Sigrún Davíðsdóttir's Icelog

Almost four years after the demise of Kaupthing Singer & Friedlander, the Financial Services Authority and Her Majesty’s Treasury have finally chosen to throw light on the final days of KSF. Their reports are poor, do not mention key issues related to the collapse of the bank and do not inspire confidence in these two institutions. True, KSF was only a small player in the UK market but it had £2.5bn in deposits from UK deposit-holders when the bank collapsed.

The Treasury report, Events leading up to the failure of Kaupthing Singer & Friedlander Limited, gives an overview of events. This report cites the report of the Special Investigative Committee, SIC, as a source but is, as far as I can see, a fairly sloppy and imprecise translation from the SIC report, two years after its publication. The Treasury report mentions ia a sum of £98m but it should be, as far as I can see from the SIC report, ISK98bn. Also, the SIC report quotes extensively from witness statements given by UK officials and others in relation to a judicial review Kaupthing brought to question the actions taken against Kaupthing in the UK. Weirdly, the Treasury report doesn’t seem to cite these witness statements or any other documents related to the judicial review, and gives a far less detailed account than the SIC report. (See the SIC report on the fall of KSF vol. 7, p. 161-175.)

The FSA focus is inexplicably narrow – and only refers to the liquidity management of KSF from 29 September 2008 until the bank was placed in administration on 8 October. There is a short overview and a so-called Final Notice. That the liquidity management is investigated only during these few days is rather superficial when the SIC report gives good reasons to wonder how the bank met its liquidity requirement over most of 2008.

The FSA summarises its findings:

The FSA has investigated the liquidity management of the UK-based, FSA-regulated bank KSFL in the period prior to KSFL being put into administration on 8 October 2008. KSFL activated its liquidity contingency process on 29 September 2008 and notified the FSA that it had done so on 30 September 2008. Nevertheless, we have found that between 29 September 2008 and 2 October 2008 KSFL did not give proper consideration to or properly monitor a special financing arrangement with its parent company in Iceland under which it could draw up to £1bn at short notice if it needed to.

The question is how this agreement with Kaupthing was presented in the KSF books.

The Final Notice states: “The existence of the Liquidity Transformation Arrangement had previously been disclosed to the FSA and had been successfully used by KSFL in the past to call on funds from KBHf.”

But what exactly did FSA see in terms of this agreement KSF had with Kaupthing hf, the Icelandic parent company?

There is good reason to ask because the SIC did look into this matter. According to the report, the KSF did a liquidity swap agreement with Kaupthing hf in March 2008 – or what is called a “Liquidity Transformation Arrangement” in the FSA final notice. When the SIC asked to see the agreement it was told no written agreement could be found. It concludes that most likely, there was no written agreement. The only thing the SIC got were some emails with a rough description of the agreement – and yet, it was an agreement involving £1bn.*

According to the Final Notice, KSF was in breach of FSA rules.

The Final Notice outlines how KSFL did not give proper consideration to, or properly monitor, a special financing arrangement with its parent company in Iceland, under which it could draw up to £1bn at short notice. KSFL assumed it could rely on receiving this £1bn ‘Liquidity Transformation Arrangement’, if needed, without testing that assumption. In addition, when it started to have concerns about this liquidity arrangement, it failed to discuss these concerns with the FSA in a timely manner.

This seems slightly confusing. According to the Final Notice, KSF’s CEO Armann Thorvaldsson notified the FSA on 29 September 2008 that the bank had moved to “code red” in accordance with its liquidity contingency. According to the Treasury report a team from the FSA was actually at the bank during these days. Yet, the FSA deems that KSF did not fully inform the FSA until in the evening of 2 October that it couldn’t make use of the LT Agreement with Kaupthing hf – and that is the failure, according to the FSA.

Again, this raises the question if the FSA had actually seen and evaluated the validity of the LT Agreement. Also, why didn’t the FSA monitor the possible use of the Agreement since the life of the bank depended on it? And since there was an FSA team at the bank, why didn’t they look at the loan book and the bank’s relationship with Kaupthing Luxembourg, where some of the more interesting loans to UK clients were issued? And surely, the relationship between KSF and Kaupthing hf would have been of interest, not least since KSF was so dependent on the mother bank, through the LTA.

