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Stanford, Millen and Tchenguiz: victims or favoured clients?

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“In my opinion, it is quite wrong that a bank can pretend to have money and security which it doesn’t have, generate a false balance sheet and use its own customers to fund acquisition ambitions.” According to the Guardian, the fashion entrepreneur Karen Millen is pursuing a series of legal claims against the Kaupthing estate, together with her ex-husband Kevin Stanford (more on his Icelandic contacts). Millen is of the opinion that Kaupthing wasn’t entirely straight about its position. She might not be the only one to think so – but before it all went to painfully wrong, her ex-husband was indeed very close to the Kaupthing managers. It’s unclear how well informed Stanford kept his ex-wife on their business dealings. He was the financial motor in their cooperation, Millen the creative one.

Millen and Stanford built up a fashion label, the Karen Millen name is still prominent on UK high streets. But the name no longer belongs to her. Millen has lost her name to Kaupthing. She is understandably upset but she isn’t the first designer to lose her/his name to the bankers by being careless about the small print.

From the SIC report and other sources it’s clear that banking the Icelandic way implied bestowing huge favours on a group of chosen clients – in all three banks the banks’ major shareholders and an extended group around them. As so often pointed out on Icelog, these clients got convenant-light and/or collateral-light loans. In some cases the bankers promised their clients that the collateral wouldn’t be enforced – or the collateral were unenforceable for some reason. They were offered a “risk-free business” – ia risk-free for the customer whereas the bank shouldered all the risk and eventual losses. (This screams of breach of fiduciary duty, indeed part of charges brought in some cases by Office of the Special Prosecutor and not doubt more to come.)

After the collapse, some of Kaupthing’s favoured clients have claimed they were victims of Kaupthing’s managers who did not inform them of the bank’s real standing. Karen Millen is the latest to complain of Kaupthing misleading her. She is, understandably, outraged at not being able to use her name for her label. A clever lawyer would have made sure it couldn’t happen. Stanford was evidently very close to the Kaupthing managers, which might have lulled him into the false believe that he didn’t need to be too careful about the wording of the contracts.

How close was Stanford to Kaupthing? Just before the collapse he was the bank’s fourth biggest shareholder and among the largest borrowers – the familiar correlation between large shareholding and huge loans in the Icelandic banks.

Here is an overview of Stanford’s loans September 2008:

What was this enormous business that Stanford was running that merited loans of €519m?

Here is how Stanford was introduced on the loan overview of exposures exceeding €45m:

Pay attention here. Stanford introduced “family and related clients.” – Did he, as sometimes happens, get paid for the introduction? – And then this, that some of this was “silent participation” of his ex-wife and vice versa. Did she have a full insight into how her name was used by her husband? Noticeably, he was the second biggest private borrower in Kaupthing Luxembourg, where all the dodgiest loans were issued.

Stanford’s Icelandic connections are on the whole quite intriguing. He wasn’t only closely connected to Kaupthing but also to Glitnir, at least after Jon Asgeir Johannesson, with ia Hannes Smarason and Palmi Haraldsson, became the bank’s largest shareholder in summer 2007. When Glitnir financed a clever dividend scheme in Byr, the building society, Millen suddenly appeared as one of the stakeholders in Byr. Was that because she was so keen to invest in an Icelandic building society? Some of Stanford’s fashion businesses were joint ventures with Johannesson and his company, Baugur.

Stanford was also close enough to Kaupthing be part of a clever set-up to influence the bank’s scarily high CDS in the summer of 2008. Together with Olafur Olafsson, Kaupthing’s second largest shareholder, Tony Yerolemou and Skuli Thorvaldsson – all of them in the Kaupthing inner circle in terms of the business opportunities they got from the bank – Stanford and Millen owned one of three companies financed by Kaupthing to buy Kaupthing CDS. This was the set-up:

This scheme doesn’t seem to have hit Stanford and Millen with losses in spite of a loan of €41m to this entreprise.

Last year, Stanford wrote a letter to the Kaupthing Singer & Friedlander estate to substantiate his claim that he should not pay back KSF £130m he had borrowed to buy Kaupthing shares. According to his understanding, this lending was part of Kaupthing’s support scheme, in other words (which Stanford didn’t use) ‘market manipulation.’ – Stanford is and wants to be taken seriously as a business man. Didn’t he see anything strange in the fact that a bank was lending him money, with no risk for Stanford, to buy its own shares, with (if the scheme was the usual one) nothing but the shares as a collateral?

