There was interesting comment by Finance Dept official Brian Ernewein at the very end of last Thursday hearing. At the very end he seemed to indicate that the FATCA 30% withholding would NOT have a significant impact on “regular” or “cash” market operations of Canadian banks but WOULD have significant impacts on Canadian banks cross border “Casino” Over the Counter Derivatives business. This is a rather interesting thing to say as Over the Counter Derivatives were largely viewed as causing the last financial financial crisis and I wonder what exactly is the Canadian public policy benefit to allow chartered banks to engage in OTC Derivatives trading with clients resident in the US/outside of Canada.
Makes sense to me. It’s not like real people were ever considered by either side unless it was as “regrettable collateral damage”, which the public and MP’s are lead to believe is insignificant or on the US side, the gravy of fines and tax grabbing – until people get wise and that dries up.
That is odd… All recent press articles seem to say that the biggest impact would be on the sale of US stock and mutual funds i.e. the impact of the withdrawing on dividends received by investment banks and their customers. It seems that that market would be way bigger than banks cross border ”Casino” Over the Counter Derivatives business, but then again, I am clueless…
Is he making a difference between investment banks and non-investment banks? Most big banks, at least in the US act as brokers as well.
What do we layman know 🙂
I still wonder why at this point, no one has actually mentioned that this 30% withdrawal might not be legal and should be challenged at international level. What are all governments so afraid of? When is it going to come out? They’re all hiding behind the threat of penalties to justify the IGA and the breach of their constitution. Nonsense. It is time to end US CBT. End CBT and most of the privacy issues go away.
This makes sense partly because if you look at the excluded firms in the IGAs. Credit Unions, Mutual Societies, Buidling Societies all have local businesses that even if there was a 30% sanction they would not be collectible because no money is crossing borders.
It makes complete sense that the derivatives market would be affected more by FATCA than mutual funds would be. In my brief search, I didn’t find any specifically Canadian data, but the global size of the outstanding OTC derivatives market in June 2013 was $692.908 trillion according the bank for international settlements, while the size of the global mutual funds industry in 2013 was $12.7 trillion according to DeLoitte. In other words, the mutual funds industry is less than 2% the size of the derivatives market. The size of this market is down to its role in speculation but even the non-speculative aspects would make it big: derivatives can act like a form of insurance and there are lots of policies that are purchased but not used. According to Stiglitz, this is a very lucrative area of the financial market because there are relatively few big competitors, so the big Canadian banks might have a clear interest. At the same time, this is a risky area that needs better regulation. The U.S. has been cracking down on capital requirements, so maybe Canadian banks hoped to benefit from not having to hold as much capital? Would that make sense?.
I am sorry but saying that derivatives are a ‘casino’ is a bit ignorant. If you enter the market and are part of a transaction on the underlying then they make perfect sense and lower risk.
For example if your business will generate returns in US $ but want to have stable returns in CAD $ you will use derivatives to share the risk with somebody doing the reverse.
Or you will have corn in Aug you use derivatives to lock in the price now with somebody who must consume corn in Aug.
They also let the markets adjust to demand by predicting future prices in a more efficient manner.
I have tried to point out before that the Canadian government is very likely misunderstanding or overstating the risks of the withholding tax. Ernewein is correct that the “cash market” impact of the withholding is pretty slight. In an extreme case, T-Bills could simply be swapped over to the Bank of Canada via a repo transaction the day before any payments were due from the US. Transaction costs would make US T-Bills pretty unattractive going forward, but there are work-arounds. Make no mistake, it would be a spanner in the works, but the adverse impacts would be felt BILATERALLY. Remember – it is not as if New York is doing the world a favour by being a financial centre. They derive a huge amount of fee revenue and, to the extent NY becomes off limits due to significant segments of the world economy being “blacklisted” by FATCA, then (after a transition period) other centres would take over. London could handle a huge amount of what NY now handles without skipping a beat. The main problem would be extracting the US and its institutions from the middle of trades: kind of like changing your carbuerator while the car is running at 100/kmh on the highway.
The derivatives market – particularly the Canadian end – is tied to the cash market. The nominal values used in derivatives trades can appear astronomical but their risk management groups engage in a lot of these trades simply to balance their risk book to zero or to whatever bias (long or short a currency, long or short rates, etc) they have chosen. Indeed, several times the worlds’ GDP is tied up in OTC (over the counter – as opposed to exchange-traded) derivatives. The main risk in that structure remains the counterparty solvency risk: if BofA were to collapse and its side of all of its derivatives were tossed out the window all at once, the entire derivatives market could face serial defaults and world Armageddon would ensue. Apart from that, a perfectly wonderful marketplace 🙂
Just so you have a concrete example, of what a derivative is, the example I gave the other day will serve: BofA swaps a five year fixed rate interest obligation for a five year floating rate obligation with BMO based on a nominal amount specified (say, $1 billion US). Every interest payment date, they exchange the fixed and floating rate amounts (more likely, one side pays the net amount) in the chosen currency. BofA and BMO might have dozens if not hundreds of such swaps outstanding on any given day. Each side assumes the other will pay on time etc. and has the right to terminate not just one trade but ALL trades if there is a default.
