Bond dealers step up pressure on EU tax

Date: 03/09/1998

By Tim Jones

PLAYERS in the 3-trillion-ecu market for foreign currency debt are stepping up their campaign against the European Commission's controversial plan for an EU-wide savings tax.

The proposal, strongly supported by the German and French governments, has run into opposition from the British because of its alleged potential for undermining the London-dominated eurobond market.

Representatives of issuers and traders have both produced studies into the potential impact of the imposition of the 20&percent; tax and are seeking early meetings with Commission officials to discuss them.

In a new report to be published tomorrow (4 September), the body which regulates eurobond trading, the International Securities Market Association (ISMA), claims the proposal is “damaging to the market”.

“If this is agreed, it will drive capital out of Europe, push up the cost of capital for non-governmental borrowers, and they won't even collect any revenue worth talking about,” said ISMA chief executive John Langton. “It is unacceptable and, with economic and monetary union approaching, it is nonsensical to think you can put these kinds of controls in place.”

In a sister study published last week, the International Primary Markets Association (IPMA), representing 88 of the world's biggest issuers and underwriters of international debt, found that the tax could hit as many as 7&percent; of all outstanding eurobonds and transfer 4.5 billion ecu from investors to bond issuers.

If the proposal is approved by all EU governments, financial institutions would have to withhold 20&percent; from the interest 'coupon' paid to non-residents or provide details of interest paid to that saver's home tax authority. All debt instruments, including bonds as well as bank deposits, would be covered if they were in the name of a non-resident individual.

When eurobonds - debt issued in a currency foreign to that of the issuer - are launched, they include a clause stating that if a withholding tax is introduced at some time during the lifetime of the bond, the issuers will assume the extra cost.

This means that if a tax of 30&percent; on interest income were introduced, a bond-issuer paying 10&percent; every year to investors would agree to pay them 13&percent;: a practice known in the market as 'grossing-up'.

However, to insure themselves against such an event, issuers often reserve the right to pay off the bond in full at the 'par' price at which it was offered. The investor uses the proceeds to buy a tax-exempted bond in another market.

Anticipating this problem, the Commission proposal suggests that the tax should be withheld not from the investor, but from paying agents when they are in the same country as the issuer. This would apply largely to the UK.

US investment bank Merrill Lynch calculates that outstanding bonds are trading at more than 5&percent; premium over their issue because of a general fall in interest rates across the world over the past five years.

If the tax were introduced, the incentive for issuers to pay off their bonds at par and gain a 4.5-billion-ecu windfall would be overwhelming.

“We calculate that this would affect 5-7&percent; of outstanding bonds,” said IPMA secretary-general Cliff Dammers. “We were not expecting that. It took everyone by surprise. We are calling on the Commission to make an exemption in the directive for eurobonds.”