Stanford says that after talking to former Kaupthing Singer & Friedlander staff he now understands that the Kaupthing Edge deposits were used to buy ‘crap’ assets from Kaupthing Iceland, which lent the money on to Kaupthing Luxembourg that then had the money to lend to high net worth clients like Stanford. This scheme, according to Stanford, enabled senior Kaupthing managers to sell their Kaupthing shares.

This is an interesting description of the use of the Kaupthing Edge deposits, which (contrary to Landsbanki’s Icesave) were in a UK subsidiary and consequently guaranteed by the UK deposit guarantee scheme.* Stanford is right that the money was lent to high net worth clients – but not just to any clients: it was lent to the favoured clients who got the conventant-light loans. Kaupthing senior managers may have sold some of their shares but they did by far not sell out – it would have caused too much of attention and undermined trust in the bank.

Other big Kaupthing clients, like Vincent and Robert Tchenguiz, have also complained of being the victims of Kaupthing’s market manipulation. All these people are – or have been – locked in lawsuits with Kaupthing. The claims to the media is part of their PR strategy.

Being duped by Kaupthing means someone did the duping, allegedly the managers of the bank. Yet, none of these ‘ill-treated’ is suing any of the managers. They are suing the failed bank’s estate. That’s logical because the estate has assets. But it also raises the question if the strong bonds, which clearly connected the Kaupthing senior managers and their major clients, have survived the collapse and the consequent losses.

It’s also worth noticing that in spite of enormous loans that the favoured clients got, they have, like Stanford and the Tchenguiz brothers, proved remarkably resilient to losses. That may be due to luck, business acumen or both – but a part of it might also be the convenant- and collateral-light loans that Kaupthing did, after all, bestow on them. Which is part of the Kaupthing-related cases that both the Serious Fraud Office and the OSP are investigating. This way of banking runs against all business logic. The question is what sort of logic it followed.

*The fact that Kaupthing Edge was guaranteed by the UK deposit guarantee seems to be one of the motives for the SFO investigation. I find it incomprehensible that SFO isn’t investigating Landsbanki’s Icesave, which the UK Government did bail out – hence the Icesave dispute.

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Written by Sigrún Davídsdóttir

March 23rd, 2012 at 10:37 pm

Posted in Iceland

Lessons from Iceland: the SIC report and its long lasting effect / 10 years after

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The Bill passed by the Icelandic parliament in December 2008 on setting up an independent investigative commission, the Special Investigative Commission did not catch much attention at the time. The goal was nothing less than finding out the truth in order to establish events leading up to the 2008 banking collapse, analyse causes and drawing some lessons. The SIC report was an exemplary work and immensely important at the time to establish a narrative of the crisis. But in hindsight, there is yet another lesson to be learnt: its importance does not diminish with time as it helps to counteract special interests seeking to rewrite history.

There were no big headlines when on 12 December 2008 Alþingi, the Icelandic parliament, passed a Bill to set up an investigative commission “to investigate and analyse the processes leading to the collapse of the three main banks in Iceland,”which had shaken the island two months earlier. The palpable lack of enthusiasm and attention was understandable: the nation was still stunned and there was no tradition in Iceland for such commissions. No one knew what to expect, the safest bet was to not expect very much.

That all changed when the Commission presented its results in April 2010. Not only was the report long – 2600 pages in print in addition to online-only material – but it did actually tell the real story behind the collapse: the immensely rapid growth of the banks, from one GDP in 2002 to ten times the GDP in 2008, the stronghold the largest shareholders, incidentally also the largest borrowers, had on the banks’ managements, the political apathy and lax regulation by weak regulators, stemming from awe of the financial sector.

Unfortunately, the SIC report was not translated in full into English; see executive summary and some excerpts here.

With time, the report’s importance has not diminished: at the time, it clarified what had happened thus preventing those involved or others with special interest, to reshape the past according to their own interests. With time, hindering the reshaping of the past has become of major importance, also in order to draw the right lessons from the calamitous events in October 2008.

What was the SIC?

