Sigrún Davíðsdóttir's Icelog

Thinking back to five years ago, Iceland was forced to take the right decisions, not saving the big banks. But that was perhaps the easy decision: after all, the major part of creditors in these banks were foreigners. Later on, frantic attempts were made to save the very Icelandic banks, i.e. Saga Capital, VBS and some saving societies. Now, the idea is to tax estates where foreigners are ca. 90% of creditors whereas other failed financial companies are not taxed. “Fuck the foreigners” was a policy after the collapse – and it still seems to be the only policy five years after the collapse.

Last week, in the policy speech by prime minister Sigmundur Davíð Gunnlaugsson Icelanders were told that Iceland is a country almost too good to be true. However, for basic principles Iceland is less good. One of the basic principles is that property rights are inviolable. Some wonder if such principles still count in Iceland.

Part of the budget proposals, put forth last week, is that estates of the failed banks should be taxed. Taxing debt is a novel thing, remains to be seen how that idea fares. The proposal is vague as to how and what is being taxed. The proposal mentions the estates of Kaupthing, Glitnir and Landsbanki. The justification is that these three banks caused a lot of damage to Iceland – another novelty: tax is based on the principle of damage and the perceived good and evil.

There are however other failed financial institutions that did indeed cause a lot of harm and cost: Saga Capital and VBS, to mention just two, in addition to SpKef, Byr and others: the government did indeed try to save the two first ones and lost a lot of money on the attempt.

The intention seems clear enough. It would indeed be much more clear-cut if the definition was plainly to tax “estates where major part of creditors are foreign.”

Now on the fifth anniversary of the bank collapse politicians have been reminding Icelanders of the harm foreigners have caused Icelanders, i.a. the British actions five years ago against Kaupthing and Landsbanki. Less has ben said of what went on in the years before these few fateful days. And no mention is made of the fact that Icelanders, contrary to most other crisis-struck countries do actually know what happened and why: there is the SIC report that gives a clear and concise account of what happened.

The prime ministers is untiring in telling Icelanders what a great nation Iceland is. It is interesting to keep in mind the political rhetoric in Argentina. In any free country, i.e. a country, which is not locked up inside capital controls, citizens can vote with their currency, in the sense that if they do not like the policy they can go abroad. In Iceland – and in Argentina – that is not possible.

Both in Argentina and Iceland politicians constantly remind their countrymen of the unfair foreigners. In Argentina, this has been going on for almost 13 years. In Iceland, it is just beginning.

Qui vivra verra – but so far, Iceland seems to be emulating Argentina in trying to be a country that writes its own rules, forcing these rules on its citizens because they cannot go anywhere else and acting as if the outer world does not matter. Argentina, after almost 13 years, is waking up to the fact that this may not be that easy. Iceland still has years to find out if isolation matters. As one economist puts it, capital controls strangle the economy.

The weather has been glorious these days of the fifth collapse anniversary, as seen on the photo, taken on the outskirt of Reykjavík (for those who know Reykjavík it was taken out on the tip of Seltjarnarnes last night), truly if feels as a view of forever. In truth, the view here seems to be the view into populism, the only fast-growing thing within Iceland of capital controls.

 

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There is yet no clear plan in sight as to how to deal with the estates of the failed banks and, eventually, lifting the capital controls in Iceland. However, the fact that the government has declared it intends to use a given “wind-fall” from the estates indicates that there is a certain wish(ful thinking). The question is how this “wish” will materialise – and most of all, if the creditors will stage some counteraction, either as a group or single creditors, to seek to claim their foreign assets in foreign courts.

“I hope to see you and your money! in Iceland,” said prime minister Sigmundur Davíð Gunnlaugsson at the end of his speech at “Iceland Investment Forum” in London September 19. His words were met with laughter, more nervous than merry. Many of those present are creditors to the Icelandic banks, possibly not eager to invest more in Iceland until the fate of their last investment is clear.

