Why should a UK bank become a tax collector for the Germans? That is the not-so-hidden agenda that international bondholders see behind a proposed EU directive on taxation of savings.
They fear that such a directive, if implemented, could cause a tax event that triggers wholesale calling of up to 8% of the $3 trillion Eurobonds outstanding, resulting in a chaos of refinancings in a market already heavily stressed by Emu and the year 2000 problem.
The proposal is the “ill-conceived brain-child of German chancellor Helmut Kohl in an attempt to win votes for his re-election in September”, Eurobond specialists opine. If so, it may die a well-deserved death as early as October, they hope and pray.
The proposal, rushed out in May, only five months after the first discussions by European economic and finance ministers (Ecofin) in December, is aimed at “removing distortions in the single market”, according to the Brussels preamble. The directive will be aimed at eliminating “non-taxation of income” (ie tax evasion), the document says, although it will also seek to correct distortions caused by double taxation. It is likely to affect all interest payments to individuals, not corporate entities, including interest on bonds, deposits, even venture capital investments, with a levy of 20%. Bond strips, which are all interest, would be particularly hit.
EU member states would be required to legislate to ensure that paying agents in their jurisdiction either levy withholding tax at source on interest earnings by residents of other member states, or pass that earnings information on to the beneficiary’s home government. Luxembourg and London tend to be the home of Eurobond paying agents. For years, Germany has wanted to haul back the tax revenue lost because German residents have kept money deposits or Eurobond accounts in Luxembourg.
In December, Ecofin agreed in principle on such tax harmonization, but the UK government insisted that Eurobonds should be kept out of the equation. In five months, the UK proviso seems to have been lost or overruled.
“The views of business associations on this proposal have been received,” says the Brussels document in a concluding paragraph dubbed “consultation”. “They have all expressed strong support for the removal of source country taxes on cross-border interest and royalty payments in order to remove obstacles to financial flows.” Five European trade associations are mentioned, including the European Mortgage Federation (EMF). But the consultation seems to have left much to be desired. “There was no real consultation procedure,” says Tobias Mackie, head of economic affairs at the EMF. The EMF represents a plethora of often conflicting European views but even so was surprised to see Eurobonds included.
The International Primary Markets Association (Ipma) is not just astonished, it is up in arms, together with the London Investment Bankers Association (Liba), the British Bankers Association (BBA), the International Securities Market Association (Isma), the International Swaps & Derivatives Association (Isda), the International Paying Agents Association (Ipaa), none of which was consulted by Brussels. They are cooperating on various pieces of research into the possible impact of such a directive.
Their strongest card is a picture of the potential market chaos caused by refinancing up to $240 billion of Eurobonds. Surely the folk in Brussels didn’t think this through. A small but significant number of Eurobonds have a tax event provision designed to ensure that the economic benefit of the coupon flow is not curtailed. If a new or higher tax is imposed the issuer must make up payments to the gross level. The issuer often has a let-out, which is the option to call the bond and redeem at par. Given present interest rates, issuers might well be tempted to seize this opportunity to call their bonds and refinance more cheaply.
But the bond provisions aren’t uniform or clear. Ipma and Liba are examining the small print of hundreds of bond issues to estimate the number of those likely to be grossed up or called. “Of 100 bond issues you might find only two that were the same,” says Helen Style at Ipma. The uncertainty and lack of uniformity are almost the worst aspect since the callability of bonds would be open to endless litigation.
Bond issuers may be asked not to call their bonds capriciously because they spot a windfall. On the other hand, they may see it as their fiduciary responsibility to take the windfall or risk being sued by shareholders or other stakeholders. A single bondholder may in some cases be able to trigger a call, whether the issuer wants to or not. That could play havoc with swaps matched with bond issues.
At a time when Brussels and the European Central Bank will be trying to establish a benchmark euro yield curve, uncertainty about the future value of large numbers of bonds can only make the yield curve more fuzzy. “It will make all yield curves more diffuse and raise the cost of finance,” says Con Keating, chairman of the Committee on Methods & Measures, a bondholder interest group in London.
“It will be totally counter-productive as far as Eurobonds are concerned,” says Style at Ipma. “It won’t produce tax revenue and it won’t stop tax evasion.” The industry associations support the principle of making taxation more effective but they suggest a global approach ie an OECD resolution rather than an EU one would be more useful. Otherwise, the paying agent business will simply migrate to Switzerland and elsewhere beyond EU borders just as dollar bond business migrated out of the US in the 1960s.
It would take only one EU member state to veto the directive and stop it in its tracks. Luxembourg is the most obvious candidate, since it stands to suffer most, but apparently feels it’s someone else’s turn to get tough on the European Commission. Ireland and the UK are next in line, each dependent on a livelihood as financial centres. “Moving the paying agency business to Switzerland will cost London a lot of jobs,” says Keating. Worse still, warns Style, “what other business could flee with it?” David Shirreff
CORRECTION: Awards for Excellence
We omitted the names of some recipients of our Awards for Excellence last month. Besides the winners profiled, several other firms are highly commended for their activities: Citibank for project finance; Salomon Smith Barney for government bond trading; Deutsche for Eurobond trading; Chase as underwriter of emerging-market debt; Deutsche for bringing new issuers; Goldman Sachs and Morgan Stanley for international equity research and ING Barings for emerging-market equity research. Qatar National Bank was best bank in Qatar. Apologies to all.
