Sigrún Davíðsdóttir's Icelog

What is the reaction to the EFTA Court’s Icesave ruling in Iceland and abroad? In Iceland, there is no gleeful victory, in Brussels people worry about the effect on perception and depositors’ protection and in the UK and the Netherlands politicians sense that there is no obvious way to recuperate their respective cost of paying Icesave depositors

I keep being asked if Icelanders are celebrating after the unexpected Icesave ruling of the EFTA Court. The answer is: no, not really. There is no victorious glee, as far as I can sense, but a huge relief. A friend who sat at a café in Reykjavik the morning after the judgement mentioned palpable relief but said people were also talking about the irresponsible behaviour of Landsbanki and the other banks.

The measured mood can be seen here where Prime Minister Johanna Sigurdardottir (the second lady from the right) took a few dance steps while waiting on Monday to go on air after the EFTA Court judgement on Monday – very small steps, no big swings.

It will be interesting to see how and if the EFTA Court judgement will influence the electoral campaign in Iceland where election is expected latest in April. After the leaders of the Progressive Party declared they would propose a vote of no confidence against the Government they then changed their mind. After all, the voters will have a say very soon.

It seems that Facebook – a much used tool in Icelandic public debate – was overflowing with unflattering comments about politicians who were in favour of earlier Icesave agreements. However, many do recognise that the judgement was truly unexpected. At the time, negotiating an agreement to end the dispute and eradicate the accompanying uncertainty seemed like the sensible thing to do at the time.

Membership of the European will be an election topic. At first, I thought the judgement would be a weapon for the eurosceptics – after all, it had paid to go against the received wisdom of negotiating. Now I am less sure. It can also be reasoned that the EFTA Court – part of the European Economic Area pillar – did save Iceland from the British and the Dutch claims. The Dutch and the British opted to use the European Economic Area, EEA, Treaty and EFTA Surveillance Authority to challenge the Icelandic position of not paying. At the end of that path lay victory for Iceland. – Suffice it to say that the judgement is not a clear-cut weapon for any one party.

The view from Berlaymont

It is no exaggeration to say that people at Berlaymont and elsewhere in EU institutions are gobsmacked and shaken by the EFTA Court ruling. So is indeed everyone else who has read the ruling. To have it black on white – albeit from the EFTA Court and not the European Court of Justice (but there should be homogeneity between the two) – that the Directive on deposit guarantee schemes does not protect depositor in a major collapse shook the ground under the whole European banking system though depositors may not have noticed it. At least not yet.

An excellent legal reading of the judgement on European Law Blog summarises the judgement regarding the Directive by saying it “might be called a lifejacket, but it doesn’t mean it’s built for emergencies.

The ruling is based on the deposit Directive as it was in 2008 – it has been changed since – but it has, as far as I can see, not been changed in such a way as to make it unequivocal that the state is the final guarantor. If the idea with the changes in 2009 was to make states guarantee deposits a short sentence saying that they did, could have been inserted. That was not done. Understandably so, because it raises moral hazards as is pointed out in the ruling.

The Directive was designed to give depositors the feeling the state did indeed guarantee the DGS and make investors think that no, of course the state doesn’t do that. This was always an impossible task, it just went unobserved – until the EFTA Court judgment on Icesave. – It is, I believe, still not clear from the Directive that the state guarantees a result.

According to the statement by Stefaan de Rynck, Michael Barnier’s spokesman, the Commission will study the judgement but so far, it has not changed an iota in the Commission’s understanding of the Directive: “The Commission maintains its interpretation of the current Deposit Guarantee Scheme (DGS) in the EU.  The deposit guarantee schemes in the 27 Member States also apply in the event of a systemic crisis, and Member States are responsible to ensure that national deposit guarantee schemes effectively pay the compensation guaranteed by EU law within the whole single market.” – I have also heard that not everyone in the Commission is unhappy with the judgement. Some think this clarification was useful because the Directive was flawed as it was and the changes have not repaired the flaws.

No doubt, the ruling will be read back and forth over the coming weeks. But one thing could be taken as a lesson, not from the ruling but from action taken in Iceland in October 2008: make deposits priority claims in case of a bank collapse. This has indeed put the foreign Landsbanki depositors in a better place than would have been in a comparable situation with any other bank.

Another point Iceland emphasised is that a state facing a situation like the Icelandic one, will do whatever it takes to save its own interests – and it will not necessarily use a deposit guarantee scheme. Iceland moved domestic deposits to a new bank. The British Government moved Kaupthing Edge deposits to the Dutch ING (which interestingly went bust shortly after).

I can see that deposits need to be protected – but I have some aversion to DGS as I find the moral hazard too great. On this topic the Court quotes an article by Joseph Stiglitz – a first time the Court quotes anything but another judgement in its own ruling (see paragraph 167).

