Rate of tax 0.20% shared between the buyer 1% 0.25% 0.15% for Swiss securities, 0.3% 0.5% and seller of the chargeable for non-Swiss securities security

Key reliefs Exemption for transfer between Exemptions for intermediaries, Exemptions for asset to share Exemptions for certain capital Exemptions for intermediaries, associated companies (i.e. those transfers between companies transactions and intra group markets transactions, including certain capital markets with a 90% association) within a group relief group, transactions stock lending transactions (including stock foreign transfers and stock loans) and transfers within a borrowing group

Financial transaction taxes February 2013 PwC 8 The EU FTT will impact financial institutions For example, see Figure 4 below. In Scenario (1), “The EU FTT will impact financial globally and not just those based in the European the Japanese bank is subject to the EU FTT as a institutions globally and not just countries. result of transacting with a German counterparty those based in the European This is for two key reasons: despite having no physical presence within the ECP countries.” zone. This contrasts with the stamp model where 1) under the current Commission proposals, a the German Bank would normally be the financial institution located outside of the ECP accountable party. zone that is a party to an in-scope financial transaction with a counterparty established Likewise under Scenario (2), the UK broker dealer within the ECP zone is subject to the tax; and in selling shares in a Swiss company would be brought within the scope of the EU FTT by virtue of 2) it is likely that the majority of the economic transacting with a bank situated within the ECP cost of the FTT will be passed on to the end zone. investor by the financial institution. In both scenarios, the US corporate is likely to bear Even if the ECP countries choose to push ahead the economic cost of the FTT indirectly through with an FTT which is closer to a more traditional increased brokerage fees in the case of Scenario (1) stamp-style regime, any company or individual or through the pricing of the CFD in the case of entering into a transaction over securities issued by Scenario (2). companies located within the ECP zone will be subject to the FTT.

Figure 4: the global impact of an EU FTT

1. German bank acting for a US corporate customer buys French equities from Japanese Bank and sells to its customer

Purchase Sale Japanese bank German bank US Corporate

2. German bank writes CFD over Swiss equities with US corporate and hedges CFD by purchasing reference equities from UK Broker Dealer

Purchase CFD UK Broker Dealer German bank US Corporate

Key

Swiss equities Charge under EU FTT Charge under French FTT

Financial transaction taxes February 2013 PwC 9 At this stage, it is not clear what the final form of However, to make their voices heard now, financial “Financial institutions need the EU FTT will be, nor is it clear when the EU FTT institutions need to assess the impact of proposed to develop a strategic response now.” will ultimately take effect. However, in our view regimes and engage governments in discussion. financial institutions need to develop a strategic 4. FTTs can have a very short lead time response now. Recent experience from the French and Italian FTTs has shown that FTTs can be introduced with Notwithstanding uncertainty on how EU and very little lead time. This is coupled with a lack of domestic FTT regimes will develop, in our view clarity in the rules and related guidance, often until financial institutions cannot afford to ignore the very shortly before (or after) the regime comes into FTT developments and wait for clarity. There are a force. This means that institutions struggle to number of reasons for this. implement a response and frequently the cost of 1. FTTs are not going away implementation is many times higher because it is As we have discussed earlier, FTTs are politically being completed in a ‘burning platform’, tactical attractive and regarded as a valuable new source of environment rather than through adopting a more revenue for governments. Given this trend, considered, strategic approach. financial institutions need to be prepared to deal with FTTs over the foreseeable future. So, what should institutions be doing now? 2. FTTs can have a significant impact on In our experience, many institutions developed a financial institutions ‘tactical’ solution to the French FTT, quickly In our experience, FTTs impact institutions in a amending systems and processes to deal with the very wide range of areas. FTTs can impact the regime at short notice. Very few institutions are viability of business lines, product pricing, preparing for the EU FTT regime because the focus operational and systems requirements, so far has been preparing for domestic FTTs that legal agreements with clients, and many other are in force already or coming into force in ways besides the direct impact of the FTT. coming months. 3. The final shape of many regimes is not yet decided However, given the pace of developments in this area, and the number of FTTs expected over the With the shape of certain FTT regimes (including, coming months and years, in our view institutions in particular, the proposed EU FTT) not yet need to take a more strategic approach in finalised, there remains time for discussions with responding to these developments. Furthermore, government and the EU to refine the precise form any response should seek to leverage the work done of these taxes. For example, banks and brokers already in responding to previous FTT regimes. would want to ensure that any new FTT has a broad The following sections of this document set out based exemption for market makers (the current what we observe in the industry by way of EU Directive contains no such exemption). responding to these developments and our recommendations for the practical steps For asset managers, a key issue will be the scope of institutions can be taking now. any charge on the issue and redemption of shares or fund units.

