Who Needs a Trading Tax When Interest Rates Are Zero?

European regulators are implementing plans for a trading tax to penalise ‘short term speculation’ and ‘reduce volatility’. While it is unclear that a trading tax can achieve either of these objectives, one certainty is that a trading tax will lead to less turnover, lower profits and job losses in the financial sector. But is a trading tax really necessary in the current environment where broker/dealers are already feeling the pain of low volumes?

One inadvertent side-effect of low interest rates is that it chokes off trading. Broker commissions can run from 5bp to 25bp on a bond transaction depending on the size of the deal. When base rates are 4 or 5%, the commission as a proportion of one year return is almost negligible, so few investors will baulk at executing their intended trade. When base rates are 0%, however, the trade motivation must be compelling before an investor proceeds with the trade – simply put, the trade starts out in negative territory at the annual horizon.

This became a major hurdle during our flagship First Degree Long Horizon Absolute Return Fund’s recent rebalancing exercise. We ranked trades on a pre- and post- commission expected return basis, with two of our six candidate trades being knocked out simply because trading commission mopped up too much of the juice.

Brokers and dealers know this and it remains a mystery why they are still reluctant to cut their commission – when confronted with the option of executing at a lower fee or shelving the deal they choose the latter.

Politicians with a vendetta against the finance industry need not worry about a trading tax – their Central Bankers are effectively squeezing profits and shutting down the industry for them.