Alternative Investment Management Association

Transcription

1 European Commission Directorate-General for Taxation and Customs Union Rue de Spa 3, Office 06/31 B-1049 Brussels Submitted via to: Dear Sir / Madam, 19 April 2011 AIMA s submission in response to the Commission s Consultation paper on Taxation of the Financial Sector (paper dated 22 February 2011) Introduction AIMA is the trade body for the hedge fund industry globally and we represent all constituencies within the sector including hedge fund managers, fund of hedge funds managers, prime brokers, fund administrators, accountants and lawyers. Our membership comprises over 1,200 corporate bodies in 45 countries, of whom around 65% are managers. We thank the Commission for the opportunity to comment as part of its public consultation on its proposals for taxation of the financial sector, specifically with respect to the Commission s wish to: a. test the assumptions made in the paper and collect related evidence as to the definition of the problems the Commission seeks to address; b. assess the impacts of the policy options; and c. consult on more detailed aspects of the feasibility and design of policy options. We also note that the Commission s rationale for future, additional taxation of the financial sector includes: - financing to support the recent financial crisis, fiscal consolidation and possible under-taxation of the sector; - deterring systemic risk and excessive risk-taking; and - uncoordinated national measures which can give rise to migration, distorted competition and double taxation. Preliminary comments While we understand those bases for considering additional taxation, we do not agree that a Financial Transactions Tax (FTT) and/or a Financial Activities Tax (FAT), as proposed in the paper, are appropriate or workable measures for the Member States of the EU. We do not believe that such EU-wide taxes should be introduced, even if there were consensus among all Member States. We note that the Commission says that debate would be held later as to use of revenue that would be raised by the taxes it proposes. That does not conform to the principle that taxes are introduced to fund specific areas, sectors or activities. We consider that the proposed taxes could, unless applied globally, lead to migration outside the EU and redomiciliation of funds which have already recently re-domiciled from tax-neutral jurisdictions to EU 1

2 jurisdictions. This is particularly the case for FTT in respect of which one needs to recognise that trading of financial assets can take place anywhere in the world and the establishment of an FTT would simply lead to the same assets being traded outside the EU, in the USA or in Asia. Aspects of competitiveness are especially important in this respect as the competitiveness of the EU in financial services could be impacted in a material way if either FTT or FAT were implemented without global agreement, in a manner that is not aimed at achieving clearly articulated objectives or in a way which is disproportionate to the stated aims. One of the key points of discussion during the Brussels Tax Forum was the objective for introducing FTT or FAT. Multiple objectives were suggested, from being a means to raise tax to fund development aid commitments to being a means to correct market failure. Many of these suggested objectives are conflicting and may even be mutually exclusive. During the Forum, it appeared that there was no movement towards agreement on what the objective of such taxes should be. In our view, without a common agreed objective, any policy is unlikely to succeed. Representatives from the OECD and IMF both noted the need to define objectives and we agree with their comments. Accordingly, there should be a thorough economic impact assessment of the effects of FTT or FAT. That assessment should be completed so that market participants can be confident that any policy response is clear and proportional to its stated aims. Hedge funds, the financial crisis and Systemically Important Financial Institutions (SIFIs) (reference Section 4.1 of the paper) We support a long-term, sustainable regime to regulate SIFIs and that clearly necessitates assessment of any institution which might be considered systemically important. There should, however, be consideration of appropriate and objective criteria for the assessment of systemic importance, particularly with regard to non-bank financial entities such as hedge fund managers. As an important preliminary point, we believe that the criteria should be applied in as consistent a manner as possible across industries and sectors and market participants. We believe that no hedge fund based or operating anywhere in the world should be deemed systemically important, in terms of the potential to threaten financial stability. This is because, in our view, no single hedge fund is today sufficiently large, leveraged, complex or interconnected that its failure or financial stress would cause a market disruption severe enough to destabilise any financial system. In contrast to many other financial institutions, hundreds of hedge funds closed during the financial crisis, without causing material financial stress to any of their counterparties. It is estimated that, between 2000 and 2009, around 5,000 hedge funds closed or went into liquidation globally, with a significant proportion doing so during the latter half of that period ( ). 1 Despite the significant increase in closures during the crisis and over a period of acute stress, no hedge fund closure gave rise to destabilising stress in its counterparty relationships or the market at large. As the designation of companies as systemically important is designed to remove the need for (and reliance on) government intervention and funding of private financial institutions and as such assistance was given during the financial crisis to prevent financial meltdown, those companies who participated should certainly be considered in assessments of systemic importance. It is to be noted, however, that hedge funds were never considered for such assistance. Evidence shows that hedge funds do close but they do not anticipate or seek government assistance and their closure does not create risk for their counterparties. No hedge fund or other private fund receives any US federal or EU guarantee (as deposit-taking banks do). 1 The HFR Global Hedge Fund Industry Report for the second quarter 2010 suggests that at the height of the financial crisis in 2008, 1,471 hedge funds closed, which can be compared against the closures of hedge funds five years earlier (in 2003) of only