Financial transaction taxes February 2013 PwC 10 “FTTs impact across the organisation. Financial institutions need to act now and involve the stakeholders from across the business.”

FTTs impact a number of different areas of a financial institution from the front office trading strategies through to the clearing and settlement systems and processes. The level of impact in each of these areas will vary depending on the type of institution - broker, custodian, asset manager etc. For each of the areas of the organisation which are likely to be impacted, the table below summarises the key activities that will need to be undertaken by those functions in response, together with a summary of the main deliverables which will be required.

Front office/trading Operations Tax and legal Technology Risk management and compliance

• Determine how the FTT would • Assess the changes • Determine the role that the in- • Map existing systems from front- • Define what risk impact trading strategies and the needed to current house tax resource will play in office booking to clearing and management procedures products that each desk/location/ operations function providing tax technical input and settlement interface for all in-scope are required to monitor fund vehicle has a mandate activities and in supporting constructive products. compliance with FTT

s to trade. processes to cope with engagement with governments. • Review existing data fields to regimes and the extent to e

i • Determine whether FTT costs will be settling FTT across a • Review customer terms and determine what additional which any third party t i

v recharged to end investors or the diverse range of conditions to determine whether information should be held on assurance is required. i

t extent to which these will be financial instruments. the FTT can be recharged to counterparties and customers. c

A absorbed internally. customers where appropriate. • Assess third party vendor solutions • Assess the impact of FTT on market • Prepare detailed memo setting for data feeds on legal entities, in- liquidity, product pricing and out the technical analysis of FTT scope securities and tax engines. bid/offer spreads. regime as it will apply to the • Determine whether tax engines • For products which are potentially organisation. developed in-house for other FTT subject to FTT review and identify • Identify key areas of uncertainty regimes can be adapted to cater for the booking locations. in the application of the rules the new requirements. • Map the location of counterparties to given its business profile and in-scope financial transactions. trading activities.

• Inventory of products, transaction • Documentation of • Detailed memo setting out the • Documentation summarising • Compliance model. s e

l types and the location of existing process flows technical requirements of the existing systems architecture. • Internal audit review

b counterparties. for the operation FTT regime. • Recommendations as to third party procedures. a

r • Operating model for recharging FTT. functions at each • Recommendation of the vendor solutions. • Controls documentation. e

v • High-level model of impact across the stage of the approach to amending existing • Recommendations as to changes to i l

e product range. transaction life-cycle. customer terms and conditions. systems architecture to capture

D additional data fields.

Financial transaction taxes February 2013 PwC 11 What we observe in the industry

Our observations of industry practices

Financial transaction taxes February 2013 PwC 12 Brokers and custodians “What we observe in the industry” Governance • Most brokers and custodians have put in place working groups in response to the French FTT and in anticipation of the Italian FTT. • They have typically established working groups comprising subject matter experts from across the organisation, covering legal, compliance, tax, operations, front-office, and technology. • Ownership generally sits with the business or operations in the location where the primary infrastructure supporting the impacted businesses sits.

