Sigrún Davíðsdóttir's Icelog

The Investigative Committee on Pension Funds, ICPF, sat up at the behest of the Icelandic Association of Pension Funds, LL, had a hard act to follow, producing a report that would be as thorough and informative as the Special Investigative Committee. The SIC was set up by the Icelandic Althing to investigate the collapse of the Icelandic banks. In short, the ICPF hasn’t addressed the issues nearly as sharply and comprehensively as many had hoped for.

To be fair, the ICPF didn’t have the same wide access to material and sources as the SIC since it was working on behalf of the LL and not Althing. However, that doesn’t excuse the lack of sharp questions and focus on the relevant topics. With a sharper focus and a clear definition of the most relevant issues a lot more could have been squeezed out the available material.

About eight out of 32 Icelandic pension funds hold around 70% of the funds’ assets. Consequently, it would have been relevant to focus on these seven funds and scrutinise their activities. Instead, all the funds are dealt with more or less evenly.

The report focuses on the losses made, in total ISK480bn, almost €3bn. The assets of the funds now amount to ISK1.909.498.621. These numbers are interesting but they are not new and could already be gauged from stats available from the Central Bank. What is of great interest – and unfortunately not dealt with adequately in the report – is 1) why the funds were in general so sloppy when it came to covenants, an issue previously underlined on Icelog – and 2) why the funds took part in currency deals from which the funds incurred heavy losses, ISK36bn, €222m.

As to topics mentioned but not really dealt with is that commissions paid to funds abroad can’t be read from the funds’ financial statements. It would be interesting to know why that is the case – and to whom the commissions were paid. The reasoning behind many investments is quasi non-existent. It would be interesting to know why and what that says about decision-making at the funds.

Abnormally weak guarantees and covenants – and extended loans

An interesting case in point is when Kaupthing brokers sold a ISK1bn worth of bonds, €6m, for Bakkavor – whose major shareholders were two brothers, Agust og Lydur Gudmundsson who incidentally were also Kaupthing’s largest shareholders. These bonds were not secured by any operations and were used as a take-over fund for Bakkavor. The funds that bought these bonds bought the risk of shares at the price of bonds. A fabulous deal for Bakkavor and a truly lousy deal for the bondholders, the pension funds.

Also lacking here were clauses related to changes in relevant parameters such as capital. There were simply no proper covenants that would trigger a repayment of the loan in case there were significant changes affecting the status of the bond issuer. Neither the pension funds nor the banks showed any interest in more strict covenants.

This is all the more interesting when one keeps in mind that the banks did indeed operate abroad where pension funds would never have looked at such bonds. The question is why there was this difference? And who made the decisions on behalf of the pension funds? Were their fund managers too inexperienced? And is this way of doing things still thriving?

Because of these weak covenants the holding companies like Exista, Baugur and the other usual suspects could sweep up money from the pension funds. This practice has led to grotesque losses for the funds.

Out of total losses for the funds of ISK480bn, 90bn, €555m, stem from losses of corporate bonds and ISK100bn, €62m stem from bonds from financial institutions. Losses from shareholding amount the ISK199bn, €124m.

Losses related to the different business spheres are interesting: 44% of losses relate to Exista and related companies such as Exista, Kaupthing’s main shareholders, in total ISK171bn, €105m; 20% of the losses relate to the Baugur sphere, Glitnir’s main shareholders from mid 2007, or ISK77bn, €47m. For some reason, losses related to Landsbanki’s main shareholders Bjorgolfur Thor and his father Bjorgolfur Gudmundsson are not calculated but according to Visir (the media website owned by Jon Asgeir Johannesson of Baugur fame) losses attributed to the Bjorgolfsson’s sphere amount to ISK74bn, €46m.

An example of the report’s lack of perspicacity is its treatment of prolonged loans. It’s simply pointed out that increasingly new bonds, which were due, like bullet loans, on a single date, paid the bonds. This hid the fact that the bond issuers could not repay their loans. Again, this is only pointed out but there is no analysis as to why this practice became so prevalent and if this is still the case.

Incidentally, this trend follows what was happening at the banks: that the favoured borrowers were lent money to repay their loans, thus hiding the fact that they couldn’t or wouldn’t pay.

It’s already been pointed out on Icelog how the banks lent to holding companies, in reality turning them into banks without the risk management. By buying bonds from these companies, the pension funds did their part to make this possible.

The currency hedges

One of the issues, which expose the close ties between the banks and the pension funds, are the forex deals. Instead of holding on to their foreign assets, many pension funds actually sold their foreign currency towards the end, when the banks were seriously short on currency. The funds were led into believing that betting on a rising ISK was a wise thing to do because they had foreign assets they should be hedging. This view didn’t take into account that the foreign assets were in themselves hedged the Icelandic assets.

There was also a painful shortage of settlement provisions in the contracts concluded by the pension funds with the banks on management or purchase of currency hedges. International contracts on currency hedges usually have so-called ISDA terms and conditions, which describe in detail how they are to be dealt with in the case of flawed assumptions on the part of the contracting parties.

It is quite clear that the funds were easily swayed by the banks into these disastrously bad deals. Here, a much greater digging is needed. Why did the pension funds agree to these deals? Who convinced them? Was this really in the interest of the pension funds? What was the motivation – and last, but not least, what there the relations between fund managers at the pension funds and the banks?

Iceland is a small society and personal relations run back and forth there, as in other small societies. There are plenty of rumours and stories about pension fund managers and fund employees being wined and dined and pampered home and abroad by the banks and the companies from whom they bought bonds. Unfortunately, this aspect isn’t explored.

As said earlier, only a handful of the funds hold the largest part of the Icelandic pension funds’ assets. Each fund had perhaps two or so fund managers – in total, 10-20 people were the key people during the last few years before the collapse of the banks. It wouldn’t have been overly complicated to map their relationships to the banks, check on “revolving doors” etc. But that wasn’t done and consequently the whole saga isn’t told in this report.

Follow me on Twitter for running updates.