Sigrún Davíðsdóttir's Icelog

In recent weeks Icelandic business leaders have voiced concern on the isolation of Icelandic businesses behind capital controls and by breaking off EU access negotiation. In order to lift the controls – or rather, start the process towards that goal – it is necessary to negotiate the payment schedule of the Landsbanki bond and the ISK assets of Glitnir and Kaupthing. Possible solutions are in sight but it is ultimately a political question and not about economics. So far, it is unclear if the government is seeking to lift the controls or if it also seeking to fatten the state coffers. Another – and in the long run possibly a more serious problem – is a short-term plan with no perspective on the future. As the CBI points out in its latest Financial Stability Report the solution has to be holistic, safeguard financial stability and pave the way for Icelandic public and private entities to international credit markets.

The word among those involved in the winding-up of the estates of Glitnir and Kaupthing is that these are by no means difficult cases but the weirdest process they have been involved in. The “weirdness” stems from the fact that although the minister of finance has the last word on the winding-up of the two estates, there is no one to negotiate with. One of those involved complained that they keep coming to Iceland, for meetings and presentation, but there is no one with a mandate to make any decisions.

The process has been rambling, with a committee that then was not really a committee and had no chairman. The prevailing assumption in Iceland seems to be that Iceland has all the good cards on its hand and can afford to wait as long as it pleases, “to make the creditors sweat” as some have been whispering. But that may be a slight misconception.

What should focus the mind of the government is first of all the growing and vocal irritation within the Icelandic business community on lack of credible plan to lift the controls. Also, 2016 is a crunch year when the new Landsbanki cannot pay (not for lack of liquidity but of foreign currency). Uncertainty on repayment is particularly unfortunate since the new bank is owned by the state. The third issue are legal risks. The fourth issue, somewhat hypothetical in terms of time but absolutely real in terms of effect, is the relative cohesion of the creditors, contrary to what it could later.

The process

The process of abolishing the capital controls has been rambling. Under the previous government the Central Bank was working on the payment-of-balance analysis and prognosis and published a report, only in Icelandic,* in March last year as well as reports on abolition plans. In early 2013 an ad hoc working group with members from the Icelandic government, EU Commission, the European Central Bank and the IMF was set up to work on an interim report. However, when the present government announced it was putting EU accession talks on hold the EU Commission notified the government it would withdraw from the group, which then met its demise.

During the election campaign last year the Progressive party announced time and again that “unavoidably” the state would make money on the winding up the banks’ estate and these funds should be used for debt relief. When announced in November it came as a surprise that the debt relief was to be funded with a banking tax, also on the estates, not from money from the winding-up process. Much less has been heard of this fountain of funds, the winding up process, lately.

The new government announced it would appoint a “capital controls abolition director,” due to be appointed soon after the government took over. However, this position was never filled. End of November the government set up an “advisory group” with the task of making proposals on steps and overall plan of abolishing the capital controls. It was unclear if this was a committee or not (said by adversaries not to be a committee because a committee would be bound by law on gender equality) and it was too informal to have a chairman.

However, in a recent report on the abolition progress (after an Althing resolution last year a report on the abolition progress is published twice a year) Sigurbjörn Þorkelsson, a banker in London, is said to be its chairman. Other members were Eiríkur Svavarsson, Jón Helgi Egilsson, Jón Birgir Jónsson, Ragnar Árnason and Reimar Pétursson. Benedikt Árnason and Benedikt Gíslason, both from the Ministry of finance, assisted the group.

Its proposals have not been made public and the group seems to have come up with a smorgasbord of proposals but no overall plan, as far as is known. Also, there are rumours of differing opinions within the group. Recently, Benedikt Gíslason gave a presentation at Independence party’s head quarters but the scanty reporting did not indicate any firm view on the process and the immediate future. According to the rumour mill the members have been giving power-point presentation at various meetings; always the same slides but the interpretation varies according to who presents the slides.

This group has now been disbanded. It now seems it will be substituted with a new group. Also, it is rumours that international advisers of all types have been visiting the ministry of finance strutting their feathers. So far no names have been confirmed nor is it clear what the mandate will be.

The numbers

The capital controls stem from the fact that Iceland does not generate enough foreign currency, fx, to meet demand on converting ISK into fx. There are three main hurdles: pre-2008 foreign-owned ISK, mostly so-called “glacier bonds,” ISK327bn, €2.1bn – ISK assets in the estates of LBI (the Landsbanki estate), Glitnir and Kaupthing – and liabilities by Icelandic entities, such as Landsvirkjun and the state itself, in fx, directly and indirectly state-guaranteed. In a way, it makes sense to group the Landsbanki bond in this last group since new Landsbanki, shouldering these liabilities, is state-owned.