According to the December 2008 SIC Act (in Icelandic), the goal was setting up an investigative commission, that would, at the behest of Alþingi, seek “the truth about the run-up to and the causes of the collapse of the Icelandic banks in 2008 and related events. [The SIC] is to evaluate if this was caused by mistake or neglect in carrying out law and regulation of the financial sector in Iceland and its supervision and who could be held responsible for it.” – In order to fulfil its goal the SIC was inter alia to collect information on the financial sector, assess regulation or lack thereof and come up with proposals to prevent the repetition of these events.

In some countries, most notably in South Africa after apartheid, “Truth Commissions,” have played a major part in reconciliation with the past. Although the remit of the Icelandic SIC was to establish the truth, the SIC was never referred to as a “truth commission” in Iceland though that concept has been used in foreign coverage of the SIC.

The SIC had the power to make use of a vast array of sources, both by calling in people to be questioned and documents, public or private such as bank data, including data on named individuals, data from public institutions, personal documents and memos. Data, normally confidential, had to be shared with the SIC, which was obliged to operate as any other public body handling sensitive or confidential information.

Although the SIC had to follow normal procedures of discretion on personal data the SIC could “publish information, normally subject to discretion, if the SIC deems this necessary to support its conclusions. The Commission can only publish information on personal matters of named individuals, including their financial affairs, if the public interest is greater than the interest of the individuals concerned.” – In effect, this clause lift banking secrecy.

One source close to the process of setting up the SIC surmised the political intentions behind the SIC Act did not include lifting banking secrecy, indicating that the extensive powers given to the SIC were accidental. Others have claimed the SIC’s extensive powers were always part of the plan. I am in two minds about this but my feeling is that the source close to the process was right – the powers to scrutinise the main shareholders were far greater than intended to begin with.

Naming the largest borrowers, incidentally also the largest shareholders

Intentional or not, the extensive powers enabled naming the individuals who received the largest loans from the banks, incidentally their largest shareholders and their closest business partners. This was absolutely essential in order to understand how the banks had operated: essentially, as private fiefdoms of the largest shareholders.

In order to encourage those called in for questioning to speak freely, the hearings were held behind closed doors; there were no public hearings. The SIC had extensive powers to call people in for questioning: it could ask for a court order if anyone declined its invitation, with the threat of taking that person to court on grounds of contempt in case the invitation was declined.

Criminal investigation was not part of the SIC remit but its power to call for material or call in people for questioning was parallel to that of a prosecutor. As stated in the report, the SIC was obliged to inform the State Prosecutor if there was suspicion of criminal conduct:

The SIC’s assessment, pursuant to Article 1(1) of Act no. 142/2008, was mainly aimed at the activities of public bodies and those who might be responsible for mistakes or negligence within the meaning of those terms, as defined in the Act. Although the SIC was entrusted with investigating whether weaknesses in the operations of the banks and their policies had played a part in their collapse, the Commission was not expected to address possible criminal conduct of the directors of the banks in their operations.

As to suspicion of civil servants having failed to fulfil their legal duties, the SIC was supposed to inform appropriate instances. The SIC was not obliged to inform the individuals in question. As to ministers, the SIC was to follow law on ministerial responsibility.

The three members

The SIC Act stipulated it should have three members: the Alþingi Ombudsman, then as now Tryggvi Gunnarsson, an economist and, as a chairman, a Supreme Court Justice. The nominated economist was Sigríður Benediktsdóttir, then lecturer at Yale University (director of Financial Stability at CBI 2012 to 2016 when she returned to Yale). The chairman was Páll Hreinsson (since 2011 judge at the EFTA Court).

In addition to the Commission there was a Working Group on Ethics: Vilhjálmur Árnason professor of philosophy, Salvör Nordal director of the Centre for Ethics, both at the University of Iceland and Kristín Ástgeirsdóttir director of the Equal Rights Council in Iceland. Their conclusions were published in Vol. 8 of the SIC report.

In total, the SIC had a staff of around 30 people. As with the Anton Valukas report, published in March 2010, on the collapse of Lehman Brothers, organising the material, especially the data from the banks, was a major task. The SIC had access to the databases of the three collapsed banks but had only limited data from the banks’ foreign operations.

