Regulatory pressures and their impact on operational technology requirements are top of mind issues for executives at investment banks and other institutions.
Before 2008, the usual response from institutions to most forms of regulation was a 'fix' that allowed them to maintain their operating model without making major changes. Since the crisis, and the subsequent raft of control measures applied by regional and national jurisdictions, the need has emerged for more robust, scalable solutions. Indeed, from our global conversations with major capital markets players today we typically find that two thirds of IT and operational spend is being allocated to developing strategic regulatory solutions that can accommodate more than one problem.
One very high profile and major headache for investment banks at present is developing a quick response to the EU Financial Transaction Tax (FTT), which is due to be implemented on January 1, 2014. The EU FTT is currently being agreed as a framework by 11 members of the EU (the most notable exclusion being the UK) in order to raise revenues and reduce the excessive trading that many argue contributed to the financial crisis.
While the EU FTT gains a global profile (especially as Depositary Receipts fall firmly in scope), there are in fact approximately 40 similar transaction or stamp duty taxes in operation globally. In the Asia Pacific region, for example, 12 out of 26 countries have an active transaction tax. And although the U.S. Government is still opposing the implementation of an FTT, a number of Democrat congressmen, amongst many others, continue to propose similar legislation, with Canadian organizations also pushing forward proposals.
3 Types Of In Vogue Taxes
There are potentially three 'flavors' of tax for which all institutions should currently be considering the deployment of a strategic system. The first is a UK stamp duty-style tax; the second is a EU FTT-style tax; and the third is the U.S. Foreign Account Tax Compliance Act FATCA-style tax, each operates in its own unique fashion.
Each also generates a huge workload for the operations team in terms of capturing the trades and relevant data, sifting through this data to determine those trades that are exempt, performing tax calculations and generating the messaging to the relevant authorities. To do this manually for one country is not really feasible, let alone 40 countries. It is an immense responsibility, in terms of compliance, governance and risk, to be left to a non-automated system.
[For more on how a financial transaction tax may impact the marketplace, read: Innovation in Financial Services Isn't Dead -- It's Different.]
At a recent FTT seminar of 30 prime brokers, custodians and consultants (hosted in London during June 2013 by GBST), the general view expressed was that the tactical French and Italian solutions that have been deployed to date are not scaled to sufficiently handle further jurisdictions. It was also agreed that the compelling drivers for a strategic solution to the FTT question that emerged from the seminar were automation, future proofing, risk mitigation and cost reduction and competitive advantage.
Scalability In Tax Systems
It has swiftly become apparent for those firms already involved in calculating a FTT that there are far more data flows within the organization to understand and utilize, for example, the underlying instruments and trades of a derivative. It is also worth noting that this processing is also potentially happening in real-time, for 'what-if' pre-trade analysis, as well as post-trade, pre-confirmation processing.
Tactical solutions to transactional taxes are typically not scalable and are instead resource-intensive. These solutions have limited capabilities in terms of workflow, exceptions management or rule flexibility. Industry evidence with regards to both the French and Italian experiences has demonstrated the costliness and inefficiency of these tactical solutions.
Forward-thinking firms are also now looking for a single strategic tax-processing solution that acts as a central repository for all tax rules -- not just the EU FTT. The principle is that this repository could then serve all of the regional tax requirements, interfacing with the firm's tax systems where necessary.
As each country implements their own unique version of the FTT, institutions will need to develop a unique set of calculation rules and messaging formats for each jurisdiction (as recently demonstrated by Italy's new rules). For the Head of Operations or IT, the solution they deploy will also need to interface with trading platforms, in-house ledgers, MI systems and other applications both up and downstream. Ideally the solution should embrace the whole lifecycle of a trade, including pre-trade 'what if' analysis. There are obviously huge advantages to be derived from having one central tax repository that can maintain all rules.
While the EU FTT is making its own waves in terms of European jurisdictions, at a global level a transaction tsunami threatens to swamp the tax and operations teams within most institutions. Firms need to decide what the best solution may be. Is it a tactical 'lifebelt' that will solve only one problem? Or do firms need a strategic 'life raft' that will assist with many tax challenges? This is the operational choice that needs to be made.
About The Author:
Denis Orrock, Chief Executive, GBST Capital Markets. Denis Orrock joined GBST in May 2008 and was appointed Chief Executive Officer, Capital Markets in August 2012. Previously, he managed the company's Australian Broker Services and Financial Services divisions. Prior to joining GBST, Orrock was General Manager of Infochoice. Orrock has worked within the Australian financial services industry for over 15 years. He has a broad understanding of domestic wholesale and retail markets and has held advisory and trading positions with UBS, Grange Securities and Taylor Collison.