Sigrún Davíðsdóttir's Icelog

Capital controls action… without unleashing the litigation hounds

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Will they or won’t they? That is the question regarding how, if and when the Icelandic government will take the long-announced decisive action on easing the capital controls.

The news keeps seeping out in Iceland is that the Icelandic government is just about to present a plan for lifting capital controls. That would then, most likely and uncontroversially, entail the second part of the CBI action from earlier, when investment opportunities for offshore ISK were reined in. Seems, as I mentioned in a blog on earlier CBI action, that this would then be bonds, most likely in FX, with long maturity.

The main interest for foreign creditors will be what measures are chosen regarding the estates of the failed banks, most notably what form of levy or tax will be chosen. Stability tax is the latest jargon to circulate whereas minister of finance Bjarni Benediktsson mentioned an ISK haircut in his March report on capital controls progress.

As often mentioned on Icelog there is “sky and ocean between” (this is an “Icelandicism”) cutting foreign-owned ISK assets or targeting the entire assets – the former is a classic way under similar circumstances, the latter would be an all-Icelandic solution.

What the government is really struggling with here is how to tax only foreigners without touching Icelandic entities. If such discrimination were simple it would have been done long ago but it clearly is not: a whiff of discrimination would unleash the litigation hounds. This is the main issue and also the main reason for it taking so looong to come up with a solution: the government has, I am told although this is staunchly denied, been looking for a solution that does not exist. And that is famously very time-consuming – a grand “sprecatura” as the Italians would say.

As before, the Icelandic economy is slowly being starved of oxygen – and as before, qui vivra verra.

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Written by Sigrún Davídsdóttir

May 19th, 2015 at 12:39 pm

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The latest on lifting capital controls

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The latest is… that there is nothing much to report on how the Icelandic government is progressing on lifting the capital controls. For the best part of last year Bjarni Benediktsson minister of finance said there would be a holistic plan by the end of the year; none was seen. Now prime minister Sigmundur Davíð Gunnlaugsson has said action will be taken before the end of this parliament, i.e. by the end of May. However, in addition to capital controls the government is dealing with strikes and contentious issues like fishing quotas.

Bankruptcy route, exit tax and stability tax – these have been the ideas flickering in the Icelandic media and among those following the arduous course of lifting capital controls in Iceland. And as spelled out earlier, both the Central Bank of Iceland, CBI, the International Monetary Fund, IMF and minister of finance Bjarni Benediktsson have been advocating for an orderly consensual solution, which should include the assets for foreign creditors.

After so many unfulfilled announcements by the government leaders it seems difficult to believe that this government is ever going to take any decisive steps towards lifting capital controls. Indeed some long time observers of Icelandic politics have repeatedly told me that this government will take no such steps. But lifting now seems the plan, according to recent announcement by prime minister Sigmundur Davíð Gunnlaugsson, who has otherwise been quiet on the controls for some while, after big words earlier on the money that could be made.

The circle to square: levying foreigners but not discriminating

According to Icelandic media a Bill of law has been drafted and is just waiting to be presented to parliament. Such a draft has existed for a long time, I believe, but has not been presented because the two government leaders do not agree on fundamental issues. Though firmly denied by the two leaders I hear from all directions that this disagreement has been there from the beginning. Whether they are now any closer to a common solution remains to be seen.

Part of the impossibility of deciding on a plan is the strife to slam a levy on creditors without hitting Icelandic pension funds, other Icelandic entities and last but not least the UK Treasury, which holds claims stemming from Icesave. Whatever the measure it has to, or should, fulfill some legal parameters such as not discriminating between domestic and foreign entities. This has proven to be the real hindrance, as far as I understand.

At the behest of Glitnir Winding up Board, two Icelandic academics recently published a report outlining possible solutions. It has been clear for a long time that there are sensible solutions to be found. Unfortunately, the sensible solutions to not include a massive transfer of money to the state, which seems to be what some are seeking. I have earlier pointed out that looking for a solution, which does not exist, might take a long time. The feeling is that a lot of time has been wasted on exactly that though Benediktsson staunchly denied this following the new report.

Political storm and strange behaviour

One reason some observers remain doubtful on any action regarding capital controls is that the government is struggling with many thorny issues. Like wood fires in dry weather strikes are springing up all over Iceland and in different sectors. And as so often with this government there seems remarkable bewilderment as to how to proceed. Yet, the strikes were of course announced months ago – already in autumn it was clear what was coming.

In addition there are several politically seriously divisive topics up in Alþingi, the Icelandic Parliament. Just today, proposals for new power plants was introduced, with some unexpected additions, which caused a hefty debate and angry words from the opposition. Recently presented changes to fishery management and quotas, mackerel quotas in particular, led the opposition to accuse the government of handing out Icelandic resources to the few against the general interest of all Icelanders. The government is introducing a new housing Bill, presented by a Progressive minister, but only part of it has been presented so far, allegedly because Benediktsson opposes his coalition partner’s plan on how to finance it.

The prime minister’s behaviour keeps drawing attention. It was noted that he did not show up at the CBI’s annual meeting earlier this year. And he made the disappearing act during a recent Alþingi question time: he showed up at the beginning only to leave unannounced before it ended, much to the anger of opposition MPs who feel they rarely get to debate with him in person.

The rising cost to Iceland of inaction

In a nut shell this is the political situation in Iceland: topics that touch a raw political nerve, such as power plants and fishing quotas, strikes, a prime minister whose erratic behaviour is much noted and an alleged disagreement between the two government leaders on the capital controls and other key issues. Under these circumstances it remains to be seen if this long awaited plan on lifting capital controls, i.e. how to deal with the estates of the failed banks, will indeed see the light of day any time soon.

While all of this is going on creditors can just quietly sell their claims. In general, as the price of claims goes down the litigation appetite goes up; so far this market is still thin and no great changes visible. As oft repeated here on Icelog the sad thing is that yes, there are indeed viable solutions to lifting the capital controls. While politicians postpone viable solutions Iceland is living with the unavoidably rising cost of capital controls: there is a cost to doing nothing.

*For earlier Icelogs on capital controls see here. I don’t think there is any angle of this issue I haven’t covered earlier so for those who are looking for particular issues do use the “search” option.

*UPDATE – forgot to mention: for the latests data on economy and the estates of the failed banks relevant for capital controls see the CBI’s latest Financial Stability report, published  in April, especially the governor’s introduction and chapter VII.

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Written by Sigrún Davídsdóttir

May 12th, 2015 at 6:53 pm

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Further insight into “Kaupthinking”

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The ongoing case against nine Kaupthing managers and staff gives an intriguing insight into the bank’s extensive buying and selling of own shares, which the Office of the Special Prosecutor claims involves market manipulation and breach of fiduciary duty. Witness statements by foreign employees have been especially informative.

In a witness statement today Jan Petter Sissener former head of Kaupthing Norway said he had not had faith in Kaupthing’s annual accounts for 2007. Irked by the bank’s reporting on buying and selling of own shares he asked a law firm in London to look at the bank’s activities from the point of view of international business ethics.

The firm concluded the bank’s behavior was entirely unacceptable. Sissener said that following heated conversation with Kaupthing’s CEO Hreiðar Már Sigurðsson, one of the nine charged now, and the bank’s chief legal officer Helgi Sigurðsson these trades had been stopped for a while but then later resumed again. Sissener left Kaupthing in February 2008 because of these differences of opinion regarding Kaupthing’s reporting on proprietary trading in own shares, which the bank funded to a large extent as shown extensively in the SIC report in 2010.

Another foreign employee, Nick Holton, an international compliance officer with Kaupthing, resigned at the end of July 2008, following a disagreement with senior management. Holton wanted to make some changes but failed to secure support. He said he had had serious doubts about what was going on and wondered at the time whether it was due to negligence or lack of organization. In addition, he worried about his own reputation after working for Kaupthing. He said he had pointed out to the chief legal officer that trading in own shares was illegal in many countries. Holton said it had come as a surprise when he realized that Kaupthing owned 4% of own shares but he did not know at the time that Kaupthing had funded big purchases of its shares for clients nor was he aware of losses stemming from these transactions.

Niels de Connick-Smith, a Danish business man, who sat on the board of Kaupthing, said that as far as he knew Kaupthing’s purchase of own shares had not been discussed on the board.

Senior Kaupthing managers now charged – Sigurður Einarsson, Hreiðar Már Sigurðsson and Magnús Guðmundsson, all of them already in prison following a judgment in the al Thani case – have all been questioned. They deny all charges. The same goes for Ingólfur Helgason, formerly the CEO of Kaupthing Iceland.

The five employees, charged in this case, who carried out the trades said they did so on orders, mostly from Ingólfur Helgason. Helgason denies having operated on his own but would have taken orders, mostly from Sigurðsson. Einarsson claims that being the chairman of the board meant he had no direct involvement in transactions of this type and consequently they would have been outside of his horizon.

