As Leicester City celebrated promotion to the English Premier League (EPL) last Saturday (5th April) it also became the first club in England that will probably have to pay a new Financial Fair Play (FFP) Tax. This tax is not paid to the government, but is effectively a fine imposed by the English Football League (EFL) on teams who break FFP regulations.
On Tuesday 8th April 2014 representatives from all the Championship clubs met with officials from the English Football League (EFL) in order to discuss the implementation of FFP. It had been reported in February that a number of teams were unhappy about the implementation of the FFP rules and were threatening to take legal action against the league. Unsurprisingly, one of these clubs was rumoured to be Leicester City.
In April 2012, 21 out of the 24 clubs in the Championship agreed on a set of new FFP regulations. These rules place a limit on the size of any financial losses that a team can incur in a given season before punishments, such as a tax, are imposed on them. The English Football League (EFL) stated that the aim of the FFP regulations was to
reduce the levels of losses being incurred at some clubs and, over time, establish a league of financially self-sustaining professional football clubs.
Under the agreed set of rules, all teams in the Championship have to provide a set of annual accounts by 1st December for the previous season: i.e. the first reporting period was in December 2012, when clubs had to submit accounts for 2011–12. No penalties were applied for the first two reporting periods as teams were given time to adjust to the new FFP framework. However sanctions come into effect for the 2013–14 season.
For the 2013–14 season the FFP rules set a threshold of £3 million as the size of the pre-tax financial losses that a team can incur before having to face any sanctions. If a team incurs a pre-tax loss of greater than £3 million but less than £8 million then punishments from the league can be avoided if the team’s owner invests enough money into the club so that the loss is effectively limited to £3 million: i.e. if the club reports a loss of £7 million then the owner would have to invest a minimum of £4 million of his/her own cash to avoid any sanctions.
The club is not allowed to finance the loss by borrowing or adding to the level of the team’s debt. If the owner cannot/refuses to make the investment or the pre-tax loss is greater than £8 million then the team is subject to one of two possible sanctions depending on whether it is promoted or not.
First, if the club is not promoted to the EPL, then it is subject to a transfer ban from the 1st January 2015: i.e. it will be unable to sign new players at the start of the transfer window. The ban remains in place until the club is able to submit financial information that clearly shows that it is meeting the FFP guidelines.
Second, if the club is promoted to the EPL then instead of a transfer embargo it has to pay the FFP Tax. The amount of tax the firm has to pay to the league depends on the size of the financial loss it has incurred. The larger the loss, the greater the tax it has to pay. The marginal rate of tax also increases with the size of the loss.
In order to help illustrate how the tax works it is useful to take a simple example. Leicester city reported a pre-tax loss of £34 million in 2012–13. If the club managed to reduce its pre-tax losses to £15 million in 2013–14 then, given its promotion, it would be subject to the tax. If we also assume that the owners are willing and able to invest £5 million of their own money into the club then the rate of tax the team would have to pay is based on the size of its losses over £8 million in the following way:
1% on losses between £8,000,001 and £8,100,000
20% on losses between £8,100,001 and £8,500,000
40% on losses between £8,500,001 and £9,000,000
60% on losses between £9,000,001 and £13,000,000
80% on losses between £13,000,001 and £18,000,000
100% on any losses over £18,000,000
Therefore with a loss of £15 million the FFP tax that Leicester would have to pay is £4,281,000 (£1,000 + £80,000 + £200,000 + £2.4million + £1.6million). If the club instead made a pre-tax financial loss of £30,000 in the 2013–14 season, then the FFP tax it would have to pay increases to £18,681,000 (£1,000 + £80,000 + £200,000 + £2.4million + £4 million + £12 million).
It was originally agreed that the revenue generated from the FFP tax would be shared equally by the teams in the Championship who managed to meet the FFP regulations. However the EPL objected to this provision and the money will now be donated to charity by the EFL.
Based on the financial results reported in 2012–13, about half the clubs in the Championship would be subject to either a transfer ban or FFP tax in January 2015. It was reported in the press in February that a number of clubs had instructed the solicitors, Brabners, to write to the EFL threatening legal action.
