Sigrún Davíðsdóttir's Icelog

The Kaupthing settlement ends one part of Vincent Tchenguiz Kaupthing saga. But the other part is the SFO investigation into Kaupthing and the Tchenguiz brothers.

As the settlement between Vincent Tchenguiz and the Kaupthing ResCom is private and confidential there is no clear answer to the question above, but some guesses can made from the sparsely worded Kaupthing press release:

The Resolution Committee and the Winding-up Committee of Kaupthing confirm that all claims against Kaupthing lodged by the trustee of the Tchenguiz Family Trust (the “Trustee”) have been withdrawn pursuant to an agreement made between Kaupthing and the Trustee. The Trustee’s claims against Kaupthing were rejected by the Winding-up Committee of Kaupthing in March 2010, who referred the dispute to the Reykjavik District Court in Iceland, on 3 August 2010. The Trustee commenced litigation proceedings in the High Court of England on 1 July 2010. Both sets of proceedings have been withdrawn on the same basis.

The court cases in the UK and Iceland are withdrawn. But there must be more to the settlement than just this. Tchenguiz took a loan of £100m. That loan is, most likely, still there and has to be paid off and will not be written off. In that case, Kaupthing can claim victory since recovery is paramount to the Kaupthing creditors.

What Tchenguiz gains is control, in some shape or form, over corporate structures where Kaupthing claimed to hold collaterals. There are several banks, beside Kaupthing, that have lent into these structures. Tchenguiz has been held back in restructuring and re-negotiating his debt as long as Kaupthing upheld its claims. With the Kaupthing settlement, Tchenguiz will be free to seek new deals with his creditors. The Kaupthing settlement doesn’t solve all his problems but is an important step for him to work out how to proceed.

But there is still the other Tchenguiz, Robert, who has unresolved issues with Kaupthing. Kaupthing took over his company, Oscatello, into which Vincent had pledged collaterals, turning him into a Kaupthing client with an additional loan of 100m. It will now be interesting to see what happens re Robert’s dealings with Kaupthing and the giant debt of well over €2bn that Robert amassed with Kaupthing.

As a consequence of being Kaupthing clients, both brothers are now being investigated by Serious Fraud Office. Both deny any wrongdoing and have taken action against the SFO, which so far hasn’t brought any charges. The burning question is: what is the SFO investigating? The very laconic answer from the SFO is that it’s investigating if value was extracted from the bank in the period leading up to the bank’s demise.

Reading the SIC report, it seems clear that the SFO, just like the Office of the Special Prosecutor in Iceland, has a whole buffet of possible financial issues to choose from. There is alleged market manipulation, wrong information to markets, breach of fiduciary duty and so forth. But no, SFO isn’t touching any of this. It’s investigating loans into the Oscatello structure and to the two brothers.

As demonstrated earlier, Kaupthing took collaterals that it didn’t intend to enforce. It raises questions both regarding the valuation of these assets and if this kind of service was open to all clients of the bank. There must be something about these loans that the SFO sees as highly questionable, possibly incriminating not only the bank managers involved but also the clients, the two brothers, who got the loans. Looking at the loans, the SFO must detect something that makes these loans and the deals connected to them, stand out.

Since the brothers have called for judicial reviews on SFO’s actions against them, the SFO can’t, for the time being, make use of material confiscated during house searches related to the brothers. This means that the whole investigation will stretch over a longer time. The SFO does at times open an investigation that doesn’t lead to any charges. It remains to be seen what happens with its Kaupthing investigation.

Robert was heavily involved with Kaupthing, as its biggest client. Vincent only got involved through his brother, by posting a collateral for his brother and taking out a loan with Kaupthing as well. This has meant long and intense negotiations with the Kaupthing ResCom. His settlement now means that one part of his Kaupthing saga has come to a close. As long as the SFO investigation is running Vincent isn’t quite finished with this Icelandic bank that offered its chosen clients sweet deals, which in some cases have turned into a bitter pill.

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Kaupthing and The Tchenguiz Family trust have reached a settlement regarding exposure to the bank and claims. The collaterals related to the disputed loans give an interesting insight into correlations between lenders and borrowers

‘It’s interesting to keep in mind that the collapse of the three Icelandic banks is the largest corporate failure ever, the biggest bankruptcy in the world,’ said an Icelander to me the other day. It is indeed striking that a tiny economy, with a population like a London Borough, was able, so to speak, to produce the third largest corporate default in the whole wide world, after Lehman and Washington Mutual.

An obvious reason for the size of the default is that the banks were way bigger than the underlying Icelandic economy and in a way unrelated to it. The banks were funded by international banks who thought nothing of pouring vast sums of money into these three banks, newcomers to the international world of finance, run by people who mostly had no banking experience at all except from the Icelandic bank.

