Sigrún Davíðsdóttir's Icelog

The outcome of the offshore króna auction 16 June has now been made public: offers at the rate of ISK190 a euro or lower were accepted. According to the Central Bank of Iceland press release a “total of 1,646 offers were submitted and 1,619 accepted; however, these figures could be subject to change upon final settlement. The amount of the accepted offers totalled just over 72 b.kr., out of nearly 178 b.kr. offered for sale in the auction.” – The on-shore rate is ISK139 to the euro. The question is how credible this outcome is, given the good economic conditions in Iceland. (Further to the background see an earlier Icelog here).

Although the auction apparently was a final offer the CBI is now offering to “purchase offshore króna assets not sold in the auction at the auction exchange rate of 190 kr. per euro.” The terms and conditions will be published tomorrow with the deadline at 10 o’clock this coming Monday morning, 27 June. The finale outcome of the 16 June auction and potential transactions in the following days, until Monday morning, will be published that Monday with settlement of both transactions completed on that day.

This outcome is far from the stock of ISK319bn that the offshore króna amounts to. The auction was supposed to be the last in a series of 23 auctions; this offer to buy offshore króna at the auction price of ISK190 is now a tail to that last auction.

In an interview on Rúv tonight, CBI governor Már Guðmundsson said that out of 1,646 offers submitted 1,619 had been accepted, or 98%. This means there are now a whole lot fewer offshore króna holders left – but the problem is, as Guðmundsson rightly acknowledges, that all the big funds holding these assets are holding on to their króna. “It is clear that the rather big holders have either not participated or offered a rate we could not accept,” said Guðmundsson.

In a cage – at the back of the queue

The governor said that with the auction out of the way, capital controls can now be lifted on domestic entities and individuals, i.e. Icelandic companies, pension funds etc. The process has been designed in such a way, according to Guðmundsson “that those who do not leave now stay in a similar financial environment as they have been in so far as to investment offers with added changes, which were necessary to secure that this environment would be stable even if we lift controls on domestic entities. They (i.e. the offshore króna holders) will now go to the back of the queue, they were at the front and then at some point it will again be their turn.”

This is undoubtedly a description the big offshore króna holders will contest. They will claim that conditions have been seriously tightened. When their assets mature these assets will automatically go into deposits at 0.5% interest rates, effectively negative interest rates, held with the CBI, very much akin to the cage that Guðmundsson once described so vividly at a meeting in Iceland.*

Thus the big offshore króna holders, who did not participate (or offered a non-accepted rate) will now feel they are in a cage at the back of a queue not knowing when they will be released. Or in other words: they will claim that the sovereign isn’t paying back its loans.

Calling things their right names

What is it called if a country pays only some of its debt? The term is “selective default” – and worryingly that’s now the term attached to Iceland if offshore króna holders, where Icelandic sovereign bonds and T-bills are the underlying assets, are not paid out in full.

Offering a rate of ISK190 to a euro when the on-shore rate is ISK139 in a country doing pretty well seems like a drastic haircut – and it is incidentally involuntary, from the point of view of the offshore króna holders, although the Icelandic government claims there was a fair second offer, i.e. the cage at the end of the queue.

In a defiant answer to a WSJ op ed, minister of finance Bjarni Benediktsson rejects that Iceland can be compared to Argentina. However, he fails to point out that after fighting creditors for fifteen years Argentina did indeed finally settle with creditors. A country can claim as much as it wants that it’s honouring all its obligation but the arbiter is not the country itself but the International Swaps and Derivatives Association, ISDA, which decides on which events release credit default swaps.

Reputation risk

I have earlier talked about the mixed messages from Iceland in dealing with creditors. Last year, great care was taken in negotiating with creditors when it came to lifting capital controls on the estates of the three collapsed banks.

This time, when the sovereign is directly involved, contrary to last year, the strategy is to offer a cage at the back of a queue with no date as to when that backend will be served. There must be a strategy somewhere but I can’t see it, which is worrying since the outcome could be lengthy court cases in all and sunder jurisdictions for years to come. In the world of short-term politics that would inevitably be a problem for another day and another government.

In the meantime, the financing cost of all things Icelandic, whether state or private sector, will either go up or stay as it is, instead of going down as it well could soon with the bright economic prospects there are (and as Moody’s had already beckoned). This was kept in mind last year. Now it seems that this past of playing carefully was not a prologue to the present but an aberration. Consequently, Iceland might be back to a costly future of reputation risk.

*At a public meeting on the offshore ISK in 2013, some of those present argued that the solution to the Icelandic current account problem was just to cage in the foreign-owned assets so capital controls could be lifted on the domestic part of the economy. Present at the meeting was CBI governor Már Guðmundsson who pointed that when new investors would then arrive in Iceland they would see the cage and ask who was in it. “The investors who invested in Iceland last time around.” (From an earlier Icelog).

Update: This morning, Wed. 22 June, minister of finance Benediktsson talked at Euromoney Global Borrowers and Investors Forum where I interviewed him afterwards; Benediktsson claimed the offshore króna auction had been a success in terms of the many bids received and now those remaining would have to wait. He said there had been no legal aftermath following the composition of the estates last year, precisely because it had been well prepared but said he was not worried this time. It was to be expected that the hedge funds holding offshore króna were making a noise but that was nothing the minister was worried about.

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