In his speech the prime minister sought to stress that Iceland was keen to receive foreign investors in Iceland. “My government understands that vibrant business and industry is the basis of growth and welfare. We, therefore, welcome investments in Iceland and are willing to create an environment that is conducive to your needs as investors.”

Interestingly, last Saturday the prime minister said on Rúv that Iceland was not necessarily in need of foreign investments. Although foreign investment might in some cases bring the added value of knowledge, it was essentially a foreign loan; foreign investors just intended to get more out of their investments than they put into it. – An interesting insight into the PM’s business acumen.

In his London speech the prime minister did air his so oft repeated statements of the “leeway” in the estates of the fallen banks:

This brings me to my fourth point, namely the necessary settlement of debts of failed financial undertakings and assets of insolvent estates. My government intends to take advantage of the leeway, which inevitably will develop in tandem with the settlement of the insolvent estates, to address the needs of borrowers and persons who placed their savings in their homes. I have described this as a win-win situation as these settlements will allow us to lift the capital controls to the benefit of the creditors and borrowers alike.

The intriguing question for creditors is what this means for their recovery.

Spending time in Iceland recently I sought to gather impressions on a possible plan regarding the estates. My feeling is that this win-win situation will mostly apply to the government. For the creditors it might be more lose-lose in terms of their Icelandic assets though everyone with interests in Iceland will eventually win-win by having the capital controls lifted.

No doubt the creditors are aware of this – and might be contemplating their next move. In total, the claims against the three estates run to ISK7836, €47.6bn. The three estates hold ISK2750bn, €16.7bn. The difference is what the creditors have already lost.

So far, the estates’ foreign assets amount to ISK1793 bn, €11bn (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii). Of this sum, 57% is liquid funds. Although these are foreign assets, to a large extent held abroad and do not threaten the financial stability of Iceland, the CBI has not allowed them to be paid out, thus securing that Icelandic authorities keep an upper hand in the wrangle over the estates.

The Icelandic upper hand could however quickly turn limp if the foreign creditors, either as a group or single creditors, would choose to test their luck abroad. The fact that the government has only yesterday levied tax on the estates, could possibly instigate legal action, in this case from the estates themselves.

Below, I will try to go through issues related to the capital controls as things stand now. The topics of interest are the Landsbanki bonds, a recent Supreme Court ruling in Iceland regarding old Landsbanki, LBI, guesses as to what the government might be contemplating and what the creditors might be contemplating.

The reality behind the Landsbanki bonds

The three failed banks – Kaupthing, Glitnir and Landsbanki – were, each of them, split in two parts. Not bad and good bank, as might have been logical, but into an domestic operating bank, overtaking domestic, i.e. Icelandic, deposits and other domestic assets and liabilities and then an estate holding foreign deposits and other foreign assets and liabilities. Thus there are the three estates – LBI, Glitnir and Kaupthing – and respectively the new operating banks, Landsbankinn, Íslandsbanki and Arion Bank. The two latter are owned by the estates, i.e. the largest assets of the tow old banks are the two new banks whereas the state owns Landsbankinn.

Because of Icesave – the Landsbanki internet accounts set up in the UK and the Netherlands 2006 and 2008 – the main creditors of LBI are the deposit guarantee schemes of these two countries, both with priority claims. To some degree there is an overlap between the general creditors of the three banks. Around half of the creditors are the original bondholders; the rest has bought claims on the secondary market.

Due to uncertainties regarding Landsbanki assets, the new bank, Landsbankinn, eventually issued two bonds to LBI, to be paid in 2014-2018, mostly in foreign currency. It has been clear for a while that the scheduled repayments are too steep for the economy, i.e. LBI does not holds enough foreign currency to cover the repayment and there is not enough left on the current account for it to buy from the CBI.

The payment schedule is: 2014 ISK17bn, €100m, then ISK60-74bn, €360-450m, the next three years, having then paid the bonds in full 2018. It is disputed how much is needed. The numbers flying around have ranged from ISK50bn, €300m to 200bn, €1.21bn. This does not mean the new bank doesn’t have the funds to pay. It does, but not in foreign currency.