There were absolutely no leaks from the SIC, which meant it was unclear what to expect. Given its untrodden path, the voices expressing little faith were the most frequently heard. I had however heard early on, that the SIC had a firm grip on turning material into searchable databases, which would mean a wealth of material. With qualified members and staff, I was from early on hopeful that given their expertise of extracting and processing data the SIC report would most likely prove to be illuminating – though I certainly did not imagine how extensive and insightful it turned out to be.

Greed, fraud and the collapse of common sense

After the October 2008 collapse, my attention had been on some questionable practices that I heard of from talking to sources close to the failed banks.

One thing I had quickly established was how the banks, through their foreign subsidiaries, had offshorised their Icelandic clients. This counted not only for the wealthy businessmen who obviously understood the ramifications of offshorising but also people with relatively small funds. These latters had in many cases scant understanding of these services.

In the last few years, as information on offshorisation has come to the light via Offshoreleaks etc., it has become clear that Iceland was – and still is – the most offshorised country in the world (here, 2016 Icelog on this topic). Once the “art” of offshorisation is established, with all the vested interests accompanying it, it does not die easily – this might be considered one of the failed banks’ more evil legacies.

Another point of interest was how the banks had systematically lent clients, small and large, funds to buy the banks’ own shares, i.e. Kaupthing lent funds to buy Kaupthing shares etc. Cross-lending was also a practice: Bank A would lend clients to buy Bank B shares and Bank B lent clients to buy Bank A shares. This was partly used to hinder that shares were sold when buyers were few and far behind, causing fall in market value. In other words, massive market manipulation had slowly been emerging. Indeed, the managers of all three failed banks have in recent years been sentenced for market manipulation.

It had also emerged, that the banks’ largest shareholders/clients and their business partners had indeed been what I have called “favoured clients,” i.e. enjoying services far beyond normal business practices. One side of this came to light in the banks’ covenants in lending agreements: in the case of the “favoured clients,” the lending agreements tended to guarantee clients’ profit, leaving the banks with the losses. In other words, the banks took on far greater portion of the risk than these clients.

Icelog blogs I wrote in February 2010, before the publication of the SIC report, give some sense of what was known at the time. Already then, it seemed fair to conclude that greed, fraud and the collapse of common sense had been decisive factors in the event in Iceland in October 2008.

Monday morning 12 April 2010 – when time stood still in Iceland

The excitement in Iceland on Monday morning 12 April 2010 was palpable. The press conference was transmitted live. All around Iceland employers had arranged for staff to watch as the SIC presented its conclusions.

After Páll Hreinsson’s short introduction, Sigríður Benediktsdóttir gave an overview of the main findings regarding the banks, presenting “The main reasons for the collapse of the banks,” followed by Tryggvi Gunnarsson’s overview of the reactions within public institutions (here the presentations from the press conference, in Icelandic).

The main reason for the collapse of the three banks was their rapid growth and their size at the time they collapsed; the three big banks grew 20-fold in seven years, mainly 2004 and 2005; the rapid expansion into new/foreign markets was risky; administration and due diligence was not in tune with the banks’ growth; the quality of loans greatly deteriorated; the growth was not in tune with long-time interest of sound banking; there were strong incentives within the banks grow.

Easy access to short-term lending in international markets enabled the banks’ rapid growth, i.e. the banks’ main creditors were large international banks. With the rapid expansion, also abroad, the institutional framework in Iceland, inter alia the Central Bank and the FME, quickly became wholly inadequate. The under-funded FME, lacking political support, was no match for the banks, which systematically poached key staff from the FME. Given the size of the humungous size of the Icelandic financial system relative to GDP there was effectively no lender of last resort in Iceland; the Central Bank could in no way fulfil this role.

This had no doubt be clear to the banks’ management for some time. In his book, “Frozen Assets,” published in 2009, Ármann Þorvaldsson, manager of KSF, Kaupthing’s UK operation, writes that he “always believed that if Iceland ran into trouble it would be easy to get assistance from friendly nations… despite the relative size of the banking system in Iceland, the absolute size was of course very small.” (P. 194). – A breath-taking recklessness, naivety or both but might well have been the prevalent view at the highest echelons of the Icelandic financial sector at the time.