3 Hedge funds are heterogeneous market participants whose activities are often counter-cyclical; they tend to be contrarian or to look for inefficiencies and, through arbitrage, make markets more efficient, providing critical benefits to market liquidity. Hedge funds constitute a small part of the financial services industry, compared with banks, insurance companies, mutual funds and pension funds, and employ significantly lower levels of leverage (which is typically secured) than banks and some other financial institutions. In summary, most recent experience shows that hedge funds are safe to fail, even if they are not immune from failure. Further, registration of hedge fund managers with all the G20, main securities, regulators (in the US, likely to be a requirement from July, in the EU, from 2013 while being regulated under the laws of individual Member States in the meantime) means that data is available to enable assessment of any potential for systemic risk and will allow monitoring and reassessment of any firm, should circumstances change and cause concern at any time. Any financial company which is already subject to oversight by a G20 market regulator will now be subject to information-sharing and cooperation agreements and examination. The UK FSA s hedge fund survey report of February considered the UK s 50 largest hedge fund managers by assets under management (AUM), in terms of hedge fund assets they manage and qualifying funds for which they undertake management activities. It found that, as at 31 October 2009, there were few asset classes where the aggregate footprint 3 of the hedge fund sample was greater than 3% of any total market size and in European equities, for example, they had gross positions equal to 0.9% of the value of European equity markets. The FSA s footprint definition can also be used to measure a hedge fund s leverage because it looks at footprint and equity. The February 2010 survey concluded that, in October 2009, the funds covered had a footprint of 328% and borrowings of 202% of net equity i.e., approximately 2 or 3 times leverage under the models. The UK FSA s most recent hedge fund survey report (February ) of the same manager constituents found that, as at 30 September 2010, the footprint of surveyed hedge funds remains small within most markets, with leverage largely unchanged, so that risks to financial stability through the market channel appear limited. Footprint relative to net equity (i.e. net asset value or NAV ) was 345% for September 2010 and borrowings were 258% of net equity, i.e., again approximately 2 or 3 times leverage. In addition and importantly, hedge fund leverage is typically secured the parties that provide the leverage hold collateral from the funds, limiting the amount of risk. AIMA s comments on some specific questions set within the paper Nothwithstanding that we do not agree with the proposal for a FTT or FAT, we have these specific comments (numbers in brackets refer to options enumerated in the paper). Section 4.1 Problem definition Q2: Do you find it problematic that Member States introduce patch-work national measures without coordination? Responses to the financial crisis were responses to particular Member States problems and those problems have been different; accordingly, tailored approaches to individual, case-by-case issues should apply FSA Report February 2010 A measure of the scale of a firm s presence, its activity, concentration and dominance in a given market or asset class. It takes account of use of equity raised from investors (i.e., the fund manager s AUM) and any money borrowed, use of financial instruments, trading techniques or structures that allow a firm to extend its financial presence beyond what is possible using equity alone. 3

4 Q4: Which sectors and activities within the financial sector had most to do with the crisis? We do not offer comment on whether any other sectors or activities were responsible for the crisis but we repeat that hedge funds were not responsible, although they were affected by it. We repeat our comments made above, in opening here, with regard to the features of hedge funds and them not being systemically important financial institutions. We add that: a. A hedge fund is a simple business model, for which risk is more easily measured and managed. A fund usually has only a small number of legally distinct fund vehicles; compare that to a bank: the largest investment banks transact globally, in most markets, and operate multiple business lines through a large number of interconnected corporate entities and special purpose vehicles (Lehman Brothers had about 300 affiliated and associated companies at the time of its collapse). b. A hedge fund manager manages assets for third parties (as distinct from employing own capital) and is not exposed to any direct losses in consequence. Hedge fund managers relatively small balance sheets limit the range of activities they can undertake, as compared with banks. c. It is important to recognise the alignment of interest between a hedge fund manager and its investors. Managers typically earn fees in exchange for acting as specialist investment advisers to a small number of private and institutional investors - sophisticated investors able to withstand losses on assets and often do so by funds investing via a single, well thought-out strategy and seeking long-term, absolute and stable returns. d. Although it is said that hedge funds are able to use their small size and flexibility to engage in a wide variety of activities (e.g. going long and short, and engaging in derivatives), it is common for them to be dealing primarily with only their prime broker and selected large banking institutions and only engaging in a few markets or types of activities. Hedge funds have comparatively few counterparties and any fund s closure is unlikely to give rise to failure in any counterparty. e. The assets of a hedge fund are not directly held by the hedge fund manager, which can control and invest the fund s assets only within the limitations of its investment mandate. The combination of the fee structure, independent valuation of assets and the high water mark, along with the fact that many hedge fund managers invest (and therefore risk) their own assets in the fund is intended to align the incentives of the fund manager with those of its investors and to achieve low-risk, long-term profitability rather than high-risk, short term profits; higher risk-adjusted returns are sought and high volatility returns generally discouraged to maximise assets under management and asset management fees. Hedge fund investors are generally able to redeem their investments in the fund, should they wish, and although investors cash is invested in a pool of assets held by the fund and managed by the manager, the assets are effectively owned by the investors at all times and thus an investor can remove its share in accordance with the liquidity terms of the fund. f. Hedge funds use a combination of long-term and short-term funding to ensure that they are able to meet all liabilities. They also invest predominately in liquid investments that can be marked-to-market and sold at value quickly; where they invest in less liquid assets, their liability structure is matched to their profile. Substantial investment in illiquid investments would hamper the ability of hedge funds to retain flexibility and adapt to changing market conditions, it being the nature of funds to seek absolute returns against market movements. Liquidity is key for funds and short-term liquidity allows long-term capital survival. Q7: Which sectors and activities within the financial sector do you think are most under-taxed / over-taxed? Financial institutions are net payers of VAT as the VAT exemption means that they are unable to recover the input tax (see our comments under Section 4.4 below). Accordingly, they bear a higher taxation burden than companies in other sectors in respect of VAT. 4