Constructive • A number of industry groups have taken a very pro-active approach in trying to seek Engagement with clarity on the application of the rules and putting in place contractual documentation to Government manage exposures where the law fails to clarify the position. • On French FTT, consultation with governments has been primarily aimed at obtaining clarity on the application of the law for all the parties involved. Given time constraints, much of the discussion was undertaken after the commencement date in order to obtain clarity on the law and guidance issued. • Debate on the EU FTT has been more focused on trying to demonstrate why the FTT would have adverse impacts at a macro-economic level. Business • Banks and brokers do not generally view the FTT as a direct cost since client agreements Response will typically provide for them to pass the cost on to the end client. • Accordingly their response to the FTT developments has been to ensure that there are robust processes for ensuring compliance with the regimes, rather than changing how they conduct securities business to mitigate FTT costs. Implementation • Most brokers and custodians have taken a ‘tactical’ approach to implementation as a result of the very short lead times, primarily focusing on addressing the client interface first and ensuring that the FTT cost can be passed on to the client where appropriate. • The other key area of focus has been on ensuring that the use of the various exemptions (e.g. market maker and securities financing exemptions) can be maximised. • Significant reliance has been placed on industry groups to resolve uncertainties as to the detailed application of the requirements. • Best practice seeks to leverage lessons learned from the experience gained from operating other transfer tax regimes – for example, UK SDRT, French FTT and Hong Kong stamp duty. • Very few institutions have taken a ‘strategic’ approach in response to FTT developments, (1) seeking to develop a process which can be replicated for future regimes and (2) gathering information in a way which ensures that, for any future regimes, it is only necessary to consider what is different for that market.

Financial transaction taxes February 2013 PwC 13 Asset management “What we observe in the industry” Governance • Given that the French and Italian FTTs place the tax collection and reporting obligations with the custodians and brokers, the asset management community has not typically established dedicated teams to focus in detail on operational implications of FTTs. Constructive • There has been engagement to date in connection with the EU Commission proposals. Engagement with Those submissions that have been made focus primarily on the overall cost of doing Government business and exemptions that should apply in principle. • Input (including the submissions made by the Dutch Government in connection with the Enhanced Cooperation Procedure) has emphasised the need for an exemption for pension funds and relief for units or shares issued or redeemed in UCITS. • Another key issue for consultation on the EU FTT has been the potential for multiple charges to arise under a single transaction. This has been seen as inequitable and also arguably contrary to the public policy of encouraging saving by investors. Business • For asset managers, FTTs will be a cost that will impact their expected performance on Response investment strategies. • Certain FTTs (in particular the EU FTT) may act to charge funds distributing units (depending on the distribution model used) as well as fund investment activities. Accordingly, funds need to consider the impact on distribution strategy as well as the impact on investment strategy. • Consequently we have seen the asset management industry seek to identify the impact of the various FTTs on their business and establish a response to limit the cost of the tax by engaging in constructive discussion for changes. Implementation • The primary focus for the asset management sector has been on assessing the business impact of domestic FTTs, given the additional transactional costs associated with doing business. • As a result of the narrow scope of the netting rules in recent FTTs, asset managers have been looking at the impact of transacting across different brokers. Under the French FTT, there is no ability for a fund to net positions in relation to a particular security across different brokers. This arguably creates a tension with the requirement under the AIFMD regulatory regime to select brokers based on best execution capability.

