The European Repo Market, the FTT and Moscovici, new Tax Commissioner

The European repo market was last in the news when the Commission issued its FTT proposals last year in February.  France, through the voice of the new Tax Commissioner Pierre Moscovici, then Minister of Finance, immediately questioned the inclusion of the European repo market in the FTT plans:

To include such [repo] transactions will simply pose a major risk to the functioning of the credit market.

Yet it turns out that  the European repo market is European but in name.

Consider the membership of the European Repo Council (ERC), the private lobby that champions the interests of the repo market players in Europe. Of its 75 members in September 2014, 19 sit on the European Repo Committee, the governing board of the ERC.  Eleven of these – five headquartered in the EU - are on the FSB’s 2013 list of Globally Systemically Important Banks (G-SIBs). 

Table 1 Membership of the European Repo Committee, September 2014

Headquarters	G-SIB	Not G-SIB
Eurozone	Societe Generale (Newedge), Deutsche Bank, Unicredit	Caixabank, Bankia, Intesa Sanpaolo, Commerzbank
Europe	UBS, HSBC, Credit Suisse, Barclays
US	JP Morgan, Goldman Sachs, Citigroup
Asia		Nomura, Daiwa

 The ‘European’ repo market captures the systemic footprint of global banks headquartered in Europe and elsewhere. Its growth has been driven by what Haldane called the ‘collective migration’ of bank business models to interconnected, leveraged, high-yield trading activities. 

The (shifting) French position on the FTT

Cornelia Woll's analysis of hedge fund regulation in Europe points to a French puzzle: whereas UK and Germany behave in negotiations as expected to defend their type of financial capitalism, France changed positions ' as a result of electoral and geopolitical considerations'. The same occured with the French position on including repos in the perimeter of the FTT.

First, the French government, then led by Sarkozy, was the only government to offer an official reponse to the consultation that the European Commission initiated on a financial tax in Europe in 2011. In that response, the French government said :

Les repos, particulièrement lorsqu’ils sont conduits avec des entités non régulés, peuvent effectivement être à l’origine de vulnérabilités du secteur bancaire. Toutefois, le marché interbancaire joue un rôle très important de réallocation de liquidité. Une taxe qui découragerait l’usage de ce type d’instrument serait par nature peu discriminante et ne constitue pas le meilleur moyen de réduire ce risque, qui relève plutôt d’une amélioration de la qualité du collatéral et des incitations données aux contreparties non bancaires. En particulier, une interdiction de la collatéralisation par des instruments financiers sans prix de marché clair (niveau 3 de valorisation selon les normes IFRS) pourrait être envisagée.

Paraphrased shortly, repos  generate banking vulnerability, (as it is well established since the collapse of Lehman Brothers). Yet we cannot tax it because the repo market plays a key role in the re-allocation/distribution of liquidity. Instead impose limits on the type of collateral acceptable.

That position changed radically  in September 2011. The French and German 'engine' behind the FTT co-signed a letter to the European Commission urging it to tax repos/securities lending, particularly when 'these serve the purpose of short-selling'.  The context made all the difference: the turmoil in European financial markets throuhghout the summer of 2011 prompted France, alongside Italy, Belgium and Spain, to ban short-selling of financial shares, in France for eleven of its largest financial institutions.

Then, in September 2012, when the German and (now socialist) French governments were trying to harness support for a regional rather than European implementation of the FTT (through the enhanced cooperation procedure),  their joint letter again supports taxing repos.

But once the European Commission publishes its draft FTT directive in February 2013, the French government shifts position again. By June 2013, Pierre Moscovici joins the widespread view that taxing repos is a step too far, agreeing with the ECB that to include such transactions will simply pose a major risk to the functioning of the credit market. Clearly successive French governments need not share their assessment of the link between repos and systemic risk.

Put this in the context of deliberations of reform for the shadow banking system. The recent FSB recommandations describe repos as the shadow banking activity, linking it to leverage, asset bubbles and financial instability. Recently, the Financial Times threw its weight behind a tighther regulatory regime for repos. 

 So, how do we make sense of the shifting French position? One answer may be that the French government is now prepared to back away from its promise that it would get a much stronger FTT regime at European level compared to the narrow French FTT on equities (that excludes repos). A broader answer may be that such radical measures as taxing repos (with the trade-offs it involves for liquidity of securities markets, including government bonds markets) can only be conceived and adopted during crisis times. The European Commission certainly designed an increasingly radical FTT during moments of unprecedented turmoil in European finance. Yet adoption may be far more difficult during a benign environment, as Europe seems to be enjoying at the moment. If the later is true, we should expect that after the September elections, Germany will join the French position on repos. The difficult questions of the systemic consequences of repo markets will then again be only asked by the FSB.