Parking shares

The prosecutor has played informative recordings from phone tappings. In one of them the bank’s chief legal officer is talking about transactions in 2008 where the bank lent over ISK10bn, to an offshore company, Desulo Trading owned by an Icelandic business man, Egill Ágústsson. Desulo Trading then bought Kaupthing shares; over a few months it bought 2% of the bank. According to the legal officer the bank was “literally parking the shares” in what he called quite “clearly fictive trades.”

The owner of Desulo Trading has said in an earlier witness statement that he was not told of these transactions and was quite shocked when he saw the substantial loans issued to his company. One Kaupthing Luxembourg employee said the company was, in the end, quite obviously “just like a dustbin” in the bank. Apart from loans to Desulo Trading two other companies are involved in this case, also belonging to big Kaupthing clients, Holt Investment owned by Luxembourg investor Skúli Þorvaldsson and Mata Investments, owned by Gísli V. Einarsson and his family.

Þorvaldsson is charged in another case regarding embezzlement from Kaupthing, together with Sigurðsson, Guðmundsson and Guðný Arna Sveinsdóttir Kaupthing’s chief financial officer, seen to have been very close to the Kaupthing management.

In total, Kaupthing sold almost 18% of the bank’s share in seven large transactions shortly before it collapsed, in all cases funding the share purchase with Kaupthing loans. The largest transaction was when a Qatari sheikh bought 5,1% for which the three above mentioned managers and Ólafur Ólafsson, the bank’s second largest shareholder, are now serving 3 to 5 1/2 years in prison in the so-called al Thani case.

I have earlier stated that I wonder if anything like this was going on in other banks up to the crisis. Here, some Irish banks come to mind re loans to ten shareholders in Anglo Irish. An Irish Court found two bankers guilty but they were not sent to prison because the judge found regulators had failed to warn the bankers of the illegal activity. Icelandic senior bankers have been less lucky.

*This report is based on Rúv reporting on the ongoing case, found here, in Icelandic.

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Written by Sigrún Davídsdóttir

May 11th, 2015 at 10:53 pm

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This time, no different from earlier: FX risk hidden from borrowers

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The Swiss Franc unpegging from the euro 15 January this year brought the risk of foreign currency borrowing for unhedged borrowers yet again to the fore. In Central, Eastern and South-Eastern Europe lending in Swiss Franc and other foreign currency, most notably in euros, has been common since the early 2000s, often amounting to more than half of loans issued to households. The 2008 crisis put some damper on this lending, did not stop it though and in addition legacy issues remain. Now, actions by foreign currency borrowers in various countries are also unveiling a less glorious aspect: mis-selling and breach of European Directives on consumer protection. Senior bankers involved in foreign currency lending invariably claim that banks could not possibly foresee FX fluctuation. Yet, all of this has happened earlier in different parts of the world, most notably in Australia in the 1980s.

“The 2008-09 financial crisis has highlighted the problems associated with currency mismatches in the balance sheets of emerging market borrowers, particularly in Emerging Europe,” economists at the European Bank of Reconstruction and Development, EBRD, Jeromin Zettelmeyer, Piroska Nagy and Stephen Jeffrey wrote in the summer of 2009.*

In the grand scheme of Western and Northern European countries this mismatch was a little-noticed side-effect of the 2008 crisis. But at the EBRD, focused on Central, Eastern, South East European, CESEE, countries, its chief economist Erik Berglöf and his colleagues worried since foreign currency, FX, lending was common in this part of Europe. FX lending per se was not the problem but the fact that these loans were to a great extent issued to unhedged borrowers, i.e. borrowers who have neither assets nor income in FX. This lending was also partly the focus of the Vienna Initiative, launched in January 2009 by the EBRD, European and international organisations and banks to help resolve problems arising from CESEE countries mainly being served by foreign banks.

In Iceland FX lending took off from 2003 following the privatisation of the banks: with the banks growing far beyond the funding capacity of Icelandic depositors, foreign funding poured in to finance the banks’ expansion abroad. Icelandic interest rates were high and the rates of euro, Swiss Franc, CHF and yen attractive. Less so in October 2008 when the banks had collapsed: at the end of October 2007 1 euro stood at ISK85, a year later at ISK150 and by October 2009 at ISK185.

After Icelandic borrowers sued one of the banks, the Supreme Court ruled in a 2010 judgement that FX loans were indeed legal but not FX indexed loans, which most of household loans were. It took further time and several judgements to determine the course of action: household loans were recalculated in ISK at the very favourable foreign interest rates. Court cases are still on-going, now to test FX lending against European directives on consumer-protection.

In all these stories of FX loans turning into a millstone around the neck of borrowers in various European countries senior bankers invariably say the same thing: “we couldn’t possibly foresee the currency fluctuations!” In a narrow sense this is true: it is not easy to foresee when exactly a currency fluctuation will happen. Yet, these fluctuation are frequent; consequently, if a loan has a maturity of more than just a few years it is as sure as the earth revolving around the sun that a fluctuation of ca. 20%, often considerably more, will happen.

Interestingly, many of the banks issuing FX loans in emerging Europe did indeed make provisions for the risk, only not on behalf of their clients. According to economist at the Swiss National Bank, SNB, Pinar Yeşin “banks in Europe have continuously held more foreign-currency-denominated assets than liabilities, indicating their awareness of the exchange-rate-induced credit risk they face.”

Indeed, many of the banks lending to unhedged borrowers took measures to hedge themselves. Understandably so since it has all happened before. Recent stories of FX lending misery in various European countries are nothing but a rerun of what happened in many countries all over the world in earlier decades: i.a., events in Australia in the 1980s are like a blueprint of the European events. In Australia leaked documents unveiled that senior bankers knew full well of the risk to unhedged borrowers but they kept it to themselves.

It can also be argued that given certain conditions FX lending led to systematic lending to CESEE clients borrowing more than they would have coped with in domestic currency making FX lending a type of sub-prime lending. What now seems clear is that cases of mis-selling, unclear fees and insufficient documentation now seem to be emerging, albeit slowly, in European FX lending to unhedged borrowers.

FX lending in CESEE: to what extent and why

A striking snapshot of lending in Emerging Europe is that “local currency finance comes second,” with the exception of the Czech Republic and Poland, as Piroska Nagy pointed out in October 2010, referring to EBRD research. With under-developed financial markets in these countries banking systems there are largely dominated by foreign banks or subsidiaries of foreign banks.

This also means, as Nagy underlined, that there is an urgent need to reduce “systemic risks associated with FX lending to unhedged borrowers” as this would remove key vulnerabilities and “enhance monetary policy effectiveness.”

Although action has been taken in some of the European countries hit by FX lending, “legacy” issues remain, i.e. problems stemming from prolific FX lending in the years up to 2008 and even later. In short, FX lending is still a problem to many households and a threat to European banks, in addition to non-performing loans, i.e. loans in arrears, arising from unhedged FX lending.

The most striking mismatch in terms of banks’ behaviour is evident in the operations of the Austrian banks that have been lending in FX at home in Austria the euro country, but also abroad in the neighbouring CESEE countries. In Austria, FX loans were available to wealthy individuals who mostly hedged their FX balloon loans (i.e. a type of “interest only” loans) with insurance of some sort. Abroad however, “these loans in most cases had not been granted mostly to relatively high income households,” as somewhat euphemistically stated in the Financial Stability report by the Austrian Central Bank, OeNB in 2009.

There is plenty of anecdotal evidence to conclude that during the boom years banks were pushing FX loans to borrowers, rather than the other way around. Thus, it can be concluded that the FX lending in CESEE countries was a form of sub-prime lending, that is people who did not meet the requirements for borrowing in the domestic currency could borrow, or borrow more, in FX. This would then also explain why FX loans to unhedged borrowers did become such a major problem in these countries.

Where these loans have become a political issue FX borrowers have often been met with allegations of greed; that they were trying to gain by gambling on the FX market. In 2010 Martin Brown, economist at the SNB and two other economists published a study on “Foreign Currency Loans – Demand or Supply Driven?” They attempted to answer the question by studying loans to Bulgarian companies 2003-2007. What they discovered was i.a. that for 32% of the FX business loans issued in their sample the companies had indeed asked for local currency loan.

“Our analysis suggests that the bank lends in foreign currency, not only to less risky firms, but also when the firm requests a long-term loan and when the bank itself has more funding in euro. These results imply that foreign currency borrowing in Eastern Europe is not only driven by borrowers who try to benefit from lower interest rates but also by banks hesitant to lend long-term in local currency and eager to match the currency structure of their assets and liabilities.”