The SIC report concludes (p. 173-175) that in the relationship between KSF and Kaupthing hf normal arm’s length principles were not followed: KSF did not make margin calls on Kaupthing hf although there were all the reasons to do so – nor did KSF stop its repo with Kaupthing when it could no longer fund the repos in the UK market. On the contrary, it sent more money to Iceland, thereby weakening its own position.

The Treasury report has only this to say about margin calls:

The Treasury was informed by the FSA that KSF was, prior to 3 October 2008, paying margin calls, estimated at £500-600mn, on behalf of Kaupthing Bank hf, thus providing an effective transfer of funds to its parent company. The FSA agreed a voluntary variation of permission (VvoP) with KSF on 3 October 2008 which prevented this continuing.

The FSA mentions margin calls only as signals of the difficulties Kaupthing hf was experiencing:

On 15 September 2008 Lehman Brothers Holdings Inc filed for bankruptcy protection, which acutely aggravated the global financial crisis. From this date, KSFL received an increasing number of signals which suggested that KBHf was
experiencing significant liquidity difficulties. These included KBHf wishing to accelerate certain transactions and negotiating the timing and method of payment of  margin calls. These signals should have indicated that KBHf needed to improve its cash liquidity.

Consequently, neither the FSA nor the Treasury identify the problematic relationship between the subsidiary and the mother bank in Iceland. These UK authorities seem to ignore the fact that in spite of the flow of money from KSF to Iceland KSF did not treat the mother company as independently as it should have. This was, according to the SIC report, a key factor in the collapse of KSF – and yet, it isn’t mentioned in the FSA’s Final Notice and the Treasury report.

The lack of efficacy on behalf of the FSA is easier to understand now, after two days of Parliamentary hearing where MPs couldn’t get their head around why it took the FSA three years from FSA officials first heard of US LIBOR investigations until they so much as started thinking about investigating the LIBOR rigging. More bark than bites, as one commentator said.

One of the few unsolved mysteries of what went on in Iceland these early days in October 2008 are loans from the Central Bank of Iceland to Kaupthing, in total ca €600m. The largest loan, €500m, was issued after-hours 6 October when it was clear that Kaupthing, just like Glitnir and Landsbanki, was beyond salvation. Smaller loans were issued on 2 October and then on 8 October. The only reason for issuing these loans would have been if they could have saved Kaupthing – but that was far from being the case as should have been clear to everyone late in the afternoon of 6 October. Funds would have been most needed at KSF, in order to prevent cross default being triggered, but it’s clear both from the SIC report and the two UK reports that the money never reached UK shores. The mystery is where this money ended up – and why, according to Icelandic parliamentary sources, there doesn’t seem to be a proper documentation for the €500m loan at the CBI.

A part of the KSF saga, told in the Treasury report, relates to KSF in the Isle of Man, which was a direct subsidiary of Kaupthing Iceland and not of KSF UK. As early as Spring 2008 KSFIOM was required by the FSC (IOM Financial regulator) to zero its exposure to the Kaupthing Group, and yet the directors continued to forward deposits to KSF UK, where they remained exposed to the Group. KSFIOM’s accounts (September 2008) show £557 million with KSF UK. Had the regulator enforced its requirement and the directors adhered to it then KSFIOM would in all probability still be trading today. Again, broken promises on behalf of a Kaupthing bank and no stringency on behalf of its regulator.

The close connection between KSFIOM and the island’s regulator is of interest. One of the KSFIOM’s non-exec directors was also vice-chairman of the FSC. What seems normal in the Isle of Man would not be acceptable in London.*

All three reports – the two UK reports and the SIC report – show clearly how during the last days the Kaupthing management day after day made promises, which were  never fulfilled. That is in accordance with the banks’ behaviour towards regulators in Iceland and their unwillingness to supply full information until the very end. As an explanation of what went wrong in KSF, the Final Notice and the Treasury report definitely don’t tell the whole story of why KSF collapsed, which transferred the burden of KSF-related deposit guarantees to the UK tax payers.

*In 2010, the KSFIOM Depositor Action Group sent a response to the Tynvald’s (the Parliament in IOM) Select Committee on KSFIOM, with valuable insight into the Isle of Man operation. Another valuable source of material re the KSFIOM is the website of the Depositor Action Group. 

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