One particular concern was the ability of the clubs in the Championship subject to FFP rules to compete with teams relegated from the EPL. When the original FFP regulations were agreed, the teams relegated from the EPL received parachute payments of £48 million over a 4-year period. Following the record-breaking TV deal to broadcast EPL games, the payments were increased to £59 million for the 2013–14 season.
Following the meeting on Tuesday 8th April a spokesman from the EFL said
Considerable progress was achieved on potential improvements to the current regulations following a constructive debate between the clubs.
It will be interesting to see what changes are finally agreed and the implications they will have for the competitive balance of the league.
Articles
Why Championship clubs are crying foul over financial fair play The Guardian (26/2/14)
Wage bills result in big losses at Leicester City and Nottingham Forest The Guardian (5/3/14)
Financial fair play: Championship clubs make progress on talks BBC Sport (10/4/14)
Financial Fair Play in the Football League The Football League (25/4/12)
Loss leaders – Financial Fair Play Rules When Saturday Comes (25/4/12)
Richard Scudamore: financial fair play rules unsustainable in present form The Guardian (14/3/14)
Questions
- To what extent do you think that the implementation of the FFP regulations will either increase or decrease the competitive balance of the Championship?
- An article in the magazine ‘When Saturday Comes’ made the following statement “Last season’s champions, QPR, lost £25.4m and would have been handed a ‘tax’ of at least £17.4m based on 2013-14 thresholds”. Explain why this statement is not accurate. What mistake has the author made when trying to calculate the level of FFP tax payable?
- Nottingham Forest reported pre-tax financial losses of £17 million in 2012-13. If they made the same losses in 2013-14 and were promoted to the EPL, calculate how much FFP tax they would have to pay under current regulations.
- To what extent do you think that the money generated by the FFP tax should be equally distributed between the teams in the Championship who meet the FFP regulations.
- Why do you think team owners might need regulations to restrict the level of losses that they can make. Why might sport be different from other sectors?
Profits are maximised where marginal cost equals marginal revenue. And in a perfectly competitive market, where price equals marginal revenue, profits are maximised where marginal cost equals price. But what if marginal cost equals zero? Should the competitive profit-maximising firm give the product away? Or is there simply no opportunity for making a profit when there is a high degree of competition?
This is the dilemma considered in the articles linked below. According to Jeremy Rifkin, what we are seeing is the development of technologies that have indeed pushed marginal cost to zero, or close to it, in a large number of sectors of the economy. For example, information can be distributed over the Internet at little or no cost, other than the time of the distributor who is often willing to do this freely in a spirit of sharing. What many people are becoming, says Rifkin, are ‘prosumers’: producing, sharing and consuming.
Over the past decade millions of consumers have become prosumers, producing and sharing music, videos, news, and knowledge at near-zero marginal cost and nearly for free, shrinking revenues in the music, newspaper and book-publishing industries.
What was once confined to a limited number of industries – music, photography, news, publishing and entertainment – is now spreading.
A new economic paradigm – the collaborative commons – has leaped onto the world stage as a powerful challenger to the capitalist market.
A growing legion of prosumers is producing and sharing information, not only knowledge, news and entertainment, but also renewable energy, 3D printed products and online college courses at near-zero marginal cost on the collaborative commons. They are even sharing cars, homes, clothes and tools, entirely bypassing the conventional capitalist market.
So is a collaborative commons a new paradigm that can replace capitalism in a large number of sectors? Are we gradually becoming sharers? And elsewhere, are we becoming swappers?
Articles
Capitalism is making way for the age of free The Guardian, Jeremy Rifkin (31/3/14)
The End of the Capitalist Era, and What Comes Next Huffington Post, Jeremy Rifkin (1/4/14)
Has the Post-Capitalist Economy Finally Arrived? Working Knowledge, James Heskett (2/4/14)
Questions
- In what aspects of your life are you a prosumer? Is this type of behaviour typical of what has always gone on in families and society?
- If marginal cost is zero, why may average cost be well above zero? Illustrate with a diagram.