Financial transaction taxes February 2013 PwC 14 A framework for response

Our recommended approach to the issue

Financial transaction taxes February 2013 PwC 15 • Manage changing rules “Financial institutions need to adopt • Ensure key messages are conveyed to an integrated strategy, recognising governments, and Figure 5: An integrated strategy for that there is likely to be significant dealing with FTTs • Develop an approach to preparing for changes overlap in the scope of the domestic to operational systems and processes, and to FTTs and the EU FTT” facilitate required changes to the business FTT impact assessment strategy. Financial institutions need to start considering When should this work begin? In our view there Current Proposed Current their approach to preparing for FTTs now. In our are good reasons for launching a strategy now, FTT rules FTT rules state view they should look to obtain synergies from the including the following: work they undertake in response to domestic FTTs • With the shape of the EU FTT to be debated to minimise the amount of re-work required in the among the participating countries in the coming event the ECP is successful. months, now is the time to engage with In order to respond to the challenges posed by governments and provide input on the design of FTTs, financial institutions need to adopt an the regime. Governance integrated strategy, recognising that there is likely • More domestic FTTs may take effect in the short to be significant overlap in the scope of the term. The Italian FTT comes into force on 1 domestic FTTs and the EU FTT. March 2013. The integrated strategy should include the • Given the complexity and scale of the business following key elements (see Figure 5): operated by financial institutions, a full impact Constructive assessment is likely to require careful planning Engagement Business Implement- • An impact assessment of FTT across all lines of with Response ation business; and sufficient time for analysis. Government • A strategic response, based on the results of the However, these points need to be balanced with the impact assessment, covering the following areas: following considerations: • As new regimes are announced, there will • Constructive Engagement with inevitably be some replication of work in Government performing subsequent impact assessments. • Business Response For this reason, to the extent possible, • Implementation institutions should seek to capture data likely to be relevant for all regimes as part of the first The strategy needs to be supported by an impact assessment and seek to leverage this in appropriate governance model to: future exercises. • The final shape of a number of future FTT regimes (including the EU FTT) is not yet certain, which means that work on a detailed business response and implementation is not yet possible. However, the impact of future regimes can still be assessed based on what is known at this stage and certain assumptions about the final end state. Financial transaction taxes February 2013 PwC 16 For many institutions, there is currently a need to An impact assessment can therefore use a ‘building “The various domestic FTT proposals respond specifically to the Italian FTT. In doing blocks’ approach – building on knowledge of the and the EU FTT model can be viewed so, many are considering how to build on the work impact of existing FTT regimes and seeking to along a spectrum. This reflects the already undertaken in preparing for the French identify commonality between the existing and key attributes of FTT regimes that FTT. future regimes, thereby enabling previous impact need to be considered.” In our view, the implementation of the Italian FTT assessment work to be re-used. This approach presents an opportunity to start gathering the ensures that those areas that are most likely to be information required to assess the impact of in scope under a new FTT are prioritised as part of further domestic FTTs and/or the EU FTT, and to any implementation work. build the governance framework in anticipation of Following this process, the impact of those aspects these regimes. This is because there will be certain of new FTT regimes which differ from existing features of existing regimes that will be replicated FTTs can then be reviewed. The results of this in future regimes. review can then be used as a starting point for the review of other FTT regimes which are yet wider To illustrate this conceptually, the various domestic in scope. FTT proposals and the EU FTT model can be viewed along a spectrum, with ‘narrower scope’ FTTs, closer to the UK SDRT model, at one end of the spectrum and ‘wider scope’ FTTs, such as the current EU FTT proposal, at the other end (see Figure 6). This reflects the key attributes of FTT regimes that need to be considered.

Figure 6: The spectrum of FTT regimes

EU FTT French Italian UK SDRT proposal FTT FTT

• Tax based on location of securities • Tax based on location of parties • Few instruments in scope • Many instruments in scope Final • Few transactions in scope • Many transactions in scope EU FTT? • Exemptions, e.g. market maker relief • Few exemptions • Single charge • Purchaser and seller liable

Financial transaction taxes February 2013 PwC 17 Turning to the lessons learned from the French These lessons can be used to focus resources for “In order to implement an efficient FTT in particular, many institutions impacted by implementation, enable effective communication of strategy for managing future FTTs, it new FTTs have already had to deal with the key messages and help to inform any adaptation of is of critical importance to maximise French regime. business strategy. the benefits of the lessons learned In light of the approach set out on the previous The table sets out what we consider to be the key from preparing for the French tax.” page, in order to implement an efficient strategy for issues from the French FTT experience for financial managing future FTTs it is therefore of critical institutions to learn from. importance to maximise the benefits of the lessons learned from preparing for the French tax.

French FTT challenges Learning for future FTTs Lack of clarity in the rules • Need to look for areas of commonality among regimes and guidance • Consider compiling list of key issues likely to be relevant – this will help in planning ahead and developing responses (key issues include the scope of any market maker exemption, the types of products covered, impact of netting arrangements, etc.) Need for constructive • By developing a list of key common issues and engaging at an early stage with local tax authorities, institutions will be engagement best placed to ensure that future regimes are implemented in a practical way Importance of developing a • FTT renders trading in taxed instruments less attractive, thus business cases for activities in such instruments need to strategic response be reviewed, in particular for those cases where margins are tight already • Depending on the results of the business case analysis, trading strategies and asset allocation need to be reviewed • Where trading in taxed instruments is offered as a service to customers (e.g. brokers trading on behalf of asset managers), the contracts with the customers must be reviewed (on pricing, at a minimum); business relations might be re-defined or even given up Importance of understanding • Requires the assembly of a combined team with representatives from the business, operations, IT and Tax and Legal the underlying business from in particular a product, operational, and • Across this team issues to be considered include products traded, identity of counterparties, legal entities involved, legal perspective interaction between desks, how transactions are cleared and settled, etc. Importance of legal • Necessary to have a clear understanding under existing legal documentation as to who will bear the cost of FTT, documentation requiring a review of existing terms and conditions with customers and counterparties • In particular, review agreements to determine accountability where there are chains of brokers