There are some concerns within the EU Commission that the European Court of Justice might have ruled differently on the Directive, ie that the EFTA Court’s ruling was more narrow than its rulings hitherto, leaving a sense of divergence between the EFTA and EU pillar of the single market. After all, there should be homogeneity between or within the two pillars. However this feeling will develop DGS and especially the joint one now being discussed are not a matter for courts to decide but, as Michael Waibel points out in his summary of the judgement, “a matter for the parliaments to decide.”

The Court concludes that the Directive does not apply to systemic failure like in Iceland. But that does not mean depositors are unprotected as seen from the examples of above. And the very best deposit guarantee is to regulate and supervise banks so they simply don’t fail. In any case, as paragraph 161 in the EFTA judgement reminds the reader, a state will not only use one tool to save a bank but all tools needed: “They may benefit from other provisions of EEA law regarding financial services, as well as the activities of supervisors, central banks, and governments.”

What will the Dutch and the Brits do?

The feeling is that the Dutch are most unwilling to forget the Icesave dispute, the British less so. Therefore, the Dutch are no doubt seeking and searching for ways to recuperate the costs accrued by paying out Icesave depositors. The deposits themselves will come – and are coming – from the Landsbanki estate. Not the cost.

As far as I can sense there is no willingness in the corridors of Berlaymont to support Dutch Icesave grievances. The Berlaymontians are worried but neither for the Dutch nor the British but for the EU financial system, EU consumers and depositors.

There are all sorts of rumours as to what the Dutch are mulling over. It is even being mentioned they are looking at the nuclear option – of leaving the EEA. (Normally, the EEA countries are said to be Iceland, Norway and Liechtenstein but since the EU is part to the EEA treaty so are the EU member states.) As the Grexit debate clarified there are no provisions for leaving the EU. With the EEA it is different. If the Dutch left it would put the EEA – already a bit of an eyesore in the EU landscape for some – it would put that construction in jeopardy. The question how much political goodwill the Dutch would reap from an action that does look more like a tantrum of a spoiled kid than a carefully planned policy. The EU does not much need yet another event to challenge its equilibrium.

At the beginning of the Icesave dispute the Dutch and the British had two options to pursue their goal of recuperating costs. There was the EEA/ESA route, eventually chosen and, since the two states were of the opinion that Iceland had promised to pay but later retracted an earlier promise, there was the option to sue Iceland for contractual breach.

For the British there was no single contract but what they consider a string of broken promises. For the Dutch, in addition to a similar string, there is a Memorandum from October 11 2008, signed by the then Dutch Ambassador and two Icelandic civil servants – the director of the Icelandic deposit guarantee fund, TIF and the permanent secretary of the Ministry of Finance.

In to the Memorandum the Dutch Government declared it would lend Iceland what amounted to EUR20.887 (the European minimum guarantee of EUR20.000 with added currency cost) – there was no total amount mentioned – against 6.7% interest (quite hefty at the time of low interest rates). This money would then be put at the disposal of the Dutch Central Bank and used to pay out the Icesave depositors.

That Iceland never paid according to the agreement can be explained by the fact that the loan was never issued. Further, these civil servants signed on behalf of their Governments but no further governmental contract or agreement was made. However, the Dutch might still try to use this – as far as I can see rather feeble ground – to sue Iceland for contractual breach. The Dutch may claim they have some further documentation but I find it difficult to believe there are still unknown documents related to Icesave (though I would not exclude it).

Icesave – the end?

Is the January 28 EFTA Court judgment the end of the Icesave saga? As far as I can see it is the end to the dispute between the three countries – Iceland, Britain and the Netherlands. It also seems the EU has come to the same conclusion.

However, the effect of the judgement on the Directive will rumble on for a while with EU’s legal heads and other studying it closely. The EU Commission must figure out how to respond. It won’t be easy to reach the same opaque equilibrium as previously now that the EFTA Court has spoken. A drastic rethinking on DGS, also in terms of a pan-European scheme in a planned banking union, would be desirable. But that is perhaps hoping for too much.

Addita: In response to an FT Editorial on Icesave here is a letter of mine to the FT, published January 31:

A misleading version of Iceland’s recovery

Sir, After all the excellent FT reporting on Icesave it is astounding that your editorial should have turned the history of Iceland’s recovery into a heroic saga of a small island challenging the big powers and the bankers of this world.

This is a highly misleading version of the recovery saga. Correct, it didn’t bail out the three banks but smaller financial institutions were bailed out, to the exorbitant cost of 20-25 per cent of gross domestic product.

What Iceland has, however, done wisely is to write down debt, both of companies and private individuals, as well as easing its bankruptcy law, thereby avoiding a zombie economy. This part, not the Icesave saga, is “the victory for law and economic sense”. That is what debt-ridden countries could learn from the Icelandic recovery.

In general, not only in Iceland, voters tend to vote for the future by evaluating what the various political programmes means for them instead of focusing on the past. Voters can punish politicians for their policy but I rather doubt they will punish the parties for their stance on Icesave – I would guess their perspective is broader.

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