Merkel-Sarkozy Tobin tax proposal finds little support

The surprise proposal by German Chancellor Angela Merkel and French President Nicolas Sarkozy to introduce a “financial transactions tax” across Europe to dampen market speculation appears to have attracted very few supporters, with analysts expecting the UK to steer clear of such a move.

The proposal for the tax  – also known as a Tobin tax after economist James Tobin, who first suggested one in relation to currency transactions in the early 1970s -  emerged from talks between Merkel and Sarkozy yesterday aimed at thrashing out measures to tackle the sovereign debt crisis that is spreading across the eurozone.

The proposals put forward by the two leaders did not include the introduction of euro zone bonds or expanding Europe’s rescue fund. Instead,  Sarkozy and Merkel called for a “financial transactions tax” and constitutional amendments requiring euro zone members to balance their budgets.

Reports suggest that the Merkel-Sarkozy proposal for a Tobin tax will be included in a letter to be sent to European Council President Herman Van Rompuy, who will in turn consult with other Eurozone members.

As well as looking to tame aggressive speculative activity, a Tobin tax could be viewed by Merkel and Sarkozy as a useful means of generating badly needed revenue.

Whatever their intentions, the proposal has not impressed analysts. James Hamilton, analyst at Numis, expects the UK to veto a proposal that effectively amounts to “a tax on the UK to help fund the failing Euro experiment”.

He adds: “Were the UK government to adopt the tax, however, arbitrage channels would widen, markets would become less efficient and the volume of trade would diminish albeit only modestly.”

Looking at stocks who are exposed to the introduction of a financial transaction tax, Hamilton notes that interdealer broker  ICAP (LON:IAP), especially given the global nature of its operations, and rival Tullett Prebon (LON:TLPR), are likely to less impacted than the London Stock Exchange (LON:LSE) or derivatives trader IG Group (LON:IGG), as the latter two would find it more difficult to relocate trades.

The analyst notes that ICAP and Tullett’s products and customers are global, with the companies having market presence all over the world. As a result relocating trade to alternative venues would be relatively easy for them, although he foresees some potential difficulties in their circumventing the Tobin tax if staff remained in the tax zone.

As for the LSE, Hamilton points out that there are a number of the large cap stocks traded on the exchange that have multiple jurisdiction quotes, for instance HSBC.

“Inevitably large institutions [like HSBC] will wish to minimise the tax they pay and potentially change the location of their trade. We would expect volumes to decline particularly for the likes of high frequency trade.

As for IG Group, Hamilton reckons it may be difficult for the company to relocate its European trade. While it is possible for the trades undertaken to be sent to a computer outside the tax zone, this path could be blocked by the authorities.

Hamilton adds: “The percentage gap between the cheapest and most expensive trading venues will decline proportionately to the cost of the tax. At this point, service, execution and all the other advantages IG holds over its competitors become more of a differentiator.

“Volumes have historically proved to be very price sensitive and while we believe IG would be able to pass the tax onto its customers, volumes would be expected to be negatively impacted."

Numis currently rates ICAP shares, which trade on a forward multiple of 10, at ‘hold’, with a price target of 535 pence. The broker has Tullet shares, trading on a multiple of 7.6, as a ‘buy', with a 486 pence price target.

LSE shares, on a multiple of 10.8, are rated a ‘hold’ by Numis, with a price target of 948 pence, while IG, trading on forward multiple of 11.4, is deemed a ‘buy’, with a price target of 594 pence.

More broadly, Hamilton says that a Tobin tax would very disproportionately fall on the UK, with the accrued revenue being spent in (continental) Europe: “Consequently it would seem obvious that the UK would utilise its veto and reject a tax that would undoubtedly reduce UK GDP, increase unemployment and reduce the tax take in the UK as trade relocates outside the tax zone.

He points out, however, that the Liberal Democrats do support a Tobin tax and “given the disproportionate influence they have in government, the risk cannot be ignored".

UBS analysts also believe that a Tobin tax could have significant, negative consequences for volumes, noting the example of Sweden in the 1990s where such a tax resulted in a hefty 85 percent fall in volumes.

The analysts believe the UK, with its huge financial services sector, would be worst hit and therefore most unlikely to back the proposal.