In other words, the banks had more funding in euro than in the local currency and consequently, by lending in FX (here, euro), the banks were hedging themselves in addition to distancing themselves from instable domestic conditions. A further support for this theory is FX lending in Iceland, which took off when the banks started to seek funding on international markets. (The effect on banks’ FX funding is not uncontested: further on reasons for FX lending in Europe see EBRD’s “Transition Report” 2010, Ch. 3, esp. Box 3.2.)

The Australian lesson: with clear information “…nobody in their right mind… would have gone ahead with it”

Financial deregulation began in Australia in the early 1970s. Against that background, the Australian dollar was floated in December 1983. In the years up to 1985 banks in Australia had been lending in FX, often to farmers who previously had little recourse to bank credit. However, the Australian dollar started falling in early 1985; from end of 1984 to the lowest point in July 1986 the trade-weighted index depreciated by more then a third. Consequently, the FX loans became too heavy a burden for many of the burrowers, with the usual ensuing misery: bankruptcy, loss of homes, breaking up of marriages and, in the most tragic cases, suicide.

The Australian bankers shrugged their shoulders; it had all been unforeseeable. FX borrowers who tried suing the banks lost miserably in court, unable to prove that bankers had told them the currency fluctuations would never be that severe and if it did the bank would intervene. As one judge put it: “A foreign borrowing is not itself dangerous merely because opportunities for profit, or loss, may exist.” The prevailing understanding in the justice system was that those borrowing in FX had willingly taken on a gamble where some lose, some win.

But gambling turned out to be a mistaken parallel: a gambler knows he is gambling; the FX borrowers did not know they were involved in FX gambling. The borrowers got organised, by 1989 they had formed the Foreign Currency Borrowers Association and assisted in suing the banks. The tide finally turned in favour of the borrowers and against the banks; the courts realised that unlike gamblers the borrowers had been wholly unaware of the risk because the banks had not done their duty in properly informing the FX borrowers of the risk. But by this time FX borrowers had already been suffering pain and misery for four to five years.

What changed the situation were internal documents, two letters, tabled on the first day of a case against one of the banks, Westpac. The letters, provided by a Westpac whistle-blower, John McLennan, showed that when the loan in question was issued in March 1985 the Westpac management was already well aware of the risk but said nothing to clients. Staff dealing with clients was often ignorant of the risks and did not fully understand the products they were welling. When it transpired who had provided the documents Westpac sued McLennan – a classic example of harassment whistle-blowers almost invariably suffer – but later settled with McLennan.

As a former senior manager summed it up in 1991: “Let us face it – nobody in their right mind, if they had done a proper analysis of what could happen, would have gone ahead with it.” (See here for an overview of some Australian court cases regarding FX loans).

FX borrowers of all lands, unify!

“Probably like a lot of other people (.) I felt that the banks knew what they were doing, and you know, that they could be trusted in giving you the right advice,” is how one Westpac borrower summed it up in a 1989 documentary on the Australian FX lending saga.

This misplaced trust in banks delayed action against the banks in Australia in the 1980s and in all similar sagas. However, at some point bank clients realise the banks take their care of duty towards clients lightly but are better at safeguarding own interests. As in Australia, the most effective way is setting up an association to fight the banks in a more targeted cost-efficient way.

This has now happened in many European countries hit by FX loans and devaluation. At a conference in Cyprus in early December, organised by a Cypriot solicitor Katherine Alexander-Theodotou, representatives from fifteen countries gathered to share experience and inform of state of affairs and actions taken in their countries regarding FX loans. This group is now working as an umbrella organization at a European level, has a website and aims i.a. at influencing consumer protection at European level.

Spain is part of the euro zone and yet banks in Spain have been selling FX loans. Patricia Suárez Ramírez is the president of Asuapedefin, a Spanish association of FX borrowers set up in 2009. She says that since the Swiss unpegging in January the number of Asuapedefin members has doubled. “There is an information mismatch between the banks and their clients. Given the full information, nobody in their right mind would invest all their assets in foreign currency and guarantee with their home. Banks have access to forecasts like Bloomberg and knew from early 2007 that the euro would devalue against the Swiss Franc and Japanese Yen.”

As in Australia, the first cases in most of the European countries have in general and for various reasons not been successful: judges have often not been experienced enough in financial matters; as in Australia clients lack evidence; there tends to be a bias favouring the banks and so far, only few cases have reached higher instances of the courts. However, in Europe the tide might be turning in favour of FX borrowers, thanks to an fervent Hungarian FX borrower.

The case of Árpád Kásler and the European Court of Justice

In April 2014 the European Court of Justice, ECJ, ruled on a Hungarian case, referred to it by a Hungarian Court: Árpád Kásler and his wife v OTP Jelzálogbank, ECJ C‑26/13. The Káslers had contested the bank’s charging structure, which they claimed unduly favoured the bank and also claimed the loan contract had not been clear: the contract authorised the bank to calculate the monthly instalment on the basis of the selling rate of the CHF, on which the loan was based, whereas the amount of the loan advanced was determined by the bank on the basis of the buying rate of the CHF.

After winning their case the bank appealed the judgement after which the Hungarian Court requested a preliminary ruling from the ECJ, concerning “the interpretation of Articles 4(2) and 6(1) of Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts (OJ 1993 L 95, p. 29, ‘the Directive’ or ‘Directive 93/13’).”

In its judgment the ECJ partly sided with the Káslers. It ruled that the fee structure was unjust: the bank did not, as it claimed, incur any service costs as the loan was indeed only indexed to CHF; the bank did not actually go into the market to buy CHF. The Court also ruled that it was not enough that the contract was “grammatically intelligible to the consumer” but should also be set out in such a way “that consumer is in a position to evaluate… the economic consequences” of the contract for him. Regarding the third question – what should substitute the contract if it was deemed unfair – the ECJ left it to the national court to decide on the substitute.

Following the ECJ judgement in April 2014, the Hungarian Supreme Court ruled in favour of the Káslers: the fee structure had indeed favoured the bank and was not fair, the contract was not clear enough and the loan should be linked to interest rates set by the Hungarian Central Bank. – As in the Australian cases Kásler’s fight had taken years and come at immense personal pain and pecuniary cost.

Hungarian law are not precedent-based, which meant that the effect on other similar loan contracts was not evident. In July 2014 the Hungarian Parliament decided that banks lending in FX should return the fee that the Kásler judgement had deemed unfair.

The European Banking Authority, EBS is the new European regulator. The ECJ ruling in many ways reflects what the EBA has been pointing from the time it was set up in 2011. In its advice in 2013 on good practice for responsible mortgage lending it emphasises “a comprehensive disclosure approach in foreign currency lending, for example using scenarios to illustrate the effect of interest and exchange rate movements.”

Calculated gamble v being blind-folded at the gambling table

“Since the ECJ judgment in the Kásler case, judges in Spain have started to agree with consumers from banks,” says Patricia Suárez Ramírez. So far, anecdotal evidence supports her view that the ECJ judgment in the Kásler case is, albeit slowly, determining the course of other similar cases in other EU countries.

The FX loans were clearly a risk to unhedged borrowers in the countries where these loans were prevalent. If judgements to come will be in favour of borrowers, as in ECJ C‑26/13, the banks clearly face losses: in some cases even considerable losses if the FX loans will have to be recalculated on an extensive scale, as did indeed happen in Iceland.

Voices from the financial sector are already pointing out the unfairness of demands that the banks recalculate FX loans or compensate unhedged FX borrowers. However, it seems clear that banks took a calculated gamble on FX lending to unhedged borrowers. In the best spirit of capitalism, you win some you lose some. The unfairness here does not apply to the banks but to their unhedged clients, who believed in the banks’ duty of care and who, instead of being sold a sound product, were led blind-folded to the gambling table.

*The first draft was written in July 2009; published 2010 as EBRD Working Paper.

This is the first article in a series on FX lending in Europe: the unobserved threat to FX unhedged borrowers – and European banks.The next article will be on Austrian banks, prolific FX lenders both at home and abroad, though with an intriguing difference. The series is cross-posted on Fistful of Euros.

See here an earlier article of mine on FX lending, cross-posted on Fistful of Euros and my own blog, Icelog.

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Written by Sigrún Davídsdóttir

April 28th, 2015 at 10:00 pm

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The Aurum case: media battle and a second round in Court

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Today, the Icelandic Supreme Court annulled the Reykjavík District Court acquittal in the Aurum case. This means that the District Court has to start all over again on the case. Those charged are Jón Ásgeir Jóhannesson and Lárus Welding who became Glitnir’s CEO when Jóhannesson and a group of investors bought over 30% in the bank in spring 2007. Two other Glitnir employees are also charged.

