Sigrún Davíðsdóttir's Icelog

Recent movements around ownership of Arion bank indicate that opacity and under-cover deals are again rife in Iceland, this time with foreigners involved. It could be seen coming: last year, the International Monetary Fund pointed out that an IPO of Arion bank would pose a test for the banking regulator; IMF also stated its worries about a weak regulator, exposed to political pressure, indeed worrying signs.

Mid February, Arion bank published its 2017 annual accounts. At the same time, changes to its ownership were announced: Kaupthing, Arion’s largest shareholder is buying the Icelandic state’s 13% shareholding in Arion. This seems to be a move towards fulfilling an agreement from last year, kept secret at the time: four of Kaupthing’s almost 600 owners, who last year bought shares directly in Arion, aim at getting hold of an Arion subsidiary, Valitor, a payment solution company, before Arion’s IPO, planned in the coming months. – The four particularly active funds are Taconic Capital Advisors, Attestor Capital, Och-Ziff Capital and Goldman Sachs.*

The International Monetary Fund sees the sale of Arion as a major test for the Icelandic financial regulator, FME, post-2008 collapse. As the IMF pointed out last year in its Article IV Consultations: “The Arion transaction poses a test for Fjármálaeftirlitid (FME, the banking, securities, and insurance regulator), which must ensure its fit and proper assessments are stringent and evenhanded.” According to the IMF FME is currently “not sufficiently insulated from the political process…”

The Arion test is now on-going and so far, it is not obvious that the Icelandic authorities will pass with flying colours.

Foreign funds buy into Arion – for a reason

Arion bank was founded on the ruins of old Kaupthing. Until last year, its owners were the Icelandic state, holding 13% and the rest by Kaupthing, the old bank’s estate owned by Kaupthing’s creditors. Kaupthing’s ownership in Arion is through a subsidiary, Kaupskil, set up to create an arm’s length between Kaupthing and Arion. Events over the last year or so do however cast doubt over this exercise: Kaupthing has all the power over Arion it wishes, i.e. in selecting and de-selecting board members.

In 2015, some Icelandic pension funds approached Kaupthing and indicated willingness to buy shares in Arion. After talks for over a year, Kaupthing brought the talks to an abrupt end last year. At the same time Kauphing unexpectedly announced four new Arion shareholders: Taconic Capital Advisors, Attestor Capital, Och-Ziff Capital and Goldman Sachs,* respectively holding 9.99%, 10.44%, 6.58% and 2.57%. After these transactions Kaupskil owned 57.41% and the Icelandic state 13%.

This came as a surprise to the pension funds that had not known of other Kaupthing negotiations. “This was just business,” a representative of one of the funds said to me, indicating that there had been no hard feelings. Yet, both he and others I have talked to felt that Kaupthing had fooled the pension funds. The result was a breach of trust, seen from the pension funds’ perspective.

Arion and Icelandic ministers made much of the fact that new shareholders were now on board, indicating a trust in the bank. Another way to look at it was that these four funds were all previously shareholders in Kaupthing. Therefor, Kaupthing was effectively selling to a part of itself.

These transactions between related parties did not bring any new shareholders aboard. The four funds are now both directly and indirectly, through Kaupthing, shareholders in Arion.

The secret agreement hidden in the 2017 transaction: Valitor

Part of this transaction between Kaupthing and four of its shareholders was however kept secret: the four funds made an agreement with Kaupthing that should Kaupthing come into possession of shares in Valitor the four funds would have an option on the Valitor shares.

Since this agreement, all moves by Kaupthing and the four new Arion shareholders have been aimed at bringing this to fruition, i.e. that Kaupthing would come to possess Valitor shares, which the funds would then buy. Buying Valitor in a transparent normal sale, competing for this asset with other buyers, was apparently never part of the plan.

Why this interest in Valitor? Over half of Valitor’s earnings comes from its foreign operations, it has some clever technical solutions and operates in a market the foreign funds understand well. Therefor, the funds are well positioned to make the most of this asset in a future sale. According to Icelog sources Valitor’s value is easily twice p/b.

Kaupthing wooing the pension funds

In January this year, Kaupthing approached some Icelandic pension funds with an offer to buy up to 5% in Arion. The deadline was 12 February, two days before Arion’s annual accounts were due to be published.

One Icelog source said that late in the day, the foreign funds had realised that in Iceland you can’t do any major deal without having some of the pension funds on board: their money is useful but most of all, transactions are lacklustre if the pension funds don’t give their blessing by participating. And in this case, selling before a planned IPO later this year would give an indication of price and interest.

It soon became apparent that the pension funds were not too keen to accept the offer and in the end none of them agreed to buy. The reasons given varied: the time was too short, they would have liked to see the annual accounts first, they felt the present major shareholders had an unclear vision of the bank’s future. – But underneath, there was still the lingering rancour from the abruptly ended negotiations last year.