Financial transaction taxes February 2013 PwC 18 We now turn to the practical steps required as “The impact assessment underpins part of the integrated strategy set out on page 16. Impact Assessment this strategy.” The impact assessment underpins this strategy. It is the foundation of the governance structure, the constructive engagement strategy and identification of the operational challenges for Governance implementation and allows timely formulation of Constructive business strategy. Engagement Business Implemen- with Response tation The assessment needs to use a structured Government methodology comprising a ‘top-down’ analysis of tax technical requirements coupled with a ‘bottom- up’ analysis of the business transactions and processes. This provides the best chance of obtaining a complete picture of how an FTT regime will impact across the organisation. The four key phases are set out below.

1. Scoping and 2. Requirements analysis 3. Current state 4. Gap analysis and kick-off assessment implementation planning

• To keep the impact assessment • With FTT regimes in a state of • Through the current state • The gap analysis aims to focused and resource used flux we can expect many new assessment, the aim is to identify gaps between the effectively and efficiently, this amendments and details to be identify the key attributes such current state assessment initial phase confirms scope introduced. as transactions, products, performed in phase 3 and the with key stakeholders and • This phase will be on-going counterparties, processes and requirements analysis from sponsors. throughout the project work systems which will be affected phase 2, and understand and • A series of targeted workshops and will involve monitoring by the implementation of the prioritise changes by can be run to confirm the list any changes and updates to change in legislation. establishing a strategic of businesses, products, and make sure all the latest roadmap alongside detailed systems that are expected to be developments are captured technical specifications. in scope. and considered. • A plan is developed for the impact assessment, including FTT team structure, roles, and responsibilities.

Financial transaction taxes February 2013 PwC 19 The structure will evolve during the various phases “Setting up the right governance is of the programme as its objectives change. That Impact Assessment critical to ensure that all the key said, the key focus areas for governance will remain stakeholders across the institution as follows: are involved, kept up to date with • Engagement strategy and impact assessment: Governance latest developments, drive the ensure the high-impacted areas are mobilised to implementation and report on focus the attention on the business and Constructive progress.” territories where the most effort is expected to Engagement Business Implemen- with Response tation be required, and develop the implementation Government approach.

Turning to the governance structure, setting up • Implementation: ensure that adequate progress • In addition, close coordination should be in the right governance is critical to ensuring that the is made by all impacted parties, and coordinate place with the other key regulatory/change key stakeholders across the institution are the various FTT responses (if more than one has programmes to manage synergies and share involved, kept up to date with latest developments, to be delivered simultaneously). resources where relevant. drive the implementation and report on progress. • Ongoing maintenance: whilst embedding • A Global Steering Committee overseeing the compliance into business-as-usual activities, implementation of all relevant FTTs should be monitor for new products and new taxes to in place, and could be constituted as follows: inform key stakeholders and anticipate changes.

Global Steering Committee (All FTTs) • Overall governance/decision-making authority, providing program oversight, direction, resources/funding and approval Regional Functional Business coordination representation representation

Investment • Track the developments of FTT in all relevant jurisdictions and inform FTT monitoring APAC Tax the Steering Committee and relevant parties and design team Bank • Constituted of tax experts to understand the rules and Operations/Change specialists to derive the operational impacts EMEA IT Asset Mgt

• Coordinate the activities across the various working groups and ensure timely communication to all stakeholders Americas Operations Wealth Mgt • Track progress across the different FTT regimes and different locations Central PMO and coordinate analysis and implementation Finance Retail

• Representation from key regions (and key relevant territories), key functions and all impacted businesses is essential to consistent and Custodian effective constructive engagement and implementation