The combined assets of the three estates amount to ISK2,552bn, or 143% of Icelandic GDP. The ISK assets of the estates in Glitnir are ISK302, €1.94bn, in Kaupthing ISK148bn, €950m and in LBI ISK47bn, €300m, in total ISK497, €3.19bn. The largest part of the Glitnir and Kaupthing ISK assets are the new banks, respectively Íslandsbanki, valued at ISK132bn, €850m and Arion at ISK116bn, €750m (on latest numbers and stats see the CBI latest Financial Stability Report)

Contrary to the creditors of the three estates the foreign-owned ISK, the glacier bond-holders, are not an organised group. Some have estimated that a third, perhaps as much as half of them are indeed Icelanders. Whether this group will leave rapidly or not is difficult to say but there are indications that at least part of this money is happy to stay in the high-interest Icelandic economy.

The liabilities of indirectly/directly state-guaranteed liabilities are manageable, according to the CBI, for next year, partly because fx has been put aside against rainy days. The problem becomes insurmountable in 2016-2018 unless the new Landsbanki refinances/extends, in total ISK177bn, €1.14bn for these three years.

Composition or bankruptcy?

The major question, facing the government is whether to find a solution for winding up of the estates of Glitnir and Kaupthing, i.e. composition as creditors want – or opt for filing a petition for bankruptcy straight away. Bankruptcy gives less leeway to manage assets whereas composition gives creditors much better control over the assets, which might in the long run improve their recovery. Needless to say, the creditors favour composition.

For some reason, those who speak for the bankruptcy route, have added to it the so-called “ISK-isation” of all the assets, meaning that the fx assets, mostly held abroad, must be converted into ISK, paid out and then those foreigners with bucket-loads of króna would have to negotiate an exit, participate in auctions etc. I fail to see how this route could solve anything at all or be in the interest of Icelanders. To my mind, it is chaos and risk and no solution at all. In addition to lawsuits and other legal devilry it makes the process unpredictable, possibly prolonging unnecessarily the capital controls.

Both prime minister Sigmundur Davíð Gunnlaugsson and minister of finance Bjarni Benediktsson have repeatedly hinted at this possibility. Benediktsson has argued that the winding-up process is taking unduly long though not mentioning that both Glitnir and Kaupthing put forth a draft for a composition bill in late 2012. So far, Kaupthing has received no answer. Glitnir has been answered after which they put forth another draft, as yet without an answer.

The ministers have no doubt mentioned bankruptcy to scare the creditors who perceive they will lose a lot through bankruptcy with assets unavoidably going on fire sale with the usual consequences. However, that is only money, so to speak and losses for some financial institutions. The losses for Iceland is, from my point of view, much more serious: longer time under capital controls with ensuing direct and indirect cost, uncertainty and what could be seen from abroad as increased political risk, rising from instigating a process fraught with unforeseen consequences.

The legal risks

Most of the debate in Iceland regarding the capital controls and the two estates has focused on the evident balance-of-payment problem and the need to find a solution that does not put the country’s financial stability in jeopardy. The legal risks are hardly ever mentioned.

Some of those I have spoken to, advocating the bankruptcy route, claim there is no inherent legal risk in it. As a proof they refer to an ECJ ruling regarding a case against LBI in France in which Icelandic bankruptcy laws and the procedures was found to comply with EU regulations. However, this case only shows that so far Icelandic laws are in compliance. With a different route or deviation from this course the situation might be different.

So far, none of the fx assets have been paid out to creditors – it can only happen after priority claims have been paid out, as in Glitnir and Kaupthing (LBI will only finish that earliest in 2018) and either bankruptcy or composition chosen. Paying the fx would not harm Icelandic financial stability. One reason for postponing decision is rumoured to be that preventing the fx payout makes the creditors more amenable to leaving a large chunk of ISK assets to the government. From the legal point of view this might be questionable, to say the very least. By preventing payment the state can easily risk legal action.

Frustrated creditors could use Icelandic law to seek their rights. The notorious cases of creditors vs Argentina demonstrate the ample recourse creditors have internationally to seek justice. In addition to direct legal risks there is the risk that legal wrangling tends to take a long time, possibly adding years to capital controls in Iceland – again, a costly delay for Iceland.

Legal risks are well known from similar cases in other countries and it is a well-trodden path for creditors. If the creditors feel forced to take that route the consequences might be unpleasant for Icelanders and come as a surprise. However, in an international perspective there will most likely be few novelties.

The political risk

One risk assessment regarding countries is political risk. If the government keeps dithering, postponing a solution, the political risk increases. The priority claim-holders to LBI, the British and the Dutch government, no doubt have an eye on the political risk in weighing up possible actions.

For some reason media reports in Iceland on the Landsbanki bond ignore the fact that behind Landsbanki is its owner, the state. One source said to me that the state would not do whatever it takes to save the new bank. – Needless to say, letting Landsbanki fail would create quite some turmoil, to say the very least.