Under normal circumstances, a bank never pays up all its debt in full but refinances. As things are now, that is not a realistic option for any Icelandic financial firm – Icelandic financial companies do not have access to sustainable funding. That could change but for the time being the option is not there.

The Landsbanki bonds, its stakeholders and a step towards abolishing capital controls

After some wrangling between Landsbankinn and LBI, echoing in the Icelandic press this summer, the two entities have now entered into negotiations “on possible adjustments” to earlier settlement regarding the bonds (press release here).

The outcome will be interesting for several reasons: it will remove a certain threat, explained above, to Landsbankinn and its owner, the Icelandic state; it will indicate positions of those negotiating the bonds – and it is a first big step, regarding the estates, towards abolishing the capital controls. The numbers at stake here are considerable: the expected recovery of LBI is now ISK1531bn, €9.29bn with priority claims at ISK1325, €8.04bn. This leaves ISK206bn, €1.25bn, for general claims.

The management of Landsbankinn seems to have felt that LBI was not being very forthcoming in negotiating. On the LBI side the priority creditors, essentially the Dutch and the British governments, certainly have a lot to say on this issue.

The Dutch and the British governments stand to recover their Icesave compensations, i.e. minimum compensation of €20.000 for each depositor. They have already recovered 53.9% of what they expect to get, paid out in three instalments. However, it makes quite some difference to them if they recover everything by 2018 or have to wait considerably longer.

From what I understand there is still some pent-up Icesave irritation among the Dutch and the British negotiators. But the general creditors have also been vocal on rescheduling. Although they stand to get “only” ISK206bn, this is money as well. But since general claims are not paid out until priority claims have been paid out in full, any extension of the Landsbanki bonds will mean that their waiting is prolonged.

The CBI views the rescheduling as the first firm step towards abolition of the capital controls. Many of the general creditors are also creditors to the two other banks, making the Landsbanki bond negotiation interesting in terms of issues that need to be settled re the two other estates. The Landsbanki negotiations can thus be seen as a dress rehearsal for the full performances to come.

Landsbanki bonds – possible solutions

It is clear to everyone involved that the Landsbanki bonds need to be extended. The prospect of the Icelandic economy will be debated, in terms of what could possibly be set aside of foreign currency towards bond payments but also to what extent Landsbankinn could possibly refinance its debt. All of these issues will be mulled over by those negotiating the rescheduling, in addition the more specific terms and conditions of the bonds themselves.

In Iceland, it has officially be mentioned that the rescheduling needs to be “a few years” but that seems far too optimistic. Ten or 15 years seems a more reasonable number. As it is now, the interest rates are low, which means that interest rates will no doubt be negotiated.

Landsbankinn and its owner, the state, are obviously unwilling to see the bank fail. With the bonds being a sizeable chunk of the LBI assets, its creditors are no doubt adamant to secure that the bonds get paid – if not on time then in the foreseeable future.

It is however very difficult to imagine that LBI will agree to any extension unless the creditors get something substantial in return. The intriguing question is what this “substantial” could be. An obvious bit would be a substantial up-front payment. Steinþór Pálsson CEO of Landsbankinn has already mentioned (in Icelandic) a sum of ISK70bn, €420m.

Another – and a truly interesting “substantial” – would be for the LBI to get a permission from the CBI (which has to agree to all payments) to pay out all the foreign assets of the LBI. The reason this is so interesting is that so far, none of the estates have paid out any of the foreign assets, although they, as pointed out above, to not threaten financial stability in Iceland.

At a meeting in London September 26 possible solutions were introduced. It is a pure guess as to what exactly has been offered to the LBI but it is difficult to imagine that the creditors will not try to use their bargaining position to get their foreign assets paid out.

And it is also clear, that the prime minister and Bjarni Benediktsson minister of finance, representing Landsbankinn’s owner, will need to accept whatever solution is negotiated. It must be equally likely that only a solution that the owner accepts a priori will be seriously discussed.

