Unintended Consequences: Tax Regulations and the US Listed Options Market

Regulatory, legislative and political initiatives targeted at financial markets have become a constant refrain in the global capital markets. Many of these initiatives are well-intended, designed to influence behavior perceived as contrary to best market practices and raise revenues through taxes on certain activities.

However, the unintended consequences of regulation are the bane of these efforts. Many initiatives include components that on the surface may seem logical to the regulation’s authors, but will have carry-on impacts that ripple through the industry.

Recent tax plans, both pending and finalized, threaten to wreak havoc on the US listed options market. Washington politicians have touted these initiatives as ways to simplify the tax system, eliminate loopholes and save money for both individuals and businesses. On the surface, the proposed rules present attractive goals, but in practice, they could have negative consequences on demand, raise costs for the industry and ultimately reduce trading volume, as new restrictions would impact how investors can use options to implement investment strategies and manage risk exposures.

The dangers to the options industry are very real. TABB Group has identified two tax proposals and one recently passed tax regulation that could decimate trading in the options market through trading restrictions and limitations on how brokerages service customers. These initiatives include the Department of Labor’s fiduciary proposal, the Camp Proposal, and Section 871(m) of the Internal Revenue Code.