30 July 2013 Exchange Rate Perspectives: FX and the Financial Transaction Tax Global regulation and the FTT A concern surrounding the FTT currently proposed by the European Commission is that it offers economic incentives that conflict with existing international efforts at financial market reform. Because the FTT is imposed at every stage of a financial transaction it discourages financial intermediation. Mandatory clearing rules introduced by the Dodd Frank Act in the US and EMIR in Europe aim to reduce counterparty credit risk by migrating OTC bilateral transactions to clearing houses. This has the effect of increasing transaction intermediation in cases where trades were bilaterally executed. Central clearing is designed to reduce systemic risks in the financial system. The central counterparty (CCP) acts as buyer to every seller and seller to every buyer. In so doing, it is designed to centralize financial risks that were previously dispersed between multiple counterparties. Central clearing reduces counterparty credit risk by requiring firms to post collateral against potential future losses on trades (initial margin) and the mark to market value of the same trades (variation margin). Basel III rules are similarly designed to encourage greater collateralization of OTC trades by imposing higher capital requirements on banks for trades which are not collateralized. Many financial firms will be required to clear derivative transactions using CCPs. Most non-financial corporations, however, will not. The FTT, therefore, may discourage non-financial entities from centrally clearing derivative transactions as doing so would incur higher transaction costs. Under the current European Commission proposal, it is unclear whether the FIT is to be applied to the exchange of collateral. If it were applied, this would clash with efforts to reduce counterparty credit risk. Again, financial corporations are likely to be subject to prudential margin s