- Could a monopolist make a profit if marginal cost was zero? Again, illustrate with a diagram.
- Is it desirable for there to be temporary monopoly profits for inventors of new products and services?
- What is meant by a ‘collaborative commons’? Do you participate in such a commons and, if so, how and why?
- Should tweets and Facebook posts be regarded as output?
- What is meant by an internet-of-things infrastructure?
- What are the incentives for authors to contribute to Wikipedia?
- Could marginal cost ever be zero for new physical products?
- Think about the things you buy in the supermarket. Could any of these be produced at zero marginal cost?
- How can capitalists make profits as ‘aggregators of network services and solutions’?
- Provide a critique of Rifkin’s arguments.
A previous article on this website (Why buy a football club?) focused on the issue of why people buy football clubs. This blog refers to the somewhat strange situation where people who have made large amounts of money from a very successful business career always seem to lose money when they invest in a football team.
The Deloitte’s report into football finance found that in the 2012/13 season only half the clubs in the English Premier League (EPL) made an operating profit – profits excluding net transfer expenditure. When the impact of transfer expenditure is included, even fewer clubs make any money. For example, the three teams battling it out for the EPL title this year, Chelsea, Liverpool and Manchester City, reported losses for 2012/13 of £49.4 million, £49.8 million and £51.6m respectively.
What makes the size of these losses even more astonishing is that they have occurred in a period when the revenues earned by the top clubs have increased rapidly. In 2004/05 the combined revenue of the 20 EPL clubs was £1.3billion. By 2011/12 this figure had increased to £2.36 billion.
Given these rapidly rising revenue streams, the main explanation for this poor profit performance is the growth in players’ salaries. It has been estimated that approximately 80% of the increase in revenues generated by the team in the EPL since it began in 1992 have gone to the players in higher wages. In 2011/12 the total wage bill in the EPL was a staggering £1.658 billion, with an average wage bill of £83 million per club. The average weekly wage of a player has doubled over the past six years and is now estimated to be between £25,000 and £30,000 per week.
One deal which recently hit the headlines was that of Wayne Rooney who signed a five-year contract with earnings of up to £300,000 a week or £15.6m annually. However, Mr Rooney is still a long way short of the highest paid sports star. When based on wages and win bonuses, Forbes reported this to be American footballer, Aaron Rodgers, who was paid £25.75m in 2012-13!!!
One major factor that can partly explain this rapid increase in players’ pay is the increased competition for their skills. The potential impact of the transfer system on players’ mobility and wages was discussed in an article on the website in December (Recent challenges to the football transfer system). The career of Tom Finney provides an interesting case study of the impact of the monopsony power that the transfer system and maximum wage used to give the clubs.
Finney was one of the most talented footballers of the 1940s/50s but he played at a time when there was still a maximum wage and a transfer system that was far more restrictive that it is today. He first played in the youth team for Preston North End in 1936 aged 14. Apart for a three-year period between 1942 and 1945 when he served in the army during the Second World War, he remained with Preston for his whole career. He finally retired in 1959 at the age of 38 having scored 210 goals in 473 appearances.
He also played in three World Cup final tournaments and scored 30 goals in his 76 international appearances for England.
When he died in February of this year many people talked of his loyalty to Preston and the fact that he only earned £20/week when he retired (the maximum wage at the time) and had to supplement his income by working as a plumber. However, interestingly in 1952 an Italian club – Palermo – tried to sign Finney from Preston on a deal which would have paid him a basic weekly wage of £32.25, a bonus of up to £100 per week and a signing on fee of £10,000. At the time he earned the maximum wage of £14 per week with Preston and received a win bonus of up to £2 per week. Palermo also offered him a luxury Mediterranean villa, a brand new sports car and unlimited travel between England and Italy funded by the club. Unsurprisingly, Finney was tempted by the deal and commented that:
There was a genuine appeal about the prospect of trying my luck abroad, not to mention the money and the standard of living.