As the report of the Special Investigative Commission, set up by the Icelandic Parliament shows, one of the reasons for the banks’ demise was reckless lending to very few individuals. The largest borrower was the UK property billionaire Robert Tchenguiz. Tchenguiz owned a small stake in Exista, the largest shareholder of Kaupthing and sat on the board of Exista. At the beginning of 2008, Kaupthing had lent €1.2bn to Tchenguiz. When the bank collapsed in October 2008, his loans had gone up by 80%, to €2.18bn – during a period when banks were mostly not lending at all.

During the summer of 2008 the value of collaterals that Kaupthing had against loans to Tchenguiz fell. He had no assets to top-up the gap that was estimated to be £200m. His brother Vincent, who hadn’t been a client of Kaupthing, came to his brother’s rescue and placed the necessary assets to fullfil the requirements, not with £200m but with £222.5m because Kaupthing deemed the collaterals not to be very liquid and added 10% to the original request. At the same time, Vincent borrowed £100m from Kaupthing.

How this was all done tells an interesting story of the nature of the relationship between big borrowers and the banks. It’s a well-known fact that if you owe a bank 10.000 it’s your problem. If the loan is 10bn it’s the bank’s problem. Another extension of the correlation of power between a borrower and a lender is the nature of collaterals. The two brothers deny any wrongdoing and in fact are each suing Kaupthing, claiming that the bank’s former management fraudulently misrepresented the bank’s financial position to them, costing them dear.

Company structures seem to get more complicated with every year. The level of complications does not only make assets ephemeral and opaque when it comes to tax and beneficial ownership. It also makes the assets difficult to lay hands on for the banks that take these structures, or slices of them, as collaterals. It raises the question how well these structures serve the banks as liquid assets, at hand for the banks to claw back possible losses or if assets, structured in this way, are of any use at all as collaterals.

The collaterals provided by Vincent Tchenguiz, valued at £222.5m, related to a handful of his corporate structures, all highly leveraged, where he had a slice of equity. Through court cases involving Oscatello, the company where further collateral were needed, it’s possibly to gauge the outline of these structures.

The court cases show that if Kaupthing had enforced the collaterals, in effect Vincent’s equity, the banks that had lent into the leveraged companies, lower down the corporate structures would have called in their loans, causing a domino effect of defaults where everyone would have lost. It’s the so-called ‘change of control’ clauses in loan contracts that trigger these defaults.

Now, almost three years after Kaupthing failed, Vincent Tchenguiz and Kaupthing have come to a settlement. There were no doubt myriads of things to sift through but the ‘change of control’ has been a tough one, meaning that the borrower had huge power over the lender. When it comes to settlements, both parties normally agree to non-disclosure, meaning that terms and conditions won’t be in the public domain. It’s therefore unlikely that we will ever know the sums involved, what the bank has to write off and how much the borrower will indeed pay in the end.

The fundamental idea with a collateral is that if a borrower can’t repay a loan, the bankers can shrug their shoulders and say ‘no problem, we take the collateral, liquidate it and use the proceeds to settle the debt.’ Therefore, quality collaterals tend to be liquid and of low price volatility, making them easy to turn into money to settle the unpaid debt, if needed.

A ‘change of control’ clause within a collateralised structure is like a fuse that can blow up the whole thing and atomise the assets if touched and treated the wrong way. This opens up a question of how to value assets with these possibly lethal consequences. What’s the value of a collateral that can’t be fairly easily liquidated?

But did Kaupthing know how illiquid the Oscatello collaterals were? As far as can be gauged from a court case involving Oscatello and Kaupthing (Hight Court of Justice, Queen’s Bench Division, Commercial Court, Claim no. 2010 Folio 773), it transpires that Kaupthing at first offered not to touch the collaterals for a year and then offered not to touch them at all. The collaterals could be used for making the books look in order. But in reality, the collaterals were unenforceable, raising the question what story the bank’s accounts told.

The collaterals in Oscatello are no doubt not unique to this structure. It also explains why it took such a long time to find a settlement. The Oscatello collaterals are almost certainly not unique but explain why the large borrowers in the Icelandic banks, borrowers whose loans broke regulation on limited exposure, are by and large walking away with extremely favourable settlements: the loan deals were all too often in the favour of the borrowers, securing the borrowers all the upside and the bank the downside.

It’s fair to assess that this was nothing that Kaupthing invented. Shareholders should be asking bank managers some serious questions as to loans against collaterals with ‘change of control’ clauses. And so should regulators and financial services authorities. Since these collaterals are in reality illiquid, their value has to be estimated in connection to the illiquidity. It also raises the question who gets to place collaterals of this kind and why. And ultimately, if these loans simply turned out accidentally to have these unintended consequences so strongly in favour of the borrower, at the cost of the interests of the lender.

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As is stated on the Guardian/Observer website, the article by Simon Bowers and me, published in the Observer last Sunday, is now the subject of a legal complaint from Bjorgolfur Thor Bjorgolfsson.

Last winter, Bjorgolfsson filed a complaint with the Ethical Committee of the Icelandic Press Association for my reporting on a series of off-shore companies owned by Landsbanki, used to hold shares in the bank. After considering the matter, the Ethical Committee dismissed the complaint.

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