The two tales of a Supreme Court judgment re LBI

September 24, the Icelandic Supreme Court ruled in a case (553/2013) brought by creditors of LBI, both priory and general claimants and the Icelandic state against the LBI. The case centred on how partial payments in foreign currency should be calculated, i.e. what ISK exchange rate should be used. The LBI had used the exchange rate on April 22 2009, the date when the winding-up proceeding commenced. The Reykjavík District Court had originally ruled in favour of LBI but the Supreme Court reversed that ruling.

This case has been interpreted in two distinctly different ways in Iceland, basically spinning two different tales.

The first one is a low-key tale: this ruling brings no fundamental changes. It points out, what was already known, that once the winding-up proceedings starts the assets in an estate holding foreign assets are converted into ISK, for accounting purposes. An estate can – but does not need to – pay out in foreign currency. The exchange rate for payment in foreign currency should be the rate on the day of the payment. This is how several lawyers have interpreted the ruling in the Icelandic media.

The other interpretation is a more sensational tale, so far mostly heard from politicians, i.a. the minister of finance: this ruling is a fundamental confirmation that the estates are in ISK and should only pay out in ISK.

It is interesting that both creditors and the Icelandic state supported the conclusion of the Supreme Court. The motive behind the state’s view is a remnant from the Icesave case where it held the view that the exchange rate on payment day should be used, hoping in due course to gain from ISK appreciation, as a set-off against the interest rates.

Is paying out the estates in ISK the way out of the ISK dilemma?

As mentioned above, the three estates hold ISK2750bn, €16.7bn, of which 2/3, ISK1800bn, €11bn is in foreign assets and 1/3 is ISK assets. This 1/3 is part of the problem that the capital controls keep at bay: there is not, and will not be in the foreseeable future, enough foreign currency to convert these (and some others) ISK assets, owned by foreigners. This problem is further crystallised by the fact that 5% of the claims are domestic, 95% foreign whereas 33% of the assets are domestic, 67% foreign (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii).

Listening to politicians following the Supreme Court judgment, it sounds as if paying out all of the assets of the estates in ISK, the total ISK2750bn, would be the solution to the ISK problem. A priori, as seen from the numbers above, paying all out in ISK can hardly be a solution to anything but only make a huge problem utterly humungous.

Unless, of course, something else is done as well, such as offering the creditors, now holding nothing but ISK, a certain exchange rate in order to exchange their Hvannadalshnjúkur (the highest summit in Iceland) of ISK into foreign currency, with the government then having found its frequently mentioned “leeway” there. More on that below.

As an Icelandic lawyer (not working for the creditors) said recently: “If Iceland wants to remain on good terms with the outer world the estates will be allowed to pay out their foreign assets in the foreign currency they own,” meaning that the ISK problem needs to be solved separately.

Glitnir, Kaupthing and composition

Glitnir and Kaupthing have both applied for an exemption from the capital controls, under the Foreign Exchange Act No. 87/1992 in order to proceed with composition. In this respect, composition means that the estates will be run as holding companies, working on recovering and realising assets on behalf of creditors and eventually paying out the funds recovered.

From the point of view of creditors this process is preferable to bankruptcy proceedings because a bankrupt estate needs to sell off assets in a shorter time. One of the comments heard in Iceland after the LBI ruling was that bankruptcy would allow for all assets to be paid out in ISK. This is however wrong. There is no difference as to payment between composition or bankruptcy.

Both Glitnir and Kaupthing sent an application for composition to the CBI before end of last year. CBI has not answered but following a query this summer from Glitnir, the CBI has now answered Glitnir in a letter September 23. The bank emphasises that analysis of the situation of the Glitnir estate is on-going, both within the bank and the estate.

Although a detailed analysis is not yet complete, it is clear that the Central Bank of Iceland cannot give a positive answer to the Glitnir winding-up committee’s exemption request without a solution concerning the assets that, other things being equal, will have a negative effect on Iceland’s balance of payments when they are disbursed to creditors, 93.8% of whom are non-residents, as is stated in Central Bank of Iceland Special Publication no. 9. Reference is made here to the classification of creditors, to Glitnir hf.’s króna assets (including shares in Íslandsbanki), and foreign-denominated claims against domestic parties. In order for the Central Bank to be able to grant an exemption for the above-mentioned composition agreement, there must be a solution concerning these assets, so that Iceland’s balance of payments and planned capital account liberalisation provide scope for disbursement to foreign creditors. It is important to emphasise that this is not a matter for negotiation. Either this condition is fulfilled, or it is not. Glitnir’s exemption request does not fulfil this condition at present.