However, because of the transfer system in place at the time, Preston could block the move. The chairman explained to Finney:
Tom, I’m sorry, but the whole thing is out of the question, absolutely out of the question. We are not interested in selling you and that’s that. Listen to me, if tha’ doesn’t play for Preston then tha’ doesn’t play for anybody.
The club also announced that they would not consider selling Finney for any transfer fee below £50,000. Palermo had offered £30,000 and the transfer record at the time was less that £20,000.
It is highly unlikely that football will ever return to a type of transfer system and maximum wage that gives the clubs the sort of monopsony power they had in Finney’s days. However a new set of policies have been recently agreed and introduced to try to slow down the increase in players’ pay. Financial Fair Play rules set limits on the size of financial losses that clubs can incur over a three-year period. If these rules are broken, then UEFA could prevent the guilty team from entering lucrative competitions such as the Champions League. The EPL also has the power to award points deductions.
With the combined revenues of the 20 EPL clubs forecast to increase by 24% to £3.080 billion in the 2013/14 season, it will be interesting to see how much of this money improves the financial performance of the clubs and how much goes into players’ wages.
Articles
Questions
- Draw a diagram to illustrate the impact of a maximum wage on a perfectly competitive labour market and explain your answer.
- Analyse the impact of the maximum wage on worker surplus, firm surplus and deadweight welfare loss. Draw a diagram to illustrate your answer. Comment on the impact of the maximum price on economic efficiency.
- Draw a diagram to illustrate the impact of a maximum wage on a monopsonistic labour market. Assess its impact on economic efficiency.
- Some authors have argued that the Financial Fair Play regulations are a form of vertical restraint/agreement. What is a vertical restraint?
- Find an example of a vertical restraint in a different industry. What impact will it have on economic welfare?
According to latest evidence from the Bank for International Settlements, in April 2013 some £3.2 trillion ($5.3 trillion) of foreign exchange was traded daily on global foreign exchange (forex) markets. About 40% of forex dealing goes through trading rooms in London. This market is highly profitable for the UK economy. But all is not well with the way people trade. There is a scandal about rate fixing.
Exchange rates on the forex market are freely determined by demand and supply and fluctuate second by second, 24 hours a day, except for weekends. Nevertheless, once a day rates are fixed for certain trades. At 4pm GMT a set of reference rates is set for corporate customers by banks and other traders. The rates are set at the free market average over the one minute from 16:00 to 16:01. The allegation is that banks have been colluding, through text messaging and chat rooms, to manipulate the market over that one minute.
Since the early summer of 2013, the Financial Conduct Authority (FCA) in the UK, along with counterparts in the USA, Switzerland, Hong Kong and elsewhere, has been looking into these allegations. Last week (4/3/14), the Bank of England suspended a member of its staff as part of its own investigation into potential rigging of the foreign exchange market. The allegation is not that the staff member(s) were involved in the rigging but that they might have known about it.
The Bank said that, “An oversight committee will lead further investigations into whether bank officials were involved in forex market manipulation or were aware of manipulation, or at least the potential for such manipulation.”
Meanwhile, the House of Commons Treasury Select Committee has been questioning Bank of England staff, including the governor, Mark Carney, about the scandal. Speaking to the Committee, Martin Wheatley, head of the FCA said that the investigation over rigging had been extended to 10 banks and that the allegations are every bit as bad as they have been with Libor.
Forex rigging ‘as serious as’ Libor scandal: Carney Yahoo News, Roland Jackson (11/2/14)
Forex manipulation: How it worked HITC (Here Is The City), Catherine Boyle (11/3/14)
Bank of England Chief Grilled Over Forex Scandal ABC News, Danica Kirka (11/3/14)
Carney Faces Grilling as Currency Scandal Snares BOE Bloomberg, Scott Hamilton and Suzi Ring (10/3/14)
UK financial body urges quick action over foreign exchange ‘fixing’ Reuters, Huw Jones (11/3/14)
Timeline -The FX “fixing” scandal Reuters, Jamie McGeever (11/3/14)
Forex in the spotlight Financial Times (16/2/14)
Forex scandal: What is that all about? BBC News (11/3/14)
Bank of England in shake-up after rate manipulation criticism BBC News (11/3/14)
Mark Carney faces Forex questions from MPs BBC News, Hugh Pym (11/3/14)
Bank of England’s Paul Fisher: ‘It’s not our job to go hunting for market wrongdoing’ Independent, Russell Lynch , Ben Chu (11/3/14)
Questions
- For what reasons would sterling appreciate against the dollar?
