Sigrún Davíðsdóttir's Icelog

So far, there is no solution in sight in matters that need to be solved in order to abolish capital controls in Iceland. The government blames creditor of the estates of Glitnir and Kaupthing but unresolved dispute in Landsbanki matters as well though hardly ever mentioned. The government seems to play a waiting game, perhaps to make creditors more forthcoming. Ministers maintain the government cannot interfere in a process of private companies and yet they seem to be contemplating interfering via laws, which would directly expose the government to being sued by creditors. The creditors mostly remain silent but might have more cards up their sleeves than the government seems to believe.

“It seems they’ve (creditors) been waiting to see whether the government would somehow step into the process. But this is not a project for the government. The only role of the government here is to assess whether they come up with a solution which allows for the lifting of the controls,” prime minister Sigmundur Davíð Gunnlaugsson recently said to Bloomberg. He has also stated that “I’m unaware of them having found any solution” which would allow the banks to complete creditor settlements. In September Gunnlaugsson said the controls could be lifted “in foreseeable future” if the creditors were “willing to assist us.”

And here is the creditors’ view, as expressed by Steinunn Guðbjartsdóttir head of Glitnir’s winding-up board: “It’s definitely not Glitnir that’s delaying the process when it comes to completing creditor settlements. Our proposals have simply not been answered, making it impossible for us to move forward.”*

In problem keeping the capital controls in place is the fact that foreigners own more ISK assets than can possibly be converted into foreign currency in the foreseeable future – a problem contained by the capital controls. Hence, the problem of foreign-owned ISK has to be resolved before the controls can be abolished. It will not happen over night, will no doubt take some years to abolish them in stages. However, it will be a decisive step when the ISK assets of the old banks – Kaupthing, Glitnir and Landsbanki – have been resolved

Who is waiting for whom – and what is everyone waiting for? How should these seemingly conflicting statements be interpreted? Here is an attempt at interpretation, as well as sizing up the problem and the possible solutions.

1 By late 2012 both Glitnir and Kaupthing had presented their drafts for composition of the two estates. The Central Bank, CBI, which needs to accept a composition agreement due to the capital controls, rebutted the Glitnir draft but has not replied to a new draft from Glitnir sent a new in November. Kaupthing has had no answer.

2 The CBI can only give its permission if the minister of finance, Bjarni Benediktsson, accepts the proposal, after presenting it to the parliament economy and trade committee.

3 When Gunnlaugsson claims he is unaware of any solution he is of course aware of the drafts ­– but his words need to be understood in the right context: he doesn’t recognise the solutions put forth by the estates as acceptable.

4 By saying that controls can be lifted when creditors “are willing to assist us” the prime minister seems to mean that when creditors have accepted what the government wants them to accept the government will accept their proposal.

5 The government has clearly indicated that it cannot enter into negotiations with creditors of private companies so how this “assisting” by the creditors should come about is not clear. Nor is it clear how the creditor should be informed as to what exactly is needed to solve issues now blocking a CBI agreement to composition.

6 There are those who warn that by engaging with the creditors the government might make itself liable to being sued, thus creating an unforeseen risk. At the same time, the government seems to be contemplating a legal intervention, which would clearly make it an actor in the game.

7 Further, it is not possible to prevent risk by not engaging since creditors could – and most likely will – at some point lose patience and seek ways to litigate abroad. The worst scenario would be a version of the Argentinian situation where every sum in foreign currency that Iceland pays to fulfil foreign obligation will be litigated.

Below are some points of importance in order to understand the issues at stake.

Two ways to resolve the Glitnir and Kaupthing estates: negotiate – or not

In principle, there are two ways to solve the dilemma of the two estates, i.e. how to proceed with the winding up and eventually pay out what is due to the creditors:

A) Agreement with the creditors, based on composition.

B) Bankruptcy proceedings, meaning i.a. that assets have to be sold within a fairly short time span with less creditor control than with the abovementioned route.

By presenting drafts for composition for both Kaupthing and Glitnir the creditors of these two banks (to a large extent the same creditors, ca. half are institutional bondholders owning bonds of the two banks before the collapse and then hedge funds and others dealing in distressed assets who bought the bonds after the collapse). Composition means that the estates are run as holding companies, owned by creditors, who by selling assets when circumstances are favourable recover over time what there is to recover from the estates.