At the centre of the case is a loan from Glitnir to a shelf company, FS38 to buy a share in the retailer Goldsmith, owned by Aurum Holding, from Fons, owned by Pálmi Haraldsson, a business associate of Jóhannesson. Haraldsson was i.a. a co-investor in Glitnir with Jóhannesson, where the duo were close up and intimate with the management. So much so that Welding at some point, in an email to Jóhannesson, complained that he was being treated like a branch manager and not the CEO.

The particulars of this whole loan arrangement was that after various evaluations of Goldsmith, Glitnir lent ISK6bn to FS38; it so happened that of the 6bn ISK1bn landed on Haraldsson’s account with Glitnir and an equal amount landed on Jóhannesson’s personal account.

The FS38 loan saga was already familiar from the SIC report, published in April 2010, one of many SIC’s loan sagas related to the major shareholders of the three banks. The four were charged by the Office of the Special Prosecutor. When the case came up in the District Court it was presided over by two District Court Judges the third one being a Court-appointed external expert, Sverrir Ólafsson.

In June last year the Court acquitted all four charged in the Aurum case. Soon after, it transpired that Ólafsson was the brother of Ólafur Ólafsson, at the time already sentenced by the District Court in the so-called al Thani case. Ólafur is now serving a sentence of 4 1/2 years after the Supreme Court sentenced him last January (thereby adding a year to Ólafsson’s sentence in the District Court). Foreigners always think that in Iceland everyone knows everybody, which definitely was not the case with the Ólafsson brothers – special prosecutor Ólafur Þ. Hauksson denied he had known about the relationship (and yes, Ólafsson is a very common name in Iceland and the two brothers are not at all similar) nor had the Icelandic media picked this up.

Following the revelation, Sverrir Ólafsson said in an interview with Rúv that it was inconceivable Hauksson and the OSP had not been aware of whose brother he was. According to Sverrir the fuss was only to undermine the judgement. In this interview Ólafsson used harsh words about Hauksson, seen by many as somewhat unsuited for a judge, even a lay one.

Following the District Court ruling in the Aurum case the state prosecutor (a different authority from the OSP) demanded that the judgement should be annulled because of doubt of the impartiality of one of the judges. Today, this is exactly what the Supreme Court did, which means that now the case must start anew, probably adding at least another year and probably more to the story of this case.

In addition to this the Glitnir Winding up Board has sued Jóhannesson and others for damages caused by the FS38 loan. In connection to that case, and at the demand of Glitnir, Jóhannesson’s assets were subjected to an international freezing order by a London Court in May 2010 (see herehere and here). The Glitnir case is resting until a final judgement in the criminal case; as far as is known the freezing order is still standing. However, Jóhannesson is again an active investor, i.a. in the UK but investing on behalf of his wife.

Recently, there have been articles in Icelandic on the website Vísir and in the newspaper (distributed for free) Fréttablaðið owned by 365 Media, under the ownership of Ingibjörg Pálmadóttir, wife of Jóhannesson. These articles have been insinuating lies on behalf of the Special Prosecutor regarding Ólafsson, i.e. stating that Hauksson and others at the OSP did indeed know whose brother Sverrir Ólafsson was. Earlier, the paper had also sought to sow doubt of the al Thani judgement; the sentence in one of its articles, saying that when the Courts fail the media must take over, was much noted. No doubt, Jóhannesson and his allies will fight their case ferociously, not only in the Courts but also in the media in the Jóhannesson’s sphere of influence.

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Written by Sigrún Davídsdóttir

April 22nd, 2015 at 9:47 pm

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The latest re stability tax

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Bjarni Benediktsson minister of finance did not answer directly when asked by Rúv if he knew beforehand that prime minister Sigmundur Davíð Gunnlaugsson. He only said that he and the prime minister were working closely together towards lifting the capital controls. He said work was ongoing to prepare Bill, expected before summer, but was not firm on a date.

He reiterated that the estates were a threat to stability and stability tax – not a concept heard until mentioned by the prime minister on Friday – was intended to do just that: preserve stability when it came to lifting capital controls. He did not want to answer exactly who would pay this tax or how but the tax would help authorities to control the process of lifting the controls. He also repeated what the prime minister said, that the estates had not put forward any useful plan for lifting controls.

The winding-up boards of the estates will no doubt beg to differ: they have put forth plans, which have not been answered.

At an open committee meeting on Monday governor of the Central Bank of Iceland Már Guðmundsson was asked about the tax. He said it could be compared to “pollution tax” – the estates were like a source of pollution within the economy and the tax was to mitigate the effect of this pollution. What exactly this Delphic utterance meant in practice he would not say.

For more on this issue see the two most recent blogs here below.

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Written by Sigrún Davídsdóttir

April 15th, 2015 at 2:02 pm

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Panic politics in practice

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Going on the fourth day since prime minister Sigmundur Davíð Gunnlaugsson announced stability tax, minister of finance Bjarni Benediktsson has not yet said a word on the announcement. Arriving from two weeks holiday in Florida Monday morning he did not attend the first meeting of Alþingi after the Easter break, nor did Gunnlaugsson. The two ministers are said to have spent the afternoon in meetings with Már Guðmundsson governor of the Central Bank, CBI.

My hunch is that Gunnlaugsson did not discuss his statement with Benediktsson before making the speech. The preparations of the capital controls plan-to-be have been carried out in utmost secrecy, drafts not sent in emails etc. and it certainly was not anticipated that one of the insiders, the prime minister, would then go out and announce it at a time that suited him and his party politics. Hardly a statesman-like behavior to use a party conference to make a prime-ministerial announcement of this kind. But with the prime minister getting some numbers wrong it seems he did not have the best advisers at his side in preparing for the speech.

It is also clear that the Bill Gunnlaugsson announced had not been presented earlier because the government leaders had not been able to come to an agreement on the final version. By saying that a stability tax bringing billions to the state will be presented before the end of this Alþingi Gunnlaugsson has put pressure on Benediktsson. It seems like a retaliation for the pressure Benediktsson tried to put on Gunnlaugsson last year when Benediktsson kept announcing that a liberalisation plan would be presented last year – only a much harder pressure because Gunnlaugsson did not just announce the plan but also what it actually should contain.

Vilhjálmur Bjarnason MP for Independence party said in Morgunblaðið yesterday that a tax on estates was far from international practice, would be contested in court, leading to years of court wrangling during which time the controls could not be lifted. Hörður Ægisson journalist at DV said in an interview with the webzine Eyjan that using the lifting of capital controls to make money for the state ran counter to earlier statements. Anything except dealing with foreign-owned ISK was unacceptable, according to Ægisson.

Gunnlaugsson then went a step further over the weekend when he said, in an interview to Morgunblaðið, that the billions from the stability tax would not be used but set aside, on which he and Benediktsson were in total agreement – another poisoned arrow.

So what is all this about? First of all, the stability tax is nothing like the previously discussed exit tax. An exit tax taxes capital movements. The stability tax is indeed a form of asset tax, i.e. will be levied on assets according to certain criteria. One theory is that it will be levied on assets in order to prepare for or at the time of composition of the banks’ estate. And it is to be a double digit tax.

That the advisory committee has been split on how to proceed on the tax, i.a. how to use the billions, echoes in Gunnlaugsson’s words. Of course, parking the billions goes counter to what Gunnlaugsson has been announcing. For Gunnlaugsson to claim that the two agreed on this seems like an attempt to making peace with Benediktsson after his major faux-pas in his speech.

Benediktsson was unavailable for comments yesterday. Gunnlaugsson did not want to be interviewed on Rúv. What happens now is anybody’s guess – some say this is the end of the government but as I have pointed out earlier Benediktsson is in a difficult situation. Should he swallow this or try to act? In theory, he could  turn to the opposition and see if he can find some common ground there to form a new government. That would though crave a heroic force and spirit, non of which Benediktsson has shown so far. In addition, the opposition parties have been fairly lame, difficult to gauge there the energy needed for some political fireworks.

According to a Sunday Times article by Philip Aldrick there are some meetings going on between government representatives and creditors. I have not been able to ascertain that this is indeed the case but I believe that yes, there have been some meetings, even as late as last week. The winding-up boards do not seem to be involved and only a few large creditors. It may well be that there are some parties involved trying to map some common ground where negotiations could start from. So far, the government’s official line has been not to negotiate although that seems the most sensible approach for a speedy and efficient end to the misery of capital controls. Remains to be seen.

And it also remains to be seen what comes out of Gunnlaugsson’s statement and how the government will proceed. Benediktsson has been badly treated by Gunnlaugsson who, though most likely not seeing any fault with his behaviour, has not only breached the trust of his coalition party but also ventured into Benediktsson’s territory, quite apart from the substance, i.e. that the Bill had not been presented yet because there was, as yet, no final agreement on the coming plan.

Why Gunnlaugsson chose to make his announcement? Well, this was panic politics in practice: he was standing in front of a party he led to almost 25% of votes, but now standing at ca. 10% in the polls.

