Saturday, November 17, 2012

This is what happens when regulators don't understand the market place

Dumb regulation will usually result in "unintended consequences". In the area of securities regulation, it is often the "unintended participants" who end up paying the price. Just as the derivatives regulation in the US is potentially hurting energy merchants (see discussion) and could even disrupt the energy markets, the latest anti securities industry drive in France is not achieving what it was supposedly designed for.

After Hollande claimed that his main adversary “was the world of finance”, he pushed to implement transaction tax on those evil speculators. Except that it didn't quite work out the way he intended it.
SFGare: - As France begins collecting its financial-transactions tax this month, it is becoming evident that President Francois Hollande’s levy is hitting all but the people it was aimed at: speculators.

Hollande, who called finance his “main adversary” during his election campaign, pushed through in August a 0.2 percent transaction tax on share purchases, making France the first and only country so far in Europe to have such a levy. Many investors have been escaping the tax using so-called contracts for difference, or CFDs, offered by prime brokers that let them bet on a stock’s gain or loss without owning the shares.
The small investor will indeed end up paying that tax. But the larger, more sophisticated players, including institutional funds, will simply move to the CFD market. A CFD contract is basically a forward agreement on a stock, and index, a commodity, or anything else for that matter (see attached overview). It is illegal in the US to trade forwards on a single stock, but the practice is quite common in Europe, Asia, and Australia.

In fact a fund that wants to trade a French stock (including shorting it), can simply execute a CFD with a UK (or some other) broker. One doesn't physically own the shares, but will get all the economics of the stock without fully paying for it. That's right, not only does the "speculator" avoid the new French tax, but the CFD market allows these investors to put on leverage that would be difficult to achieve in trading the stock directly. It is also a more efficient way to short stocks.

So while the small French investors are paying these new taxes, the institutional "speculators" that use leverage, active trading, and shorting, have a loophole that would be quite difficult for French regulators to close. Well done, Mr. Hollande.

CFD market information sheet
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