Recovery from bankruptcy proceedings will most likely be less, which is one reason why the creditors oppose it. Also it means they have less control over the course of events.

Under normal circumstances a government doesn’t engage with bankrupt private companies. In Iceland, the capital controls and laws passed last spring, just before the dissolution of parliament up to the election, changed all of that. At stake are first and foremost the ISK assets of Glitnir and Kaupthing – and the majority is tied up in the new banks, Íslandsbanki and Arion, respectively owned by the estates.

The amount of ISK assets of the two estates totals ISK417bn but differs greatly. Kaupthing’s ISK assets are ISK141bn, whereof Arion’s valuation amounts to ISK116bn. Glitnir owns a good deal more of ISK or ISK276bn, whereof Íslandsbanki is valued at ISK132. Kaupthing owns 87% of Arion; Glitnir owns 95% of Íslandsbanki. The rest of both banks is owned by the Icelandic state.

If the two banks could be sold for foreign currency the Kaupthing ISK problem would be more or less solved. Glitnir has a tougher task. The creditors seem to have some faith in this being possible; others find that hard to believe but it will ultimately all depend on the price.

Who will buy Iceland or rather, the two banks Íslandsbanki and Arion?

Those who buy these two banks will wield great power in the Icelandic business community and in Iceland in general. First, when the idea was floated in the late 1990s that Landsbanki would be privatised the intention of the Davíð Oddsson government (conservative) was spread ownership.

That policy evaporated when the bank was sold to father and son Björgólfur Guðmundsson and Björgólfur Thor Björgólfsson. Eventually, the three big banks – Landsbanki, Kaupthing and Íslandsbanki (later named Glitnir; the new bank has reverted to the old name) were owned and dominated by large shareholders who incidentally were not only the respective bank’s largest shareholders but their largest borrower. No wonder that ownership of the two banks, now for sale, awakes disturbing thoughts.

Who will buy the banks? Foreign investors with no previous ties to Iceland, Icelanders with money abroad, clients (Icelandic or foreign) who got mountains of loans on favourable terms from the Icelandic banks before the collapse? Or the Icelandic pension funds? There is no lack of guesses.

One thing that will clearly affect the price is how the estates will be resolved. With bankruptcy the assets would have to be sold quickly, most likely knocking the price down should two banks be sold simultaneously in Lilliputian Iceland. Conspiracy theorists might feel that if the government eventually acts in a way that lowers the price of the banks – and some investors with intriguing ties to the past banks or with the government parties (or both) – it will be no coincidence.

The official “abolition manager” that never was – and the working group without a chairman

In August, it was announced that “next week” the prime minister would appoint “an abolition manager” to oversee the process of abolishing the capital controls. But nothing happened. According to rumours the two party leaders could not agree on who should be appointed. And no one was ever appointed.

In November, a working group of four was mentioned but by the beginning of the New Year it had grown to six. There is to be no chairman (too difficult to decide on?) but a former banker, Sigurbjörn Þorkelsson is in charge though without the title. He was thought to be the one favoured by Benediktsson as an “abolition manger.” The others are two engineers, Jón Birgir Jónsson (a banker in London) and Jón Helgi Egilsson, lawyers Eiríkur Svavarsson and Reimar Pétursson as well as Ragnar Árnasson professor of economics. This group is now said to be working fast and furiously on mapping out various scenarios for the government.

In principle, no one knows what the government’s policy is in the matters of the two estates; the two party leaders have not specified how they would like to see the bank estates dissolved. Benediktsson has however said that bankruptcy law do not stipulate that composition can be negotiated forever, hinting at some change in the bankruptcy law and possibly that he would prefer rout B).

His comment could also be understood to indicate that the government was prepared to or preparing to intervene in the bankruptcy process with a bill aimed at the estates. That will be a tricky undertaking because, like in most Western countries, assets of estates are protected by laws on property rights. Creditors will obviously challenge anything that smacks of infringement on such rights.

A legal intervention – or any government intervention – will be a u-turn from the government’s present stance on declared and staunch non-engagement. It might well open up a Pandora’s box of possible legal action against the government, not only in Iceland but also abroad.

Neither A) nor B): the “krona-path”

In addition to A) and B) there is another path, which is often mentioned in the debate in Iceland but apparently not always well understood.