– – –

Gunnlaugsson speech is now available online, in Icelandic. I.a. he claims the numbers at stake for creditors in Iceland are high in international context as can be seen from Hollywood films, where $10m are a high number. An interesting insight into an apparently quite parochial mind who likes Hollywood films.

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Written by Sigrún Davídsdóttir

April 14th, 2015 at 10:07 am

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Gunnlaugsson goes solo on the abolition plan: beginning of an action plan or end of coalition?

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In an “overview speech” at his party’s annual conference prime minister Sigmundur Davíð Gunnlaugsson announced today an outline of an abolition plan, short on content – only stability tax mentioned – but long on scaremongering of creditors and their wealth amassed in Iceland, with strikingly wrong numbers. From earlier statements by Bjarni Benediktsson minister of finance, whose remit the capital controls are, it is difficult to imagine he condones Gunnlaugsson’s views. Apart from whether this is a good plan or not it is worrying that the prime minister has lately been quite “statement-happy,” expressing views, which neither Benediktsson nor others have heard of until reported on in the media.

Before the Parliament’s summer recess the government will present a Bill to lift capital controls. This is what prime minister Sigmundur Davíð Gunnlaugsson leader of the Progressive party announced at the party’s annual conference Friday.

The only concrete measure Gunnlaugsson announced is “stability tax” that according to the prime minister will bring billions of Icelandic króna to the state coffers. As earlier, Gunnlaugsson emphasised the financial gain and the need to remove the new bank’s ownership from creditors. Worryingly, Gunnlaugsson presented wrong numbers and statements, which do not quite seem to make sense or at least rest on some fairly particular interpretation of reality.

From earlier statements by minister of finance Bjarni Benediktsson on capital controls it is difficult to see how Gunnlaugsson’s statements fit Benediktsson’s prerequisites of an orderly process based on classic measures, as outlined in Benediktsson’s last status report on the controls (see my take on it here). In addition, Gunnlaugsson has now taken the initiative from Benediktsson. The question is if he did at all discuss his speech with Benediktsson beforehand – allegedly, the two do not spend much time and effort communicating.

This in addition to some recent statements from Gunnlaugsson, which have not been discussed with Benediktsson or in the government. Also, there is the report by his fellow party member Frosti Sigurjónsson on monetary systems, another solo initiative by the prime minister.

With Gunnlaugsson’s latest statement there have been some speculation if Benediktsson and his party feel to stay in this coalition much longer. However, it might prove tricky for the party to leave without making it look as if they are somehow caving into creditors whereas Gunnlaugsson is gallantly fighting them.

Icelanders are slowly learning that whenever the prime minister speaks they glimpse the world according to his “Weltanschuung” – and it does not always seem to rhyme with reality.

Wrong numbers, remarkable calculations

In his speech Gunnlaugsson said, according to Icelandic media (I have so far not found a link to the speech), that most of the creditors were hedge funds that having bought the claims in a fire sale had profited quite enormously. The claims in the collapsed banks are so high, he said, that it is difficult to imagine it – as much as ISK2500bn (which being ca 1 ½ Icelandic GDP is not that hard to imagine). “Were this sum invested it would be possible to hold Olympic games, just for the interests, every four years, for eternity.”

This is wrong. The claims themselves are around ISK7000bn, the assets of the three estates are at ISK2250bn. As to the interests of this sum possibly being a sort eternity machine to finance the Olympics this hardly adds up. If we postulate that half of the assets are in cash at 1% interest rates and other assets carry 5% interest rates the annual interest rates would amount to ISK67.5bn or ISK270bn, just under $2bn, over four years. Would that be enough to finance the Olympics? The cost of the London games amounted to $14.6bn, ISK2000bn, the cost of Sochi $51bn, ISK7000bn.

This is worryingly wrong and far beyond reality. The fact that the prime minister does not know the correct numbers is bad but almost worse that he does not have advisers to enlighten him and find the correct numbers for him. Whoever tried to impress him with the Olympics parallel if clearly not fit to be an adviser on financial matters.

Tellingly, all these numbers and the Olympics calculations were diligently reported on Morgunblaðið’s front page today.

The spying conniving creditors

With all these assets (albeit a wrong number) Gunnlaugsson concluded that creditors would be prepared to go to some length to protect their assets. Who wouldn’t? he asked, considering the sums.

“It is known that most if not all larger legal firms in Iceland have worked on behalf of these parties or their representatives. It would be hard to find a PR firm, operating in Iceland that has not worked for these same parties in addition to a large number of advisers in various fields. This activity is almost frightening and it is impossible to tell how far they reach but according to recent news creditors have bought services to protect their interests in this country for ISK18bn in recent years.”

Again, there is no reference to where this number comes from but it seems farfetched, to say the very least. Further, Gunnlaugsson stated:

We know that representatives of creditors have gathered personal information on politicians, journalists and others who have expressed views on these issues or are likely to do so. And in some cases people have been psychoanalysed in order to better understand how best to deal with them. Secret reports are written regularly in this country for creditors, which inform on how things are going in Iceland, on the politics, public debate, the financial system and so on. In one of the first reports it was stated that the greatest threats to the hedge funds reaching their goals, the main obstacle for them to do as they pleased, was called the Progressive party.”

Exactly what creditors have done to collect information in Iceland I don’t know but what the prime minister describes here is normal proceedings for doing business in a country (though the psychoanalysis might be rare though by far not unknown): they want to follow what is going on, how it affects their interests and so on. The alarmist tone is somewhat misplaced – creditors would not be pursuing their interests well if they did not keep a close eye on Iceland. It does not matter if it is Argentina, Greece of Iceland: firms want to understand the environment they operate in.

“One has to give it to these guys (creditors): they get the main facts right,” said Gunnlaugsson. – Getting the facts right is something less accurate people might try to learn from creditors.

The government’s turnaround in lifting capital controls

According to Gunnlaugsson it was a narrow escape that there were not major mistakes made in 2012 with regard to creditors. He especially thanked “our Sigurður Hannesson,” the MP banker who heads one of the party’s committees, is also on the capital controls’ advisory committee and known to be a close friend of Gunnlaugsson. – Gunnlaugsson did not clarify what heroic deeds were won in 2012; could be the decision to send the Icesave case to the EFTA Court or change in the currency controls legislation, which placed the foreign assets under the controls.

Gunnlaugsson stated that after the present government came to power there had been a real turnaround with regard to the capital controls and all earlier plans had been revised. – This work may ongoing but the only official plan in place is the plan presented by the Central Bank of Iceland, CBI, in 2011.

According to Gunnlaugsson, creditors worked diligently for having Iceland joining the European Union, EU, which would have forced Iceland to follow the bailout path of the euro-crisis countries. This would have forced Iceland to “pay all creditors in full and the whole overhang, not only at full price but at the overprice inherent in the creditors’ paper profit being financed by the Icelandic public through loans. This would have left Icelanders with the debt and no mercy shown. For this government this was always out of the question.

I am somewhat at loss to understand the remarks about overprice etc. so I leave it to the reader to find the logic here. I am also unaware that creditors have been trying to drag Iceland into EU but they prime minister may well know more on this than mere mortals.

When the road towards the EU had been closed, stated Gunnlaugsson, the government told the representatives of the winding-up boards and the hedge funds that it could not wait any longer. Action will be taken in the following weeks and they will bring the state hundreds of billions of króna, he said.

Again, it is difficult to marry this statement with facts. Just recently, the government sent a letter to the EU, apparently intending to break off negotiations. However, the EU says nothing has changed. According to Icelandic officials briefing foreign diplomats in Iceland the letter does not materially change anything. And so on. Linking the recent moves on the EU and the government driving a harder bargain is not obvious, to say the very least.

The need to act

Gunnlaugsson claims the creditors are not putting forth any realistic solution, which now forces the government to act on lifting capital controls. The plan is to do it before the Parliament’s summer recess. – No mention here of winding-up boards sending composition drafts to the CBI without getting answers.

As often pointed out on Icelog it is clear that government advisers have for over a year been trying to come up with a plan that could suit the two coalition leaders. Tax is one of the points of disagreement: the prime minister wants to make money on the estates; Benediktsson wants to lift the capital controls according to practice in other countries.

It might be difficult to join Benediktsson’s many statements on orderly lifting to the Progressive’s money making scheme. Politically, the Independence party does not feel it owes much to the other coalition party after Benediktsson masterminded the “correction,” Gunnlaugsson’s great election promise of debt relief.

By the time the deadline for handing in new parliamentary Bills expired end of March the coalition parties had not found a common ground on important issues regarding a plan to lift capital controls. A government can always make use of exemption to get Bills into parliament but now the thorny topics are being discussed – reaching an agreement has so far eluded the government.

