Wednesday, December 21, 2011

German Finance Minister Calls for Financial Transactions Tax and Market Transparency

The German Federal Finance Minister, Dr. Wolfgang Schäuble, called for EU-wide implementation of a financial transactions tax. In recent remarks, he also endorsed more transparency for the financial markets. More broadly, he said that one lesson of the financial crises is that a self-regulating financial market is an elusive dream. The financial markets need regulations and boundaries in order to act responsibly. The goal of federal regulators is to find a new balance between financial markets and the state. Financial markets need a regulatory framework that above all increases transparency, reduces extreme leverage, and limits excessive volatility. Only the state can provide such a framework, said the Minister, and with global markets, only the community of states.

At the same time, he fears the increasing danger of what the Minister called “regulatory parochialism”. One example of this is the proposed Financial Transaction Tax. It is short-sighted parochialism which is currently keeping the EU from implementing a European Financial Transaction Tax. If a Financial Transactions Tax were introduced in all of Europe it could help reduce volatility further, he reasoned, not least because it could make leveraged trading less profitable. He is also in favor of an FTT because financial market participants need to convincingly demonstrate to taxpayers and their fellow citizens that they are willing to contribute to clean up the mess they helped to create. One way of doing that is through the FTT. More broadly, the Minister believes that the current demonstrations against financial market participants show that the FTT can play an essential in peace-making between different parts of the society.

The European Commission has recommended that a Financial Transaction Tax be applied to all financial transactions, in particular those carried out on organized markets such as the trade of equity, bonds, derivatives, and currencies. The tax would be levied at a relatively low statutory rate and would apply each time the underlying asset was traded. A Financial Transaction Tax could narrowly apply only to stocks and bonds or could be broadly extended to all financial instruments, including derivatives and structured instruments.

To stabilize the international financial system, continued the Minister, regulators need to overcome such parochial behavior, increase transparency and reduce volatility. Dark pools and over-the-counter-trades must be made more transparent, the shadow banking system, including hedge funds, must be regulated, and the risks posed by the extensive leverage of some modern financial instruments, including credit default swaps, must be contained. Similarly, the assumptions of credit rating agencies must be more transparent and the financial markets must be weaned away from their influence. States empowered rating agencies so that they could point to policy errors earlier than financial markets and thereby blunt market reactions, he noted, but the opposite has happened.