According to Icelandic bankruptcy law, the value of a failed company is calculated in ISK, which means that whatever fx it owns is converted into ISK, as well as all claims. This does not mean that that the assets themselves are converted; the conversion is for auditing purposes only.

The assets of the three banks are as follows (in ISK)

ISK                             Fx                                Domestic fx assets

Glitnir             276bn                        614bn                        35bn

Kaupthing      141bn                        570bn                        62bn

Landsbanki     51bn                         405bn                        385bn

There are those who argue – and both Gunnlaugsson and Benediktsson have touched upon this – that the estates should be considered as pure ISK assets meaning that they should also pay creditors only in ISK. This would then create an almighty ISK overhang the moment this was paid out, increasing the already far too big a reserve of ISK owned by foreigners (which after all is what the capital controls are reining in).

How could the creation of a humungous overhang, in addition to the already insurmountably large one, be a solution? Because this would be a way for the state to get a slice of the fx assets, which should then be converted back into fx, but at a much less favourable rate; another possible execution is some sort of exit levy.

A recent ruling of the Icelandic Supreme Court has been mentioned as an argument for the “krona-path”: on September 24 2013 the Court ruled in a case (in Icelandic) linked to the Landsbanki estate. The thrust of the case was that when Landsbanki paid preferred creditors, on December 2 2011 and May 24 2012, the bank used the currency rate on April 22 2009, the day the bank entered into bankruptcy proceedings.** The creditors challenged Landsbanki’s decision, lost in Reykjavík District Court but won in the Supreme Court. Consequently, it is now clear that the currency rate on the day of payment counts.

Those who adhere to the “krona-route” have interpreted this court decision to mean that an estate should pay out in ISK – whereas the decision, according to many lawyers, only says that an estate can pay out in ISK but, most importantly, does not need to. One Icelandic lawyer (not working for creditors) mentioned to me that converting fx assets into ISK in order to pay the creditors could well be seen as expropriation, again exposing the government to being sued by creditors. Since most of the fx assets are outside of Iceland, creditors claiming to be an offer for expropriation could sue the Icelandic state abroad, most likely in London.

Another cause for legal action on behalf of the creditors against the government might be if at some point they feel that by inaction the government is preventing them from accessing their undisputed assets: the fx assets. After all, the fx assets are the property of failed private companies, unrelated to the government as repeatedly emphasised by the government.

The action taken in autumn 2008 with the “Emergency Act” and capital controls was taken under exceptional circumstances. Although the lack of foreign currency poses problems there is no emergency, comparable to October 2008, to justify any exceptional measures. On the contrary, there is time to negotiate terms and conditions.

What the capital controls contain

Ultimately, the government seems to favour not so much a route as a goal: a goal that brings as much to the public coffers as possible.

During the election campaign last spring prime minister Gunnlaugsson repeatedly claimed it was “unavoidable” that in dissolving the estates money would be due for the Icelandic state. As with so many other things, he never specified how exactly this should/would happen but seemed to indicate the “krona-route”: that converting fx assets should/would/needed to be converted into ISK thereby securing great wealth to the state coffers.

An aside here is that most Icelandic economists heartily agree that channelling mountains of ISK into the economy would be an almighty economic disaster. Ideally, any such windfall should be taken aside, if not actually burned. But for some reason, this argument is hardly ever uttered aloud in Iceland.

Before guessing how much is enough for the government, let us revise on how much ISK assets the capital controls contain. As mentioned above, the ISK assets of Glitnir and Kaupthing amount to ISK417 bn. The “glacier bonds” – essentially invested in carry trades in the years before the collapse – now amount to ISK340bn. Since this is money owned by a diverse group there is no one to negotiate with.

Further, these assets might partly be “patient” money, not waiting to run out of Iceland where interest rates are still attractive. There is also intriguing evidence that ca. half of the “glacier bonds” is owned by… Icelanders who bought it at a knock-down price after the collapse (which might be why this is not much talked about any longer as a problem, all the focus being on the “vulture” hedge funds” as they are often referred to in the Icelandic public debate). The last batch of foreign-owned ISK is the Landsbanki bond, debt of new Landsbanki to the old Landsbanki, now ISK247bn.