Financial transaction taxes February 2013 PwC 20 1. What issues should be focused on? “The time for constructive • Identification of the provisions to be focused Impact Assessment engagement is now. The quicker this on should begin with identification of the areas process is undertaken, the more of difficulty arising from: effective it will be.” - PastFTTs(e.g. HongKongStamp Duty, Governance UK SDRT); Effective discussions with government and Constructive regulators is a core component of the integrated - Recently in force FTTs (e.g. French and Engagement Business Implemen- Italian FTT); and with Response tation strategy. In order to be effective, the Government communication needs to be informed by the - Proposed FTTs (e.g. EU FTT). impact assessment so that the debate is focused on • Figure 7 below sets out the key areas that we the key issues relevant to the business. 3. When should constructive engagement will expect to be of interest to financial start? Having identified how an institution is impacted by institutions. the current and proposed FTTs (which will be a • The time for constructive engagement is now. 2. Who should be engaged? function of the business structure and business • With a stated start date of 1 January 2014 for model), an institution’s constructive engagement • In our view, the most effective and constructive the EU FTT, it is essential that any engagement strategy needs to address three questions. engagement with government will be that starts as soon as possible to have the best which seeks to inform the policy intent with chance possible of shaping the EU practical input/experience (e.g. limiting the Figure 7: Key areas of focus for Commission’s proposals. instruments in scope, etc.) rather than arguing constructive engagement against an FTT in its entirety. • Similarly, engagement with government bodies Transactions on the other proposed FTTs (e.g. Spanish, Instruments Parties in Basis of • Our experience with the French and Italian /activities in Portuguese, etc.) should be undertaken as soon in scope scope calculation FTTs is that the most effective and constructive scope as possible to have effective impact. engagement has been indirect debate via the local industry bodies (e.g. AMAFI, AFTI, etc.). • Consultations or discussions should not be limited to the proposed FTTs as the guidance • With respect to the EU FTT, it would be most and practice around in-force FTTs (e.g. Italian, Rate of tax Exemptions Reporting Tax payment productive to liaise with governments French, etc.) remains in its infancy. The implementing the FTT as they will be closest to guidance and practice will have practical the EU FTT implementation issues in their implications so it is important that discussions countries. with local tax authorities take place to reach the right outcome. As with the proposed FTTs, the quicker this process is undertaken the more effective it will be.

Financial transaction taxes February 2013 PwC 21 As with the other components of the strategy, this “A key factor that will drive the type will be driven from the results of the impact Impact Assessment of business response required will be assessment. whether the FTT operates a residence For a given FTT regime, a key factor that will drive model or an issuance model.” the type of business response available will be Governance whether the FTT operates a ‘residence model’ or an Turning to the Business Response component of ‘issuance model’: Constructive the integrated model, this centres around potential Engagement Business Implemen- • Residence model – the FTT is levied by with Response tation adaptations to an institution’s business model in reference to the location of the parties to the Government response to the impact of FTTs. transaction (e.g. the original draft EU FTT Such business and operational planning could released in September 2011). Depending on which model a given FTT falls into, range from minor changes to trading models in • Issuance model – the FTT is levied by reference the impact on the business model and investment response to the cost of the tax, through to to the location of the issuer of the securities strategy for financial institutions will vary. The abandoning businesses that are rendered nonviable being traded (e.g. the French and Italian FTTs). table below sets out examples of some of the by the additional cost of FTT regimes. business response techniques that might be adopted, depending on whether the FTT follows a residence model or an issuance model.

End investor considerations

Residence model (e.g. original draft EU FTT Directive) Issuance model (e.g. French and Italian FTTs)

• FTT charge will arise regardless of the market in which • Incidence of tax will depend on the market in which the Portfolio financial instruments are issued. The incidence of tax will instrument is issued. It may also depend on the type of changes therefore depend on the type of instrument traded (e.g. instrument traded (e.g. equities or equity derivatives) equities or equity derivatives) depending on the precise structure of the regime

• Trading with counterparties inside the FTT zone will give rise • Transacting over taxable instruments will give rise to a FTT Transaction to FTT charges, whereas transactions with counterparties charge regardless of the counterparty, so the focus will counterparty outside the FTT zone will not instead be on who bears the economic cost under the contractual terms

• Transactions may or may not be subject to FTT, depending on • Potential to net purchase and sale transactions, depending on Trade the group company which enters into the transaction and the provisions of the regime (this may involve using a single Infrastructure whether or not it is treated as established in the FTT zone broker for purchase and sale transactions)