In view of the foregoing, the Central Bank considers that there are no premises for setting up a process of the type proposed in the winding- up committee’s letter, and certainly not one subject to binding time limits. It is the role of the Glitnir hf. winding-up committee, in connection with its exemption request, to create the conditions that allow for the approval of an application for a composition agreement. As before, the Central Bank of Iceland is prepared to assess whether it is likely that specified options fulfil the above-mentioned conditions. If the Glitnir hf. winding-up committee has developed ideas of this type, as is asserted in its letter, the Bank is ready and willing to discuss them.

This letter indicates that the estate – and this would assumedly apply to Kaupthing as well – will need to come up with a solution on the ISK assets. The CBI is not going to negotiate though it seems to indicate willingness to engage in assessing if conditions are met or not.

Creative taxing: taxing estates of financial companies

The first action taken by the new coalition government, in power since May, regarding the estates of the fallen banks is a tax on the estates of failed financial companies, announced October 1 in the budget proposal for 2014. Bank tax will be increased from 0.041% to 0.145%, levied on all licensed financial companies, operating or in winding-up proceedings.

At first sight, this might seem to indicate all financial companies in winding-up proceedings, i.e. the three estates but also other failed financial companies such as Saga Capital, VBS, Icebank and some saving societies. However, according to the FME (Icelandic FSA) website over licensed financial companies there is only one such licensed company, now in winding-up proceedings, LBI. The other failed financial companies have all lost their licensed status and are mere holding companies.

The idea was hardly to tax only LBI but as the proposal stands, the tax apparently only hits LBI. If the tax should cover the other estates the proposal, as far as can be seen, needs to be rewritten or clarified along the lines of “companies, which were once licenced/licensed before/after anno XXX as financial companies…”

Taxing estates is, I’m told, normally not done and has, to my knowledge, never been the practice in Iceland, anymore than in other countries. Lawyers have mentioned that a tax on failed companies could be seen as an expropriation. The ministry of finance has definitely shown remarkable creativity here.*

What the government wants – all of the ISK assets and/or even more?

It is safe to conclude that the Progressive Party was voted to power on the basis of its election promises of finding a “leeway” in the estates of the collapsed banks in order to provide what the prime minister has called the most extensive debt-relief in the world. He has been unwilling to mention any numbers but one persistent number is ISK300bn, €1.8bn.

The debt-relief has been widely criticised, i.a. because of inflationary effects, by economists. It also goes against promises of the Independence Party of a sustainable fiscal policy and paying down public debt.

The government and some businessmen have been pointing out lately that it is wrong to portray the problem of capital controls as touching solely creditors locked in with their assets in Iceland. All Icelanders are locked in. Consequently, drastic moves are needed to abolish the controls.

It now seems that one of the solutions possibly contemplated by the government is to “take over” all the ISK assets and possibly some of the foreign assets – though how this would be possible is still unclear. The motive for this drastic move is that the Icelandic current account will not, for the many coming years, allow for any foreign currency to be used to convert ISK assets of foreign creditors.

Those who propose this “take over” seem to feel that the “ISK-isation” of the estates, i.e. regarding all the assets as ISK assets and paying them out in ISK, is an essential move. Writing the assets down via the exchange into foreign currency would then be one possible way of achieving this “take over.”

Although – as far as I can see – creating quite a number of problems, this would however solve two fundamental problems for the coalition government: it would provide the Progressive Party with the ISK300bn, or whatever it will decide is needed for the debt relief – and it will placate those within the Independence Party who think that “estate-windfall” should benefit Icelanders in paying down public debt.