In total, the ISK assets contained by the capital controls are close to ISK1000bn. However, dividend in the new banks, which is not paid out, piles up so the problem is not diminishing but increasing. And then there are the classic collateral damages of controls such as less investment and corruption.

How much is enough – and the narrative to support it

Then there is the question: how much is enough for the government? How much, measured in krona, is the value of the “willingness to assist,” from the point of view of the government? Ultimately, it depends on how the government views the estates: as a problem to solve – or a rich fishing ground.

Consequently, there are two possible answers:

1 Enough to run a sustainable economy where a balance of payment will ultimately decide the course of payment of ISK assets. This is a calculation the CBI is working on. Leaving aside the “glacier bonds,” the problem is the Glitnir and Kaupthing assets as well as the Landsbanki bond, in total ISK665bn. This is not an insurmountable sum, the creditors know they will not get the whole amount, are willing to negotiate (if they can find anyone to talk to) and there are state-owned assets (in the CBI holding company, ESI), which could be part of the solution. – If this procedure is followed there is however nothing for the government to lay its hands on because ultimately this is not a process, where the government is involved except to secure financial stability as spelled out by the CBI.

2 Considering how prime minister Gunnlaugsson has spoken – and indeed promised Icelanders – he and his party clearly do indeed see the estates as a fishing ground, ready to be exploited. Finance minister Benediktsson has never uttered anything in this direction and there are indications, i.a. from the appointment of an abolition director that the two party leaders do not see eye to eye in this matter. It is by now a well-established pattern in the political debate that the prime minister says X and then a few days later the finance minister says Y on the same matter. From sources close to the two coalition parties, I hear that the ultimate goal should be all of the ISK assets of the two estates and a slice of the fx assets – otherwise, the financial stability of Iceland is threatened. I am not claiming this is what the two party leaders have in mind, only that this is consistently heard from sources close to the two leaders. – The path would probably be some version of the “krona-path” and a legal intervention.

Both ministers have consistently said that the new banking levy, also on the estates (quite unorthodox to tax debt; will most likely be challenged by the estates; another saga for another day) is only natural because of the cost the banking collapse caused the Icelandic society (though how the new banks, founded after the collapse, could have caused harm is a bit of a mystery). This narrative might also well be used to argue for a “catch” from the estates (though again, this spreading of the original sin could be debated).

The tax, calculated to cost the three estates ISK120bn over four years, is an interesting sum because it indicates to the creditors that this is at least the sum wanted by the government. This sum could then be the starting point in a negotiation though, if the rumours I keep hearing, this would be very far from what the government has in mind.

The fact that Iceland won the case that the EFTA Surveillance Authority, ESA, brought against Iceland because of Icesave, emboldened the leadership of the Progressive Party. The fact that Icesave was not resolved with the British and the Dutch had two drastic consequences: it moved the ownership of Landsbanki over to the state meaning that the state, at least indirectly, guarantees a bank – and in addition burdens the state through the Landbanki bond. This is not part of the “Iceland won Icesave-saga,” as commonly told in Iceland.

In the Icelandic debate on the estates and the creditors it can at times sound as if it is decidedly un-Icelandic not to seek a “windfall” from the creditors. To be on the side of the rule of law in this matter does not seem enough. No doubt, the tone will become harsher at the hour of decision.

Contrary to natural catastrophes such as earthquakes and eruptions, the catastrophes stemming from wrong political decisions unfold over a long time. The consequences will be felt long after the term of this government comes to an end.

* Glitnir Winding-up Board has today made an unexpected move: it has hired MP Bank’s Corporate Finance Division as a financial advisor in finalising a composition agreement, to “independently review and evaluate solutions to that end.” Especially ALMC (former Straumur Bank, already through composition, now operationg under a new name, ALMC), which seemed to be sure it was going to act as Glitnir’s advisor. The intriguing part of this assignment is that a close friend and advisor to prime minister Gunnlaugsson, Sigurður Hannesson is head of private banking at MP and the CEO of MP, Sigurður Atli Jónsson, is the prime minister’s brother in law. Whether this intimacy will simplify Glitnir’s task in guessing what is enough to negotiate composition remains to be seen.

**The legal procedures are described here, p. 6, for Kaupthing; the same counts for Landsbanki and Glitnir.

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