With his speech Gunnlaugsson might intend to bring pressure on Benediktsson – as did Benediktsson try to do, albeit unsuccessfully, last year with repeated statements on a plan by the end of the year.

The only measure announced: stability tax

According to Gunnlaugsson, with no realistic plans from creditors there is no other way for the government is now forced to launch a plan to lift credit controls before the Parliament ends. The plan is a special stability tax that will bring hundreds of billions to the state, stated Gunnlaugsson. Exactly how it will be applied is unclear but it seems to replace ideas of an exit tax.

This tax, together with other action will enable the government to lift controls without endangering financial stability. “It is unacceptable,” said Gunnlaugsson, “that the Icelandic economy is held hostage by unchanged conditions and to have ownership of the financial systems as it is now (i.e. that the two new banks, Íslandsbanki and Arion Bank are owned by creditors).” – This fits with Gunnlaugsson’s earlier ambitions of both getting money out of creditors and ownership of the two new banks.

The left government would have made “terrible mistakes” of all this, contrary to the Progressive party, which has been remarkable prescient time and again, said Gunnlaugsson:

It is indeed remarkable how often we (i.e. Progressive party) experience that when we point out opportunities, warn against threats or urge that something is more closely explored or in a new light it is at first met with derision. Then it is fought but in the end viewed as common sense that should have been obvious to all. The main thing is that we Icelanders do not forget that for us everything is possible.”

“Pinch of butter” policies

During his years in office the prime minister has time and again made unfounded allegations and presented views he has not discussed with the government. In a recent article in Morgunblaðið MP Vilhjálmur Bjarnason pointed out how unfortunate it was when ministers thought aloud. One characteristic of the prime minister’s statements that sometimes he is not heard or seen for weeks for then suddenly to burst on the scene with views on everything.

Gunnlaugsson has accused the CBI of being engaged in politics. And he has accused ministries officials of leaking information, almost on a daily basis, he said. Neither allegations have been clarified or substantiated. He also worried about import of foreign food to Iceland because it could carry with it something that was changing the character of whole nations; he did not name it but seemed to be talking about toxoplasma, which luckily has not had this drastic effect in foreign lands.

Then there are all the “plans” Gunnlaugsson has announced without carrying them out or having sought any anchoring in the government. Just after coming into office he was going to appoint a capital controls “abolition manager.”

Most recently, Gunnlaugsson has announced plans to extend the Parliament house by a building sketched by Iceland’s most famous architect, Guðjón Samúelsson (1887-1950) – a house that only exists in a sketch from 1918, the year Denmark acknowledged Iceland’s sovereignty. Gunnlaugsson made this statement of Facebook April 1; when reported in the media it was widely thought to be April fools’ news.

Around that time, Gunnlaugsson also said he thought it was a good idea to build a new hospital – a long-running plan and matter of great debate in Iceland – by the Rúv building, thereby introducing a wholly new direction for the hospital. No previous discussion with minister of health or Landspítali management.

The Icelandic media has now found a name for these unexpected ideas of Gunnlaugsson: “smjörklípa” or “pinch of butter,” meaning that something is thrown into the debate to divert attention. Around the time Gunnlaugsson aired his most recent views one of his party member ministers had been unable to introduce a new housing policy, planned in four new bills. It will come at a great cost, is uncosted, and apparently the Independence party is wholly against it.

Another “pinch of butter”: new monetary system in Iceland?

Plans to revolutionise the Icelandic monetary system has made news abroad recently but less so in Iceland. The news spring from a new report, written at the behest of the prime minister (as I have already explained in detail in comment to FT Alphaville). In short, this report seems more of a favour to a Progressive party member than a basis for a new and revolutionary monetary system in Iceland.

It is indicative of the lackadaisical attitude to form and firm procedures that this report was written at the behest of the prime minister and not the minister of finance, who indeed has never expressed any interest for this topic and has not commented on the report.

All those who have been hyper-ventilating in excitement at this bold Icelandic experiment now starting should find some other source of excitement: this experiment has no political backing in Iceland. The Progressive party, whose following has collapsed from 25% in the 2013 election to ca. 10% in the polls, has little political credibility and force to further this cause.

Political risk: the major risk in Iceland

I have earlier pointed out that the greatest risk in Iceland is the political risk. It is intriguing that Gunnlaugsson chose to break the secrecy of the capital controls plan at a party conference, where he has to confront a total collapse in voters’ support is intriguing. His rhetoric of fights and battles against the conniving creditors and the party’s and his own earlier prescience is an important element in this respect.

With the two party leaders at loggerheads on major topics like the capital controls it is unavoidable that it will come to a confrontation at some point if the government is to take action. The outcome is far from clear.

There is great unhappiness among many of Benediktsson’s MPs, whom he incidentally has not trusted recently with cabinet seats. The general feeling is that it is the Independence party, which so far has been carrying out the policies of the coalition partner.

Whatever Benediktsson chooses to do he will need great political skill to steer the party through the coming months. Inaction might not help since creditors may well lose patience and explore their own possibilities, i.a. legal possibilities. If Benediktsson chooses to break away from the Progressive party he will need a clever scheme if he is not to give the coalition party and Gunnlaugsson the role that Morgunblaðið’s cartoonist has given Gunnlaugsson after his speech on Friday:

Cartoon-MblSDGcreditors110415“Now we just put stability tax on the vulture funds and that will kill the problem”

– – – –

Update: minister of finance Bjarni Benediktsson has not yet made himself available to the Icelandic media on his view regarding stability tax. Some members of the opposition have expressed surprise that there is now talk of  stability tax instead of the earlier much discussed exit tax. Guðmundur Steingrímsson leader of Bright Future pointed out both the legal risk and risk to the economy were this plan to be pursued.

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Written by Sigrún Davídsdóttir

April 11th, 2015 at 3:30 pm

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Panic politics: the biggest risk in Iceland

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In its Financial Stability reports and other reports the Central Bank of Iceland, CBI, has increasingly been stressing that conditions in Iceland and internationally for lifting controls are optimal. The same is reiterated in the latest status report by the minister of finance on progress in lifting the capital controls. However, if the status report is read closely it digresses intriguingly from what the CBI has been stressing. That poses the question whether the government is really on its way towards easing controls or only obfuscating the matter. This brings the focus to a statement increasingly heard in terms of Iceland and risk: “The main risk in Iceland is political risk”

“Premises for abolishing capital controls could hardly be better than those now in Iceland…,” minister of finance Bjarni Benediktsson said yesterday at the CBI annual meeting. “Consequently, my hopes are that major decisions will be made now in the first half of this year, pointing the way forward. The year of 2015 will be a year of action and solutions in this matter (capital controls).”

In his speech at the CBI annual meeting governor Már Guðmundsson also stressed an imminent action, stressing the unavoidable damages invariably caused by capital controls in the long run.

However, an action must be based on political synergy within the government. As I have often stressed the statements of minister of finance Bjarni Benediktsson and prime minister Sigmundur Davíð Gunnlaugsson on capital controls consistently point in different directions. Benediktsson has stressed the importance of a solution that minimises legal risk, takes as short time as possible and of course does not undermine financial stability. In addition to safeguarding financial stability, Gunnlaugsson has been focused on what Iceland could get out of the estates, recently by arguing for fairness.

In the latest status report by the minister of finance on progress in lifting the capital controls, presented on 18 March, the problem Iceland faces is defined as a balance of payments, BoP, problem. Quite rightly not a word about Icelandic debt burden; debt is not the Icelandic problem. However – and quite interestingly – the report defines this problem differently from the CBI definition. This difference has, to my mind, wide ranging consequences when it comes to understanding what the government really is doing – or not doing – to solve the capital controls.

The Icelandic business community has for a while been complaining loudly about the controls. Once upon a time every word this community uttered was law for the Independence party – but not any longer as seen so clearly from the debate on the European Union, EU and the (failed!) action to break off negotiations. This schism between the business community and the Independence party goes hand in hand with the fact that the party seems to have, possibly irretrievably, lost voters: earlier polling 35-40% it now hovers around 25%, its new normal.

I might well be reading too much into the situation but based on observations of the political realities in Iceland, i.a. the lack of political determination within the government not only regarding capital controls but in general, I very much wonder what the next two years will bring for Iceland in general and capital controls in particular.

A closer reading of the capital controls report

I have already gone through the status report here on Icelog, writing about politics in times of crashing popularity, the government’s popularity that is. There are some statements in the report, which I think give an inaccurate and misleading picture of the BoP problem. As I concluded earlier, the report seems to magnify the problems to be solved re capital controls and minimise what the government can to stabilise the situation, mostly the importance of securing trust.

If the government sincerely wants to minimise the risk of lifting the controls a plan that inspires trust is of vital importance. If that is not done – or worse, if action taken inspire fear and not trust – the outcome will inevitably be disastrous… for Iceland.