Not Onegin – but a story of twice fooled

With the rejection from the pension funds Kaupthing looked like Pushkin’s Onegin who didn’t accept Tatjana’s love when she offered it to him but then got rejected when he finally did fall in love with her – if you don’t want when you can, you can’t when you want to…

Then, lo and behold, the story turned out to an entirely different one: Kaupthing did (of course!) have a plan B, in case the pension funds rejected the offer. The story from last year was repeated: within 24 hours of the lapsed deadline, Kaupthing announced a sale of just over 5%: four Icelandic investment funds, managed by four Icelandic banks, materialised as buyers of 2.54%, with Attestor Capital and Goldman Sachs, buying in total 2.8%.

The four funds, i.e. the new Icelandic shareholders, are managed by Kvika, which is also Kaupthing’s advisor, Stefnir managed by Arion, where Kaupthing is the largest owner, Landsbréf by Landsbankinn and Íslandssjóðir by Íslandsbanki. The share division between the individual buyers has not been announced.

As one Icelog source said this was worse than anticipated in the sense that it only brings a very small amount of new owners in Arion and again, the Kaupthing-related Valitor-interested funds are participating.

The road to Valitor – and yet another opaque transaction

From this point, the plot thickens.

The 5% sale was crucial since the Arion board had agreed at its meeting 12 February that a sale of 5% of Arion shares was needed to unleash a dividend of ISK25bn. It also agreed to allow Arion to buy up to 10% of its own shares, a transaction that would then be deducted from the dividend.

The representative of the Icelandic state on the Arion board voted both against linking dividend payment to other transactions and against Arion buying own shares, both of which ran counter to the government’s ownership policy.

The Arion board, controlled by Kaupthing, however had its way here, i.e. the dividends are connected to other transactions and Arion could buy own shares. The share-buying sounds particularly ominous in Icelandic ears since this characterised the boom-time banking in Iceland.

Following the board meeting two things happened: Arion bought 9.95% of its own shares from Kaupthing (via Kaupskil) – and Kaupthing (via Kaupskil) made use of its option since 2009, buying the state’s 13% stake in Arion. This means that the Icelandic state will have no say, neither on the board or elsewhere, over Arion. Alors, all hindrance out of the road to Valitor.

The state leaves the Arion stage

In principle, this should be a good move; the state was only ever an involuntary shareholder. It owns quite enough of the financial sector, owning the two other big banks, Íslandsbanki and Landsbankinn. – However, given that this is being orchestrated by Kaupthing adds an unsettling feel to the sale.

Dividend in kind is another thing that has a particular ominous echo in Iceland, both from the boom years and also from some transactions in the last few years. The experience in Iceland is that this has mostly been done in order to tunnel assets to major shareholders, in effect cheating other shareholders and creditors. Tunnelling played a large part in the transition in Russia and Eastern Europe, a rather inglorious comparison. And how many systemically important banks in Europe pay out dividend in assets?

In an interview I did for Rúv in January with deputy director of FME, Jón Þór Sturluson, he emphasised there is nothing illegal in this. He did however point out that it is a doubtful action since estimating the value of a payment-in-kind may cause problems. And in particular, it causes reputational damage.

Strong words when they come from the regulator but, according to some of my sources, not strong enough. This is a serious issue since Arion is a systemic important bank. Thousands of Icelanders, Arion clients, are stakeholders.

Back to Valitor

Given that Valitor is one of Arion’s most valuable assets, distributing it with a secret agreement attached instead of selling it, gives the transaction a sense of tunnelling out valuable assets to preferred shareholders before the IPO. It has not yet happen but it is expected to be imminent.

Sources connected to Arion tell Icelog that Valitor might be worth more in the hands of experts such as the foreign funds. That is correct but handing Valitor over to Arion shareholders instead of selling to highest bidder seems far from being evenhanded. Sadly, it is a repetition of events seen in the last few years. The sale of Bakkavor, by Arion, and of Borgun, by Landsbanki both had a foul smell of friendly favours.

According to minister of finance Bjarni Benediktsson, leader of the Independence party, agreements between the state and Kaupthing hinder that assets would be tunnelled out of the bank. So far, it has clearly not been the case that the agreement secures some governmental oversight via the Kaupskil set-up. The most active Kaupthing creditors now rule the bank.

There has been some discussion in Iceland if the price for the Arion shares taken over by Kaupthing is the right price. To my mind, that is not the main issue – the main issue is how the Kaupthing creditors have manipulated events in Arion so far. If they achieve their goal of getting Valitor without bidding for it is the proof that the agreement was not worth much.

The intriguing thing is also that Benedikt Gíslason, who was the government’s main advisor in reaching the agreement with creditors in 2015, is now working for Kaupthing.

In plain sight

All of this is happening in broad daylight – and Icelanders have seen tunnelling before. Now it’s being done together with foreign investors. Iceland is tiny and often beyond the horizon of international media but the IMF comments last year underline the gravity of these matters.

An IMF is due to visit Iceland now in March. Just in time to evaluate how Icelandic authorities are doing on the Arion test.

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