From the numbers above, it is possible to guess at the numbers involved: all the ISK debt is about 1/3 of the estates, ISK950bn, €5.76bn, meaning there would be something like ISK650, €3.94bn, out of this process, a third of Icelandic GDP, to pay down public debt. Given that the Icelandic public debt to GDP is forecasted to be just below 100% of GDP this year, this sum would reduce the debt by a third.

Will the government proceed with these ideas? Time will tell. Relevant ministries and the CBI all have legal opinions at hand, underlining Icelandic law on property right, the importance of keeping all actions within Icelandic law etc. But if the wishful thinking becomes so strong, fuelled by little sympathy for foreign creditors, one never knows. All solutions can be made pretty in an excel document – but to turn them into something that withstands legal challenges and doesn’t just solve the problem like warming one’s toes by peeing in the shoe is quite another matter.

What the creditors could do

Five years from the collapse in Iceland, the capital controls are still in place and the foreign creditors have not yet received any of their assets, apart from the priority creditors to Landsbanki. The priority claimants to Kaupthing and Glitnir have already been paid out, respectively ISK130, €790m and ISK54bn, €330m.

Faced with the possibility that their assets will now be gnawed into by tax, it is seems likely that the estates will take a legal action to challenge the new taxation.

It has taken some years to clarify various legal issues. From the point of view of the foreign creditors, the cash part of the foreign assets – ISK1029bn, €6.24bn, of the ISK1793bn, €10.88bn or 57% – is just waiting there to be paid out.

However, that is not happening as long as the fate of the ISK assets has not been settled. And after a change in the foreign currency law in March 2012, the CBI has to agree to, give exemption to, all payments of the estates.

The bondholders and other creditors may eventually lose patients and sell their claims. In Iceland, much is made of the huge profits made by creditors. That is somewhat misleading. The bondholders have already incurred huge losses though large institutions have no doubt sought shelter behind CDS. Depending on when the buyers in the secondary bought some of them will profit handsomely.

Invariably when creditors lose hope and patience claims get sold and the buyers are those who specialise in difficult assets. These creditors use the courts as much as they can. From small creditors in the Icelandic banks I have heard that there is no lack of suitors from this pack.

It is difficult to avoid the thought that at some point the creditors might lose patience – either as a group or single creditors – and seek legal action against the Icelandic state. That would then most likely start with proceedings where the foreign assets are, to get the assets frozen, after which the creditors would try to prove that they have been waiting needlessly long and nothing is being done to solve the issues.

The Icelandic government has, until earlier this year, not been party to the fate of the estates. With a change in the foreign currency law (nr. 87/1992), the minister of finance and minister of banking have to agree to CBI exemption regarding companies with a larger balance sheet than ISK400bn, €2.42bn, which includes the estates.

This might prove to be a double-edged sword in the sense that the government now risks to be sued because of the estates of the collapsed banks.

The creditors are much vilified in the Icelandic debate, seen as vultures and predators and no politician mentions them without these words. It is ironic that now on the fifth anniversary of the collapse there are again foreigners to blame, thus clouding the fact that the creditors are there as a result of actions taken by a group of ca. thirty Icelanders.

There is much at stake for the creditors, as there is for everyone who stands to gain from the abolition of the capital controls. But those who can gain most from a successful abolition – and consequently stand to lose most from mishaps and delays – are Icelanders themselves. Hopefully, all those involved will recognise this and have the good sense to seek constructive solutions. As an economist said recently: “Capital controls are a slow death.”

*At a closer look, the three estates – of Kaupthing, Landsbanki and Glitnir – are named in the budget proposal (the budget proposal, in Icelandic). As mentioned above, there are other estates of failed financial companies in Iceland but apart from size, the real difference between these other estates and the three big estates is that in the small ones most of the creditors are Icelandic whereas the creditors to the three big ones are 93% foreign entities. – The text seems ambiguous and will most likely be clarified at some later stage.

These are all complicated issues. I hope I haven’t made mistakes, will correct them if found. However, I hope Icelog readers do check the sources if needed.

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