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Italy’s Equity Trading Tax Delivers a Mixed Brew of Results

When the Italian government introduced a tax on equities transactions in March, critics warned that trading volumes would suffer, bid-ask spreads would widen, and volatility would spike. But so far only volumes have fallen as a result of the levy.

The Italian financial transaction tax — harbinger of the apocalypse or a storm in an espresso cup? When the Italian government introduced a tax on equity trading on March 1, many in the investment community feared it would deal a decisive blow to the country’s stock market just as European equities were beginning to rebound. Critics said trading volume in Italy would decline, bid-ask spreads would widen, volatility would rise, and Italian equities would wither as investors turned their backs on a country that had become too regulated and expensive to bother with.

The tax, which is levied at a rate of 0.12 percent for on-exchange equities trades, 0.22 percent for over-the-counter trades and 0.02 percent for high frequency transactions, aims to generate revenue, reduce systemic risk by discouraging high frequency trading and create a more hospitable environment for long-only institutional investors.

The early results have been mixed. Italian equity volume declined 18 percent in the four months from January through April, according to data from London-­based European equity exchange BATS Chi-X Europe; across Europe it increased 13 percent over the same period. “Some investors have stopped trading Italian stocks as a matter of principle,” says Mark Buchanan, London-­based director of trading strategy at Credit Suisse. “Others are trading less.” But the increase in bid-ask spreads and the volatility spike that many had feared don’t appear to have materialized, Buchanan says. The FTSE MIB Index of Italian stocks was up 9.6 percent this year as of May 20 but lagged all other major European indexes except Madrid’s.

Borsa Italiana, the largest Italian exchange, declines to comment on the tax for now. “It is too early to tell what impact the tax has had,” says a spokesperson for the exchange, a subsidiary of the London Stock Exchange. The Italian Department of the Treasury has not revealed the revenue generated to date. After indicating a willingness to supply that data, a spokesperson did not respond to follow-up requests.

The decline in trading volume is not necessarily a bad thing; the tax is designed to engineer that outcome. But it’s not yet clear that the tax has succeeded, or will succeed, in steering volume in the direction policymakers would like — away from HFT and toward long-only institutional investors. Partly, that’s because the impact on HFT is as yet unknown, Buchanan says: Some high frequency firms are “still not exactly sure how the calculation of taxable events is made.”

In trying to deter high frequency traders, however, the new tax may discourage a wider range of automated trading that provides critical liquidity for institutional investors and create barriers to entering and exiting the market. “By killing off automated flow, the tax will actually make it harder for institutional investors to invest in the market,” says Rebecca Healey, a London-based analyst with consulting firm TABB Group.

Italy, with just 6 percent of overall European volume, is a small corner of the European Union equity universe, but the Italian tax could have a wider influence. Eleven EU countries, including France and Germany, have pledged to introduce a uniform tax on financial transactions in 2014. Beyond its desire to get a head start on any revenue windfall, the Italian government moved first because it wanted to shape negotiations on the broader EU levy, analysts say. The current EU proposal would cover bonds and derivatives as well as equities. The retail bond market is far more important to Italy than its equity market, and the government is keen to exclude bonds from the European tax, Healey says.

If Italian officials can show that their indigenous tax has been successful, that might give Italy a strong bargaining chip. But until a clearer picture emerges of the revenue impact and the types of investors that are turning away from the Italian market, the effectiveness and wisdom of the tax will remain under vigorous dispute. • •

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