- Most of forex trading is for speculative purposes, rather than for financing trade or investment. Why is this and does it benefit international trade?
- If foreign exchange rates fluctuate, is it not a good thing that banks collude to agree the 4pm fixed rate? Explain.
- What was the Libor scandal? Why are some people arguing that the current forex scandal is worse?
- What can the FCA do to prevent collusion over exchange rates?
The UK energy industry (electricity and gas) is an oligopoly. There are six large suppliers: the ‘Big Six’. These are British Gas (Centrica, UK), EDF Energy (EDF, France), E.ON UK (E.ON, Germany), npower (RWE, Germany), Scottish Power (Iberdrola, Spain) and SSE (SSE Group, UK). The Big Six supply around 73% of the total UK market and around 90% of the domestic market.
Energy suppliers buy wholesale gas and electricity and sell it to customers. The industry has a considerable degree of vertical integration, with the energy suppliers also being involved in both generation and local distribution (long-distance distribution through the familiar pylons is by National Grid). There is also considerable horizontal integration, with energy suppliers supplying both electricity and gas and offering ‘dual-fuel’ deals, whereby customers get a discount by buying both fuels from the same supplier.
Smaller suppliers have complained about substantial barriers to entry in the industry. In particular, they normally have to buy wholesale from one of the Big Six. Lack of transparency concerning their costs and internal transfer prices by the Big Six has led to suspicions that they are charging more to independent suppliers than to themselves.
Under new regulations announced by Ofgem, the industry regulator, the Big Six will have to post the prices at which they will trade wholesale power two years in advance and must trade fairly with independent suppliers or face financial penalties. In addition, ‘a range of measures will make the annual statements of the large companies more robust, useful and accessible.’ According to the Ofgem Press Release:
From 31 March new rules come into force meaning the six largest suppliers and the largest independent generators will have to trade fairly with independent suppliers in the wholesale market, or face financial penalties. The six largest suppliers will also have to publish the price at which they will trade wholesale power up to two years in advance. These prices must be published daily in two one-hour windows, giving independent suppliers and generators the opportunity and products they need to trade and compete effectively.
But will these measures be enough to break down the barriers to entry in the industry and make the market genuinely competitive? The following articles look at the issue.
Articles
Boost for small energy firms as Big Six are ordered to trade fairly on wholesale markets or face multi-million pound fines This is Money, Rachel Rickard Straus (26/2/14)
Energy firms told to trade fairly with smaller rivals BBC News, Rachel Fletcher (26/2/14)
Ofgem ramps up scrutiny of Big Six accounts The Telegraph, Denise Roland (26/2/14)
‘Big six’ told to trade fairly – will it make a difference? Channel 4 News, Emma Maxwell (26/2/14)
Energy regulator Ofgem forces trading rules on ‘big six’ suppliers Financial Times, Andy Sharman (26/2/14)
Information
Ofgem tears down barriers to competition to bear down as hard as possible on energy prices Ofgem Press Release (26/2/14)
The energy market explained Energy UK
Gas Ofgem
Electricity Ofgem
Energy in the United Kingdom Wikipedia
Big Six Energy Suppliers (UK) Wikipedia
Questions
- Describe the structure of the UK energy industry.
- What are the barriers to the entry of new energy suppliers and generators in the UK?
- To what extent is vertical integration in the electricity generation and supply industry in the interests of consumers?
- To what extent is horizontal integration in the electricity and gas markets in the interests of consumers?
- How will requiring the six largest energy suppliers to post their wholesale prices for the next 24 months increase competition in the energy market?
- Is greater transparency about the revenues, costs and profits of energy suppliers likely to make the market more competitive?
- Identify and discuss other measures which Ofgem could introduce to make the energy market more competitive.