Financial transaction taxes February 2013 PwC 22 The extent to which this is an issue only for brokers The implementation phase is focused on the and custodians, and whether other types of Impact Assessment practical steps required to deal with FTTs on an institutions need to consider this, will depend on ongoing basis, including systems requirements, the form of the regime. This is considered on the reporting and payment processes, infrastructure following page. Governance requirements, etc. Through the mapping exercise, the institution For each product within scope of the FTT, an needs to build an understanding of: Constructive exercise needs to be undertaken to map the existing Engagement Business Implemen- • booking entity and account structure with Response tation systems and processes in order to identify the Government changes that will be required to enable the • the clearing model used for transactions requirements of each respective FTT (domestic and • process and systems interfaces EU FTT) to be met. An example systems map that • legal documentation in place with clients • interaction between front-end systems and the might be developed in a banking context is set out and providers clearing and settlement process in Figure 8 below. • the legal capacity in which an institution acts • location of infrastructure supporting the business • specifics from clients and transaction types which might trigger exemptions • interaction between desks

Figure 8: An example systems map for a banking institution

End investor/fund/asset manager • Pricing • Client on-boarding – classification Client • Legal agreements Securities Account • Nature of client request /Central Counterparty • Confirmations /CSD/sub-custodian

Desk Front end system Core banking system Settlement interface • Product type • Account structure • ISIN codes/security ID • Payment processes • Transaction type • Flagging of exemptions • Calculation logic • Netting approach • Client type • Identifying in-scope products/clients • Reporting engine • Clearing model • Position type (Client vs. • ISIN codes/security ID • Report delivery/ proprietary) • Calculation logic declarations • Available exemptions • Collection tax events

Execution broker Settlement agent

Financial transaction taxes February 2013 PwC 23 However, whether this will be the case for future “Depending on the design of the FTTs depends on the precise form of the FTT. Impact Assessment FTT.... the operational burden could Conceptually, this point can be illustrated by be expected to fall on end investors as reference to the FTT spectrum introduced well as brokers, custodians” previously in this document (we have reproduced this below in Figure 9). Governance

For existing FTT regimes, the operational For a new FTT which is narrow in scope, closer on Constructive impact has fallen largely on the brokers, the spectrum to UK SDRT, we can expect the Engagement Business Implemen- operational burden to fall primarily on brokers, with Response tation custodians and settlement venues (including Government clearance services and Central Securities custodians and settlement venues. Depositories). Therefore for end investors (such A wider scope FTT, however, may give rise to as asset management institutions), FTTs have multiple charges for a number of financial Accordingly, if it is concluded as part of the impact primarily had an economic (i.e. cost) impact institutions involved, and place the FTT liability on assessment that the regime under review is very rather than an operational impact (though in the each such institution (indeed, this is the approach wide in scope, institutions such as asset managers case of the French FTT this cost may be of the current draft EU FTT). will need to be much more focused on operational mitigated through netting, for example). This requirements as part of the implementation phase has limited the operational work required at the For such a regime, therefore, the operational than they would be for a narrow scope FTT. Issues implementation stage. burden could be expected to fall on end investors, such as whether infrastructure needs to be as well as brokers, custodians, etc. developed in-house or whether third party service providers are engaged for operational processes will need to be considered carefully.

Figure 9: The spectrum of FTT regimes Increasing operational impact for end investors UK SDRT EU FTT proposal

• Tax based on location of securities • Tax based on location of parties • Few instruments in scope • Many instruments in scope • Few transactions in scope • Many transactions in scope • Exemptions, e.g. market maker relief • Few exemptions • Single charge • Purchaser and seller liable

Financial transaction taxes February 2013 PwC 24 How PwC can help

Our capabilities and tailored approach

Financial transaction taxes February 2013 PwC 25 We have worked on a number of engagements structured to ensure that all affected transactions “How PwC can support the assisting clients with preparing for the French and projects are captured, but flexible enough to integrated strategy” FTT. We also have a long history of advising respond to regimes that in many cases are not yet institutions on existing FTTs, such as the UK SDRT finalised. and Hong Kong stamp duty. The key features of our approach are set out below. With this experience we have developed an approach to help clients prepare for FTTs to come in the future. This approach is sufficiently

A single team Our FTT network comprises a team that brings together industry knowledge, combining tax operational expertise, and tax technical specialists. This allows us the best technical expertise chance of identifying all of the products, transaction configurations, and with industry business lines that will be impacted by FTTs and addressing the operational knowledge implications at an early stage. Our experience working with a number of existing FTTs, including the French FTT, allows us to identify the scenarios that commonly give rise to charges under FTTs. We have extensive experience in wider operational taxes matters, such as FATCA, for example.