5 Section 4.2 Taxation as a relevant measure Q8: What do you think of tax measures, versus regulatory measures and levies (connected to the financing of funds to ensure the proper resolution of financial institutions)? We believe that tax measures may be used cumulatively, with other measures, in appropriate cases. An example of a tax measure taken in the context of a regulatory regime is the UK s Financial Services Compensation Scheme s ability to introduce an exceptional levy on firms to fund compensation payable to consumers in respect of claims arising from the collapse of a failing firm. Q9: Do you consider that an FTT or an FAT could lead to cumulative social and economic effects in combination with any of the regulatory reforms in the financial sector, including the banking levy (see COM 2010(301) final)? We believe that either a FTT or FAT could result in migration to, for example, Asian jurisdictions. We are also wary of the cascade effect that can ensue from, for example, a bank levy: the bank s shareholders, employees and customers will all be affected, and savings in pension funds and other vehicles will ultimately be reduced. Section 4.3 Financial transaction tax (FTT) Q10: At what level do you think that the FTT will be most effective? We believe that it could only be effective at global level. Q11: Do you think that a broad-based FTT is a viable instrument? (3) and (7): Although it may be viable, we believe if it is implemented at EU level only, it will result in relocations. However, we do not believe it would be fair and reasonable to impose such a tax on sectors which were not responsible for the crisis and are not systemically important or risky. We note that a broad-based FTT would include not only shares and bonds but potentially interests in mutual funds and pension funds. This is wider than existing FTTs (such as Stamp Duty Reserve Tax in the UK). FTTs are however borne by the purchaser, not the banks, and as the largest purchasers of shares and bonds are other financial institutions such as mutual funds and pension funds acting in an agency capacity for third party beneficial owners, FTT (whether broad-based or narrow-based) ultimately acts to reduce their investments and their pension funds. At a time when individuals are being asked to take more responsibility for their investments and pension provision, the imposition of an FTT would act to reduce those pension assets, contrary to wider policy goals. Q13: Do you think that the value set for the underlying is (in general) a correct tax base for derivatives? (5): No; derivatives are often used for hedging purposes and that does not deserve a disproportionate tax burden. Q14: Do you consider that there would be a risk of financial engineering around the broad-based or narrowbased FTT that would undermine the objectives of the measure? (1) and We believe there is such a risk, whether a broad- or narrow-based FTT were introduced. 5