But there is one aspect of the report, which I had not paid close enough attention to until I reread it: the definition of the BoP problem. According to the report, the problem consists of three parts: “the offshore ISK problem, difficulties arising from distributions by financial undertakings in winding-up proceedings and potential capital outflows from other parties, including residents.” – Compared to customary definitions this is a somewhat non-standard definition, apparently a home-made one.

In the CBI Financial Stability report I 2014 governor Már Guðmundsson defines the Icelandic balance of payments problem: “…the problem falls broadly into three categories. First of all, the debt service burden on foreign debt is heavy, both this year and in the four years following, and exceeds the foreseeable current account surplus. Second, domestic entities other than the sovereign and the Central Bank still have only limited access to foreign credit markets on affordable terms. Third, the settlement of the failed banks’ estates could add substantially to the stock of volatile króna assets held by non-residents locked in by the capital controls. These króna assets could rise as high as nearly half of GDP if the failed banks’ ISK assets are collected in full and paid to creditors. Iceland has no excess foreign exchange revenues with which to unwind such positions, however.“

As can be easily seen from the above, there is only one source of the BoP problem in common, as defined in the status report and the CBI report: the CBI groups together ISK assets in the estates and the old offshore ISK overhang, the status report keeps it in two separate categories. The status report ignores the debt service burden but has “capital outflows from other parties, including residents.”

How to avoid solving a problem: define so it cannot be solved

Earlier, I had pointed out that the status report seemed somewhat too pessimistic in terms of outflows – trust will matter a great deal when it comes to lifting capital controls. If there is no trust in the plan on lifting or easing controls it will be a catastrophe, as indeed Guðmundsson reiterated in his speech at the CBI annual meeting.

Included in the status report’s definition of offshore ISK is also this:

Investment by non-residents in ISK-denominated domestic securities has increased greatly in recent years in tandem with their participation in the Investment Programme of the Central Bank. Total investment through the Investment Programme from the time it commenced at the beginning of 2012 now amounts to ISK 206 billion, of which ISK 97 billion is invested in bonds and ISK 82 billion in equities. Of this amount, non-resident investors own ISK 134 billion. At the beginning of 2017 the encumbrances on the first investments under the Investment Programme expire; however, these investments did not include an exit ticket. Non-residents have furthermore invested in Treasury securities through the Central Bank’s foreign currency auctions; their outstanding holdings in two inflation-indexed bond series currently amount to around ISK 9 billion. In addition to this, non- residents hold various other domestic assets which can be regarded as liquid or volatile. The conceivable outflow in connection with these assets, however, is subject to high uncertainty.

Adding these investments widens the offshore ISK definition considerably – and consequently the size of the problem. Claiming that all foreign investments in Iceland are volatile is rather stretching it – hardly any country could pay out in one go all foreign investment.

If this is the definition of the offshore ISK problem that the ministry of finance is trying to find a solution to it is not likely that a solution will be found any time soon, a version of the drunken Scot problem. Yes, defining a problem in such a way that it cannot be solved is one way of avoiding to tackle it.

Interestingly, in his speech at the bank’s annual meeting governor Guðmundsson indeed repeated the status report definition, saying the most common BoP definition was looking at funds, which might flow out as soon as controls were lifted. These funds are, he said, in the estates, the offshore ISK and then, contrary to the bank’s earlier definition, potential outflows owned by domestic entities. Problems related to the estates are well documented, he said; secondly, offshore ISK was partly non-volatile though that had to be ascertained and dealt with first, akk perfectly doable, according to Guðmundsson.

The greatest uncertainty is connected to possible outflows connected to domestic entities… Here the most important aspect is trust in Iceland and its financial system at that time, difficult to estimate right now. This will at the same time also impact on possible inflow from foreign entities,” Guðmundsson said.

The governor did not mention it but here it would be important to keep in mind that for the time being interest rates abroad are low, asset prices high – not necessarily an enticing environment for Icelandic entities.

Differently defined problems – but one-size solution

As pointed out earlier the status report concludes with two classic ways of solving BoP problems like the one Iceland now faces: “(i) imposing a haircut on domestic assets when they are converted to foreign currency, or (ii) ensuring that volatile assets are transferred to long- term assets, i.e. extending the term of liabilities. The terms and conditions of such converted assets and liabilities must ensure that they cannot be accelerated or revert to their former status. If this is done, short-term owners of such instruments can be expected to accept a discount (haircut) upon their sale while longer-term investors will profit on them in the longer term.”

These solutions are tailored to the classic BoP problem the CBI has described it earlier: a haircut on ISK assets converted to foreign currency – and binding the volatile assets, as the CBI has already started doing (taken half a step, with the missing half said to be imminent).

However, these two ways do nothing to solve the very elusive problem of “capital outflows from other parties, including residents.” The foreign-owned ISK and the old overhang are a tangible size, which as Guðmundsson said the CBI has worked on and where the methods above are a classic tool to diminish the overhang.

The capital outflows are a potentially large chunk, where haircut and extension does not help. The government is hardly keen on draining pension funds of money, “hair-cutting” debt payment etc. In other words, this problem of outflows has no clear and classic solution. Yes, the oft mentioned exit tax could be used on domestic outflows but at a cost to domestic entities and without targeting the real problem, the foreign-owned ISK.

Who wrote the status report?

The short answer is: I don’t know. As far as I know, CBI staff has mostly written earlier status reports. But on close reading it is difficult to believe that this latest status report is written there. It simply does not fit with what the bank has published earlier. But funnily enough, the conclusion with the two paths as a solution does not fit the problem as spelled out in the status report.

My hunch is that the Ministry of Finance probably got a draft from the CBI but someone else, most likely someone from the advisory committee on capital controls (though hardly Glenn Kim) then finished it, concluding with classic solutions to a BoP but not as defined in the report.

A nerdy quibble over definitions and so what?

It may very well be that I am over-extrapolating on spurious evidence. However, if the forces at large around the status report are leading the process towards lifting the capital controls I cannot see that this process will ever get near to easing or lifting the controls simply because of the lack of clarity. If the status report signifies the thinking of the advisory group it does not bode well for the process.

In addition, the process so far – changes among the advisers, conflicting statements by the government leaders, imprecise messages from the prime minister, broken promises on timing, the difficulty in acting on the Landsbanki bonds agreement, the rather remarkable side process regarding the CBI itself, re-hiring the governor and now planned CBI organisational changes – does not bode well either.

Undoubtedly, lot of ground has been covered within the CBI and in the advisory committee. The work within the CBI is clearly geared towards solving the BoP problem. And undoubtedly the minister of finance and the governor are both keen to work towards easing and lifting the controls. The question is if they will be allowed to work towards solving the BoP problem according to the classic CBI definition or if the goal is the much more elusive problem of finding funds to stem domestic and foreign outflows.

Political unpopularity and panic politics

What are the main risks in a country where the economy is going reasonably well? In terms of Iceland it is clearly the political risk.

Talk about the absent prime minister is constant in Iceland. Quite remarkably he did not show up at the CBI annual meeting – no one can remember that a prime minister has ever ignored the meeting. This week an opposition MP, Helgi Hjörvar (social democrat), pointed out that in the last six months the prime minister has answered only one written question in Parliament. Time and again the prime minister is absent and invisible, keeping the rumour mill running. Erratic behaviour and rather odd remarks is another aspect of the prime minister’s character much discussed privately but rarely on the media.

Alleged break down in communication between the two government leaders is a widely heard explanation of the government’s lack of action in various matters. Although the two have, of course, strenuously denied this it does not quell the rumours; this lack of communication is now taken for a fact among political observers in Iceland.

Looking at the erratic course of the government, shortsightedness, the lack of professionalism (because the civil service is side-lined in important issues) it is clear that the greatest risk in Iceland is political risk.

The government’s astounding unpopularity only seems to add to that risk. Will the prime minister, desperate to prove himself, make use of unconventional measures following his belief that foreign creditors are unjustly and unfairly making huge gains out of ordinary Icelanders? Will he work on wrenching the ownership of Íslandsbanki and Arion Bank, widely thought to be of great interest to him, from the estates? In all of this he apparently has unwavering backing from the darkest corners of the Independence party, visible in the writings of Morgunblaðið, which repeatedly opposes Benediktsson overtly or covertly.

By constantly promising action last year Benediktsson was no doubt trying to put pressure on his coalition partner but his tactic failed. Instead he made creditors feel he was unable to fulfil his intension. But as one observer pointed out Benediktsson has at least withstood all pressure of acting according to the prime minister’s sentiments. Many feel that compared to earlier Benediktsson is strengthened, both from this process and other things. I still feel unable to draw that conclusion, would like to see more tangible evidence.