So what happens if FATCA imposes withholding? Well, the first thing that happens is it doesn’t happen. These swaps are pretty much all governed by something called the “ISDA Master Agreement”. This is a set of common terms and conditions that the parties use to avoid negotiating a complex, separate contract each time they do a deal. Instead, they just incorporate ISDA by reference and fax each other a one-pager listing the custom terms, if any, applicable. The deals are done in minutes over the phone. The ISDA master agreement has a clause – 5(b) for those who care – which permits a party to terminate the deal if there is a change in law that would result in withholding. Thus, for example, were BMO about to be declared recalcitrant or non-compliant with FATCA on July 1, it would be able to terminate all of its agreements with BofA on June 30, pleading the imminent change in law. The parties would exchange their net payments on that date. BMO couldn’t do any NEW deals with BofA thereafter, at least not unless structured so as to avoid FATCA (and I haven’t tried to sort out how that might be done, but I expect there would be ways). The “Big Six” Canadian banks are not inconsiderable players in the market and their loss of business would cost US banks a lot of money as it would the Canadians. Of course if FI’s at multiple countries were being tossed into the pit of eternal darkness on the same day, then the party that would be an outcast would be….the US, not everyone else. London and Toronto would start to replicate all the book of business formerly done by BofA, Goldman etc and they would all be left to Fortress America as their sole source of fee revenue. Not a bad consolation prize, to be sure, but tax revenues from the banking world flowing into Washington and Albany’s coffers would actually be quite a bit smaller since the Government gets its cut out of the profits of this trade through corporate and individual income taxes among other things.
I don’t want to say that it would be a bed of roses – it would not. I merely say that the US would be cutting off its nose to spite its face if they had to do this to more than Burundi and Antigua at a time (and their banks would hate even to lose those business opportunities). A simple phone call to London, Paris and Berlin indicating “how about we all tell Washington that we won’t co-operate unless…” could have made a world of difference here. Even without that obvious step, the mere fact that the US keeps extending the deadlines and deeming countries to be in compliance that are not should speak volumes about how credible their sanction threat truly is. I’d like to see them default on paying T-bills off to China!
I agree with what most of what you saying but I note that that Miachupacabra idiot doesn’t. He says New York is the worlds greatest financial center and the US Dollar is world’s greatest currency.
If I’ve comprehended just 10% of what everyone’s written here, it’s still twice as much as I knew yesterday. Intriguing. I’m looking forward to reading more.
This is exactly what Sen Rand Paul has been saying all along: “FATCA will KILL US economy.”
He goes into more detail than that, but inasmuch as the 30% withholding is being used as a hammer, he says it will blowback to hurt US banks and US economy much more than the pain it intends to inflict on others.
And @Tim.: Again, Sen Rand Paul will be a sure ally in the litigation against FATCA by Bopp.
He also has been making the case for over a year that FATCA violates the Constitution on many levels not least of which is the illegality of the negotiations by Treasury and IRS to set up the IGAs as though they had authority to do so. They do not. The Senate, McCain and Levin notwithstanding ,are not amused or impressed with the lawless way the admin insists on the go around Congress such as this illegal move illustrates.
Sen Paul’s bill he has had in the senate since May of 2013 cites all these issues and among the violations he also mentions the 4th amendment.
He says plainly that FATCA should be killed outright and that is his aim.
Countries who sign IGAs are basically putting the bullet in the gun that FATCA is. Without the bullet of IGA the FATCA gun is empty and useless to enforce.
As for litigation v legislation. :
Legislation takes a long time and with the political landscape in the US as it is, could take much longer depending on the outcome in the mid terms.
I agree with the litigation avenue for the reasons stated in the article and though they may have a tough row to hoe, they do have a case there is no doubt. July 1 cannot be dealt with unless they employ litigation.
With heavy hitting law firms like Mr. Bopps ( who has a track record re : Mr. McCain) They may
just be able to pull it off.
Citizens United comes to mind and is emphasized in the article.( throwing out McCain-Feingold campaign finance travesty )
And here is an interesting take on FATCA from the American side:
Regarding protecting the banks:
Note the dates on these articles. 2012 and 2009 etc. But it explains just how they have approached this issue to this date and it is not a pretty picture. Particularly in light of the fact that the elites and banks and those with the wherewithall have already squirreled their wealth away from the prying eyes the rest of us must endure.
@Bubblebustin, “If I’ve comprehended just 10% of what everyone’s written here, it’s still twice as much as I knew yesterday. Intriguing. I’m looking forward to reading more.”
Just think back to your naivity five years ago. 😉
@Anne Frank, You would think that the financial centers in the EU would use FATCA as a tool to pry away business from New York.
@George – don’t think it’s not happening.
And only 15 years ago I was a struggling single parent just trying to get by. I would have most definitely ostriched. I like to think that I’m fighting for people like me then.
Right on, bubblebustin’,
Those struggling single parents, families with persons who may have disabilities, low income people who may have little in the way of financial literacy, persons with no “retirements savings” with which to pay for US tax law and accounting or immigration / nationality help, those without a voice or the strength to stand up for themselves and their families — these we do need to fight for.