A structured We have developed a structured approach comprising a ‘top-down’ analysis of approach which tax technical requirements coupled with a ‘bottom-up’ analysis of the can be replicated business transactions and processes.

A global network We have developed a network of FTT specialists across Europe, with with FTT technical representation in all countries with a domestic FTT and all countries involved and consulting in the ECP process. Each jurisdiction includes a tax specialist and a consulting specialists in each specialist so that we can cover the tax technical and operational side of any jurisdiction new regime. Our team members frequently have relationships with local industry groups and tax authorities to provide an avenue for constructive engagement with governments.

Financial transaction taxes February 2013 PwC 26 “How PwC can support the integrated strategy”

FTT impact assessment FTT Impact assessment • Assist in workshop and/or questionnaire design • Briefing and training for the business Current Proposed Current FTT rules FTT rules state • Facilitate workshop • Advise on technical requirements • Undertake gap analysis • Document current systems and processes • Project management

Governance • Reviewing governance structure, benchmarking, and providing PMO support Governance where required

Engagement with governments • Helping to devise the message and strategy around the engagement with government • Alongside industry and other professional organisations, we can bring our specialist Constructive technical expertise to bear on issues subject to consultation. Engagement Business Implement- • Using links to industry bodies with Government Response ation

Business Response • Technical input to identify the FTT consequences of proposed changes to the business strategy and model

Implementation • Reviewing tax calculation logic and decision trees • Reviewing changes to systems architecture • Developing testing procedures • Pilot testing • Reviewing third party vendor solutions

Financial transaction taxes February 2013 PwC 27 Country Localcontacts–Taxandadvisory “Our Global FTT network” Austria [email protected], [email protected] Belgium [email protected], [email protected] Estonia [email protected], [email protected] [email protected], [email protected], marie- France [email protected], [email protected], PwC Global FTT network [email protected] and [email protected] [email protected], [email protected] and Germany Network established comprising specialists across [email protected] all 11 enhanced cooperation procedure Greece [email protected], [email protected] jurisdictions and all domestic FTT locations. Hungary [email protected], [email protected] Regular communication across the network to share latest information. Hong Kong [email protected], [email protected] Ireland [email protected], [email protected] Local contacts available to your [email protected], [email protected], business globally Italy [email protected], [email protected] and [email protected] Japan [email protected], [email protected] [email protected], [email protected], Luxembourg [email protected] and [email protected] Network comprises tax and consulting specialists. [email protected], [email protected], Netherlands PwC capability to assist you on strategic [email protected] and [email protected] response, governance, systems and Portugal [email protected], [email protected] processes aspects as well as tax technical input Slovakia [email protected], [email protected] Slovenia [email protected], [email protected] South Africa [email protected], [email protected], Spain [email protected], [email protected]

Network includes individuals closely involved in Sweden [email protected], [email protected] discussions around the scope of domestic and Switzerland [email protected], [email protected] EU FTTs. [email protected], [email protected] UK [email protected], [email protected] and This ‘inside track’ will provide you with [email protected] the very latest position as the legislation Ukraine [email protected], [email protected] and practical implementation of FTT [email protected], [email protected] and US regimes evolves [email protected] EU Public Affairs Group [email protected], [email protected]

Financial transaction taxes February 2013 PwC 28 “We have established a strong network of Tax and Advisory experts across Europe to monitor the development of FTTs. They regularly issue newsflashes and webcasts to update our clients and our teams.”

Financial transaction taxes February 2013 PwC 29 Appendix – the EU FTT

The latest draft Directive for the EU FTT was This page and the four pages that follow focus on released on 14 February 2013. The key aspects of the scope of the charge. We then turn to other the proposed regime are set out in this Appendix. aspects of the regime including the rates of tax and exemptions from the charge.

The Directive applies to ‘…all financial transactions, on condition that at least one party to the transaction is established in the territory of a participating Member State and that a financial institution established in the territory of a participating Member State is party to the transaction, acting either for its own account or for the account of another person, or is acting in the name of a party to the transaction’ [Article 3]