The question for the coming months is if this government will have the courage to lift capital controls – and, if not in the short run then if indeed this government will ever have the courage. And if it does act regarding the capital controls will it be according Benediktsson’s outlines or will he be pushed to follow panic politics of a political leader who has lost popularity in record time. – It is not difficult to analyse the situation but, as always, forecasting action is infinitely trickier.

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Written by Sigrún Davídsdóttir

March 27th, 2015 at 3:41 pm

Posted in Uncategorised

Politics in times of crashing popularity

with one comment

The Minister of Finance Bjarni Benediktsson has just released his twice-a-year report on progress in removing capital controls. The tone is as if prime minister Sigmundur Davíð Gunnlaugsson did not exist. Another event, distantly related to the capital controls, is a draft Bill by two academics on the future organisation of the Central Bank of Iceland, CBI. The draft is hardly bringing out the champagne bottles since the academics propose that governor Már Guðmundsson, whom the government has been trying to remove ever since it came to power, should remain in office but with diminished power and two deputies. The backdrop to these events if the drastic fall in the government’s popularity, this time hitting the Independence party, buoying the Pirates.

Last year, the government held the CBI in uncertainty for half a year while trying – and then failing – to substitute Már Guðmundsson as the bank’s governor. At the end of that ungraceful saga (see earlier Icelog) he was reappointed but given to understand that the bank’s organisation model would be revised, even before the end of 2014, which might mean his days in office were numbered.

So far nothing has happened until recently that the two academic asked to revise the CBI Act, handed in their proposal. It is safe to conclude that it will not create much happiness, neither in the Ministry of Finance nor in the Prime Minister’s office.

This last week also saw the minister of finance present his spring report on the capital controls. Apart from general remarks on how to lift the controls in an environment suffering from balance of payment problems it is more worrying that the report seems to include some misleading or even factually wrong statements. I am not aware of this happening before, which leads me to believe that there was less input in the report from the CBI, compared to earlier, and more input from those working on lifting the controls. Again, not a good sign.

If the government is going to make a move in either of these two cases, it has to make up its mind soon because the deadline for new Parliamentary proposals, new law or amendments is the end of this week as Alþingi goes on summer recess at the end of May. There is however a legal provision for presenting Bills later requiring an agreement with the opposition. The latest opinion polls also raise the question if the government’s diminishing popularity will push the government to come up with some measures to win voters over. Another test is the fact that strikes and labour market unrest is foreseeable, most agreements will run out now in spring; particularly dark forebodings in these matters.

A sluggish reaction to CBI proposals

The two academics, Friðrik Már Baldursson professor at the University of Reykjavík and Þráinn Eggertsson from the University of Iceland, sent in their proposals on 6 March. Not until 20 March, following news based on the leaked proposals, did the Ministry of Finance publish the proposals. The academics have as yet only filled part of their remit, there is more to come but these proposals cover the most sensitive part, i.e. how to change the organisational structure of the bank. Benediktsson now has to make up his mind as to what changes he intends to make.

The proposals underline that the power given to the governor of the CBI far exceeds power wielded by central bank governors in the neighbouring countries. The two academics propose a board of three governors similar to the structure at the Bank of England where there is one governor and two deputy governors, each heading a special field within the bank.

In addition, the academics propose that Guðmundsson remains in office. If, follwong the ungraceful process last year, the government was planning to remove the present governor from office on the basis of these proposals they certainly do not provide the government with the ammunition for such action.

In Iceland, it is widely thought that the two party leaders want to revert back to the bad old days of continuous political pressure on the CBI with politically appointed governors. The sentiment in the air is that in addition to a governor with the proper professional qualification the government would like to see two more governor by his side, one anointed by the Independence party, the other by the Progressive party.

If the two government leaders find some solution here remains to be seen, also if Guðmundsson will be part of the solution or not. If things move as they mostly have done under this government, i.e. slowly, indecisively and inconclusively, not much will happen re the CBI any time soon. In addition, blatant political interference is much harder in the present day and age than some decades ago. The International Monetary Fund, IMF, has used every report on Iceland since the crisis to emphasis the importance of an independent central Bank.

Capital controls: two possible solutions

The new report by Benediktsson on the capital controls concludes that there are indeed only two possible options in dealing with balance of payment problems akin to those Iceland is now faced with: either by “(i) imposing a haircut on domestic assets when they are converted to foreign currency, or (ii) ensuring that volatile assets are transferred to long- term assets, i.e. extending the term of liabilities. The terms and conditions of such converted assets and liabilities must ensure that they cannot be accelerated or revert to their former status. If this is done, short-term owners of such instruments can be expected to accept a discount (haircut) upon their sale while longer-term investors will profit on them in the longer term.

This is quite correctly a description of classis solutions in countries with similar problems Iceland is dealing with. But this description seems completely unrelated to the political situation in Iceland where politicians, with the exception of Benediktsson, have lately been falling over themselves in outdoing each other in exit tax on the estates in their entirety, ISK assets as well as foreign assets.

The prime minister has earlier talked about the inevitability of the state accruing funds from the estates and “vulture funds” gaining distastefully on Iceland. Lately he has presented it as a principle of fairness that the estate leave funds to the state for the harm the banks caused Iceland.

There is nothing of this tone in the report.

There are however statements in the report, which are either inaccurate or misleading.

The report states: “The estates’ largest ISK assets are holdings in the new banks, in addition to which they own considerable amounts of cash. Distributions by these domestic undertakings to resident creditors will not affect the balance of payments, but distributions to foreign creditors will impact the balance of payments when the distributed assets exit Iceland.” – The fact is that if domestic creditors repatriate their foreign currency distribution this has a positive impact on the balance of payment whereas the impact is negative if foreign creditors move their ISK assets abroad. This will hardly be categoric: not all FX owned by domestic creditors will be left abroad and not all foreign-owned ISK will leave.

Re “possible outflows by domestic parties” the report points out that it is difficult to assess what these outflows could amount to. It quotes the latest IMF report, which guesses that this could be as much as 25% of GDP or ca. ISK500bn; however, IMF underlines that this development very much depends on stability and trust in Iceland, as well as the currency rate. – What this analysis in the new report lacks is to underline how Icelandic action or non-action influences these eventualities.

The same counts for the effect of trust on foreign investment in Iceland. Foreign investment will not leave a trustworthy environment. No country is in the position to pay out all foreign investment at any given time. To set that as a benchmark makes little sense.

The report points out that Iceland faces balance of payment problem, consisting of three part: “the offshore ISK problem, difficulties arising from distributions by financial undertakings in winding-up proceedings and potential capital outflows from other parties, including residents.”

However, this last part, potential outflows from other parties, including residents, differs from the balance of payment problem, as defined by the CBI. In the Financial Stability Report 1 last year the problem is said to consist of three parts: “First of all, the debt service burden on foreign debt… Second, domestic entities other than the sovereign and the Central Bank still have only limited access to foreign credit markets on affordable terms. Third, the settlement of the failed banks’ estates could add substantially to the stock of volatile króna assets held by non-residents locked in by the capital controls.”

For some reason, the new report magnifies the problem and minimises the effect of what the authorities can do to stabilise the situation by inspiring trust.

Political outlook: panic politics or power to the Pirates!

New poll caused a political earthquake last week: it showed the Pirate Party with a following of 29.1%, equivalent to 19 MPs. The party now has three MPs, got 5% in the last election. The Progressive party got 11.6%, the social democrats make a slight gain from previous poll, with 16.3% and Bright Future and Left Green with 9% each. The biggest loser is the Independence Party, falling from 28% in last poll to 23.4%. – This does not seem a freak outcome, the upswing for the Pirates, over 20%, was seen in an earlier poll from a different polling company.

To Rúv, prime minister Gunnlaugsson said that this outcome certainly was surprising but a sudden gain by one party had been happening frequently in the past years and decades. “This is perhaps first and foremost a message that people are now impatient to see the results of what the politicians are working on. However, these results are now starting to be visible however they are measured.”

This result is singularly bad for the two coalition parties. Part of the explanation is no doubt its action to break off accession negotiations with the EU, which cause great and general anger in Iceland where there is not majority for membership but strong majority for bringing the negotiations to an end. Also, the Pirates have been measured and professional in debates, ignoring special-interest groups. The rest of opposition has been fairly lame.

In addition to crashing popularity, the government now has gone through half its mandate period. It is clear that the debt relief, orchestrated by the Progressive party but brought to fruition by Minister of Finance Benediktsson has not helped. Nor has changing direction on the EU negotiations helped. The question is if this crash in popularity will cause the government to turn to panic politics, if it will possibly attempt some drastic measures to gain popularity.

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Written by Sigrún Davídsdóttir

March 23rd, 2015 at 9:45 am

Posted in Uncategorised