6 Q15: What do you think of the FTT designed as a cumulative tax, i.e. every subsequent sale is taxed at the full amount of the transaction without any deduction of previously paid FTT? (3) and (4): It is not justified because not all short-term trading is speculative and it would hinder the liquidity of the markets. For example, short-term trading can be used in the execution of a large order. Q18: Do you think that the tax incidence will fall on the financial sector or will it be shifted to the customers? We believe it will fall on the sector and all customers. Crucially, it will affect the returns of pension funds and other retail-based investment vehicles. Q19: What do you think of the administrative costs related to the broad-based FTT? The costs will be high, in terms of systems and training requirements of firms. Do you think it would be the same for a narrow-based FTT? No, because the effect will fall on clearing houses and brokers. Q20: What do you think of the effect on employment from broad-based FTT? (5): If the FTT is not globally implemented, the qualified workforce will relocate and benefit companies/branches in non-taxing countries, with broader effects in terms of the wider political, economic and social environment. Section 4.4 Financial activities tax (FAT) Three alternative approaches are suggested in the paper: addition method FAT, rent-taxing FAT and risk-taxing FAT] We note that three types of FAT with differing objectives were discussed during the Brussels Tax Forum, namely: - compensating for the VAT exemption in the financial sector; - taxing economic rents (excess profits); and - taxation of profits derived through risky activities. It is worth noting that compensation is an emotive word and that it implies that some harm has occurred for which compensation is needed. The use of the word exemption in relation to the VAT status of financial services is, however, a technical term and is misleading as the financial sector is a net payer of VAT and therefore contributes a significant amount to the tax take in this area, unlike most other companies which can offset input and output VATs, leaving them to bear little or no VAT cost within the business. The VAT exemption therefore costs the financial sector millions in additional tax each year. Removing that exemption would therefore lead to the financial sector paying less VAT rather than more. For this reason, we believe this objective should be discounted. The second objective (taxation of excess profits) should, in our view, be considered in the light of the changing regulation of the banking sector following the crisis. The requirements to increase capital means that there will be fewer excess profits in the banking sector than in previous years as the overall profitability of those banks is 6

7 likely to be permanently reduced as a result of the new capital and liquidity requirements. A FAT of this form may therefore not generate significant revenues. In our view, therefore, none of the stated objectives of a FAT provides a compelling case for the introduction of a FAT. Our responses to the specific questions in the consultation are set out below. Q22: At what level do you think the FAT will be most effective? At G20 level, at least, because otherwise the activities/profits relocation incentives would be considerable. Q30: The state of the head office or group headquarters may tax on the basis of consolidated statements and the state of the branches or group members may also tax those. What do you consider as a suitable solution? A system of credits must be embedded in the provisions. Q34: Do you think that the tax incidence of the tax will fall on the financial sector or will it be shifted to the customers? (5): It will fall on both the sector and the customers. Q35: What do you think of the administrative costs related to the FAT? The costs will be comparatively high because firms will have to introduce and implement completely new compliance, mechanisms, calculations etc. Section 4.5 Cumulative effects with other measures especially bank levies and regulatory measures We would repeat here our comments in respect of the UK Treasury s consultation paper of July 2010 on bank levy, that: - the equity and liabilities of a hedge fund manager, who is managing third party client money and not trading with a bank s assets (i.e. proprietary trading), should not contribute to any levy tax base; - no serious study has suggested that any individual UK-regulated hedge fund manager could be regarded as systemically important - in contrast to large, deposit-taking public institutions which trade their own balance sheet and thereby put at risk not only the shareholders capital but also depositors funds; and - the fact that a hedge fund (which does not engage in proprietary trading) sits within a banking group or is partly owned by a banking group should not automatically mean that they pose potential risks... to the UK financial system and wider economy 5. Q38: At what level do you think that the levy will be most effective? At G20 level, at least, because otherwise the activities/profits relocation incentives would be considerable. 5 HMT consultation paper, page 3, at: 7

8 Q50: Since some Member States have already implemented such levies, which are different in their features, what do you think the interaction should be with those levies? All individual levies/taxes based on the balance sheet should be repealed. Closing comments We are, of course, happy to discuss further with you any point or detail that arises from this submission and we look forward to hearing further, when the Commission has taken account of all submissions it receives in response to its proposals contained in the paper. Yours faithfully, Mary Richardson Director, Head of Tax Affairs 8

9 IDENTIFICATION OF THE STAKEHOLDER The Commission services would be interested in receiving contributions from all interested parties. In order to correctly assess the responses, it will be useful to group the answers by type of respondent. Therefore, respondents are requested to provide the following information: Name and address of the respondent, relevant contact details (including address for contact) The Alternative Investment Management Association Ltd ( AIMA ) 2 nd Floor, 167 Fleet Street, London. EC4A 2EA, UK. +44 (0) mrichardson@aima.org If you are registered with the Commission as an "interest representative" your identification number N/A Are you a recognised European social partner organisation or a representative of a European (sectoral) social dialogue committee No Field of activity of the respondent. Please specify your field of activity. Please indicate if you are directly affected by any of the measures and if so, which one and to what extent: Trade association for the hedge fund management industry representing managers, fund of funds managers, prime brokers, fund administrators, accountants and lawyers active in the industry all of whom could be affected by the proposals. If the respondent is an association of stakeholders, how many members do you represent and what is your membership structure? Over 1,220 member companies in over 40 countries, serving over 5,000 individuals. Do you object to publication of personal data on the grounds that such publication would harm your legitimate interests? No Do you agree to having your response to the consultation published along with other responses? Yes 9