A surprise ruling coming out of a Swedish court is set to send EU corporate and especially bank tax bills soaring. The Swedish ruling, concerning a case involving Skandia America Corporation and its Swedish parent, provided that from now on, EU-based companies would need to pay Value-added Tax (VAT) on all services offered to international subsidiaries. The ruling has large implications for the whole of the EU, as until now, EU law had considered subsidiaries to be part of the same entity and thus exempt from VAT. The ruling will have a particularly strong effect on London’s financial industry, as many of the financial firms in operation there are technically headquartered elsewhere in the EU, but conduct the majority of their business from London. Analysts say banks will adapt their practices, but may see VAT bills rising into the tens of millions of Euros. Insurance companies will likewise be affected. VAT rates across the EU range from 15% to 27%.
FINSUM: This ruling has large implications not only for London’s financial dominance and for corporate earnings, but also for government coffers, which will likely see some immediate benefits from the verdict. However, banks now have a new-found incentive to move their legal headquarters to their primary profit centers, so it could spark some national defections.
Daniel Tarullo, the Federal Reserve governor who oversees regulatory policies, announced yesterday that the Fed planned to increase pressure on large banks to downsize. The Fed believes banks are still too large and vulnerable, and wants to impose rules which will be tougher than the international standard, particularly those currently employed in Europe. The banks will be left with a tough choice—to increase their equity holdings, or shrink their overall size, which could help them maintain ROEs, but lower their overall profits. The Fed plans to formally impose higher “capital surcharges” on banks, meaning they will need to hold additional capital above and beyond what they are currently mandated to possess. The regulations will disproportionately affect large Wall Street-focused banks, which tend to borrow lots of money in short-term debt markets. The Fed is seeking to curb such practices, as they make banks highly vulnerable to short-term market shocks.
FINSUM: Looks like the regulatory pressure being heaped on banks is not set to abate. The future of banking is looking ever more like a smaller, more focused offering rather than the expansive businesses the firms touted pre-crisis. Overall returns look likely to shrink further in coming years.
The US Federal Reserve has announced that following the finalisation of the forthcoming Liquidity Coverage Ratio regulations, US banks face a $100 bn funding shortfall. This means that banks do not have enough high quality capital to meet the new regulatory guidelines. The rules, which will accept Fed reserves or US Treasury bonds as “high quality liquid capital”, are set up to prevent a repeat of events that occurred during the financial crisis. The new rules will initially only apply to the largest US banks, but will likely be extended to many more, possibly by 2017. One contentious aspect of the rules is that, as drafted, municipal bonds are not counted as high quality assets, meaning banks will be less likely to hold them. Local governments have expressed serious concern over this, as a liquidity shortfall in the securities will likely cause a funding crunch in local services, like schools, roads, and sewage.
FINSUM: This is important news as it will likely mean lower earnings for banks, as they will be required to set more capital aside to low-yielding sources. However, that is not all, as these new rules will also force them to raise equity borrowing costs 5x, shrinking what is currently a very profitable business.
Unbeknownst to most, the Ukraine crisis has had a surprising effect on the important global palm oil market—it has caused it to tumble. Palm oil is an important ingredient in a wide range of products, from soap to food, but recently, a glut of sunflower oil has lowered wholesale demand for the substance. Ukraine and Russia have both seen bumper sunflower crops this year, and because of the turmoil in the region, have been eager to sell it immediately, creating a wealth of global supply that has hurt palm oil prices. That is bad news for economies like Indonesia and Malaysia, who together produce 80% of the world’s palm oil. The declining prices have huge implications for Indonesia, as much of the country’s banking portfolio is backed by palm oil, meaning the asset quality of the country’s banks is declining rapidly. Palm oil prices have fallen 30% this year.
FINSUM: While this news may be very poor for Southeast Asia, it is great news for European food suppliers like Nestle, who are seeing the lowest prices in years for one of their principal raw materials.
Banks are beginning to protest over the new potential imposition of Basel capital rules which they say would make equity swap and borrowing transactions 4x to 5x more expensive than at present. Such transactions are massively important, as they are the mechanism which allow for investors to freely “short” certain stocks by selling in the market after borrowing them. Essentially, the banks do not want equity borrowings to be considered loans, as that would put them in a much riskier category for Basel III purposes, and mean that costs would skyrocket. The market for equity borrowing is quite large, with $760 bn of equities currently on loan in the market. The segment is a highly profitable one for banks, as it is an area where they can make hedged profits. Banks say the new rules would push equity borrowings into the shadow banking space and increase systemic risk.
FINSUM: This is a seemingly mundane but very significant story. Short-selling is considered a fundamental mechanism for fair market pricing, but if costs were to skyrocket, there would likely be much less of the activity.