The Progressive party, the winner of the last elections, is now much weakened. Both the party and its leader muster little popularity and trust according to polls. A weakened party will either try to be more reasonable and responsible, in order to get re-elected. Or it can go all-out on demagogy and populism, knowing it will only get one term in power anyway so there is nothing to lose. It is still too early to tell what route the progressives will choose. So far, the prime minister has been very absent in the Althing debate, causing much speculation as to what makes him stay away.

Partly due to the prime minister’s absence Bjarni Benediktsson leader of the Independence party has at times appeared as both the minister of finance, as he is, and an acting prime minister. Within his party there is brewing discontent that the party has gone out on a limb to make the Progressives’ promises of debt relief come true. The two Althing bills needed to carry out the debt relief plan have not yet been through Althing and it is still unclear when it will happen. Icelanders have been promised that they can apply for the relief from mid-May.

The EU issue – to break off negotiation, as the Progressives insist on – has turned into a poisonous topic for the Independence party. Its leaders point at polls showing that its voters are in favour but the fact is that many of the more EU-friendly voters have already left the party. The party has now a much smaller following than ever in the past when it hovered around 40% while now hovering around and well under 30%. A new conservative EU-friendly party is still in the making but not yet born.

The feeling is that the cause of inaction regarding the estates of Glitnir and Kaupthing is due to differing views within the government. As long as the course is unclear political tension and the ensuing risk of inaction is in sight.

Ultimately, as pointed out on Icelog earlier, the controls will be decided in a political wrangling. Understanding that politics is a key issue here.

Possible solutions

The worst problem for Iceland is the Landsbanki bond since the liabilities are on Iceland, indirectly a sovereign problem since the new Landsbanki is state-owned. Theoretically, the solution is simple: extending the payment schedule, with adjusted interest rates. Although simple in theory, it is clearly not that simple in reality. Here, contrary to what seems to be generally understood in Iceland, the creditors have the upper hand. Nothing is really clear until the solution here is clear.

In addition, it is clear to everyone, including the creditors, that Iceland does not create enough fx to pay out, in the near future, ISK assets held by foreigners. With focus on the estates of Glitnir and Kaupthing the question is what to do about it.

There are of course the usual. One is extending payment etc but that is not very satisfactory for various reasons, i.a. risk rising from unforeseen circumstances etc. Haircut is another way. The CBI has been in favour of 75%; Arion bank analysts recently mentioned 55% as the necessary number.

However, the CBI has lately been advocating solving the problem within the framework of the estates, i.a. using domestic held fx, asset swaps etc. – 5.7% of the claims are owned by Icelanders, in total just over ISK100bn, mostly held by the Eignasafn Seðlabankans (the CBI asset-holding company).

The creditors have pointed out that selling the two banks, Arion and Íslandsbanki, to foreigners/for fx might be the solution. As pointed out in the 2014 report on capital controls: “Sale of the holdings for foreign currency to non- residents who intend to hold these assets for a longer term would avoid such negative effects, although there might be pressure over a longer period when the banks paid dividends to their foreign owners.” – However, also regarding dividend there are possible solutions.

As it is, everyone is losing out on inaction. Creditors lose around ISK100bn, €640m, a year because of lost interest. Icelandic businesses and ultimately the country are losing, as always happens when capital controls stay longer than necessary Icelandic businesses and ultimately the country are losing both money and opportunities.

Analysts at Arion Bank have done some calculations, pointing out that the only real problem is the Landsbanki bond. Here is their interesting overview.

The risky silence on long-term perspectives

The latest CBI financial stability report states: “The next stages of the winding-up proceed- ings must safeguards financial stability and ensures access of domestic entities to foreign credit markets. Finding a comprehensive solution to the estates’ affairs is a prerequisite for lifting of the capital controls.”

In addition to a missing comprehensive view and a holistic solution is missing a vision of the future after lifting the controls is nowhere in sight. How will Iceland cope on its own after the controls have been lifted? Can Iceland survive with no controls, will controls on inflows or outflows be needed, should the króna be pegged or not, another currency found? And is the EEA agreement enough for Iceland in the long run?

In September 2012, the CBI produced an extensive and informative report, Iceland’s currency and exchange rate policy options (only small part of it in English), inducing realism in an often lofty so as not to say wholly misleading debate, on the currency options. Instead of instigating a debate it more or less ended all debate without any ensuing policy.

As far as is known the government is not working on any comprehensive analysis of future options. Some say that politician are avoiding to discuss these wider issues and the government, or rather the Progressives, is hell-bent only on finding some clever way of fleecing foreigners. Yet, if there is only that policy once they are fleeced, what next?

The solution to lifting the capital controls needs to be coherent and comprehensive – but to back it up there also needs to be a clear plan for the future after the capital controls. That is what politics should be about. The EU debate shows that there is an ongoing battle for the soul of Iceland going on – whether to dare to engage with the outer world or to withdraw and isolate, letting the forces that have ruled Iceland for the last decades rule on.

*Sorry, this is of course wrong. Here is the report in English.

Follow me on Twitter for running updates.