New EU Tax Could Dramatically Increase The Cost of Foreign Exchange For Businesses

July 23rd, 2012

Foreign exchange costs could rise dramatically for EU companies with the introduction of a new financial transaction taxation, which could increase the costs for foreign currency exchange transaction by up to 18 times. This tax which has been proposed by the European Commission could add tax of 0.1% on derivatives, equity and bond transaction beginning in 2014, which will generate an estimated €57 billion every year.

This has caused uproar among many London based companies and institutions as the new tax could pose a very serious threat to the City’s future. It will dramatically increase the cost of foreign exchange transactions with Europe, affecting the most liquid and traded products, pension funds, insurance companies and major corporates will be those most badly hit.  What will end up happening is that these taxes will be passed on to their end-users.

While spot foreign exchange would not be affected, forex forwards will and this could directly increase the cost of transactions by up to seven times. To provide an example, the cost of a euro/dollar swap with a value of €25 million, would be subject to a tax rate of 0.01%. The current transaction cost for the end-user is €279, but when the new proposed tax is factored in, it could add €2,500 to the cost, which would be levied on both dealer and financial institution.

It is believed that if the new tax goes ahead, businesses will be driven out of the EU to more favorable jurisdictions. It is estimated that around 70% would be forced to migrate which could be anything from mobile phone companies to banks.

This foreign exchange tax would in effect penalise businesses trading with Europe, the combination of indirect and direct costs taking place as a result of a reduced liquidity in the market and wider bid-ask spreads, would mean that raising €1 in tax would likely cost users more than the amount of the tax itself.  Europe could once again be shooting itself in the foot.

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