The banks’ largest shareholders and their “abnormally easy access to lending”

When it came to “Indebtedness of the banks’ largest owners” the conclusions were truly staggering: “The SIC concludes that the owners of the three largest banks and Straumur (investment bank where the main shareholders were the same as in Landsbanki, i.e. Björgólfur Thor Björgólfsson and his fater) had abnormally easy access to lending in these banks, apparently only because their ownership of these banks.”

The largest exposures of the three large banks were to the banks’ largest shareholders. “This raises the question if the lending was solely decided on commercial terms. The banks’ operations were in many ways characterised by maximising the interest of the large shareholders who held the reins rather than running a solid bank with the interest of all shareholders in mind and showing reasonable responsibility towards shareholders.” – Creative accounting helped the banks to avoid breaking rules on large exposures.

Benediktsdóttir showed graphs to illustrate the lending to the largest shareholders in the various banks. It is worth keeping in mind that these large shareholders all had foreign assets and were all clients of foreign banks as well. In general, the Icelandic lending shot up in 2007 when international funding dried up. At this point, the Icelandic banks really showed how favoured the large shareholders were because these clients were, en masse, getting merciless margin calls from their foreign lenders.

In reality, the Icelandic banks were at the mercy of their shareholders. If the large shareholders and/or their holding companies would default, the banks themselves were clearly next in line. The banks could not make margin calls where their own shares were collateral as it would flood the markets with shares no one wanted to buy with the obvious consequence of crashing share prices.

Two of the graphs from the SIC report, shown at the press conference in April 2010, exposed the clear drift in lending at a decisive time: to Björgólfur Thor Björgólfsson, still an active investor based in London and to Fons, a holding company owned by Pálmi Haraldsson, who for years was a close business partner of Jón Ásgeir Jóhannesson, once a king on the UK high street with shops like Iceland, Karen Millen, Debenhams and House of Fraser to his name.

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The lending related to Fons/Haraldsson is particularly striking since Haraldsson was part of the consortium Jóhannesson led in spring of 2007 to buy around 40% of Glitnir: after the consortium bought Glitnir, the lending to Haraldsson shot up like an unassailable rock.

Absolution of risk

The common thread in so many of the SIC stories was how favoured clients – and in some cases bank managers themselves – were time and again wholly exempt from risk. One striking example is an email (emphasis mine), sent by Ármann Þorvaldsson and Kaupthing Luxembourg manager Magnús Guðundsson, jokingly calling themselves “associations of loyal CEOs,” to Kaupthing’s chairman Sigurður Einarsson and CEO Hreiðar Sigurðsson.

Hi Siggi and Hreidar, Armann and I have discussed this (association of loyal CEOs) and have come to the following conclusion on our shares in the bank: 1. We set up a SPV (each of us) where we place all shares and loans. 2. We get additional loans amounting to 90% LTV or ISK90 to every 100 in the company which means that we can take out some money right away. 3. We get a permission to borrow more if the bank’s shares rise, up to 1000. It means that if the shares go over 1000 we can’t borrow more. 4. The bank wouldn’t make any margin calls on us and would shoulder any theoretical loss should it occur.We would be interested in using some of this money to put into Kaupthing Capital Partners [an investment fund owned by the bank and key managers] Regards Magnus and Armann

This set-up, where the borrower is risk-free and the bank shoulders all the risk, has lead to several cases where bankers being sentenced for breach of fiduciary duty, i.e. lending in such a way that it was from the beginning clear that losses would land with the bank. (Three of these Kaupthing bankers, Guðmundsson, Einarsson and Sigurðsson, not Þorvaldsson, have been charged and sentenced in more than one criminal case).

The “home-knitted” crisis

Due to measures taken in October 2008 in the UK against the Icelandic banks, there was a strong sense in Iceland that the Icelandic banks had collapsed because of British action. The use of anti-terrorism legislation by the British government against Landsbanki greatly contributed to these sentiments.

A small nation, far away from other countries, Icelanders have a strong sense of “us” and “the others.” This no doubt exacerbated the understanding in Iceland around the banking collapse that if it hadn’t been for evil-meaning foreigners, hell-bent on teaching Iceland a lesson, all would have been fine with the banks. Some leading bankers and large shareholders were of the opinion that Icelanders had been such brilliant bankers and businessmen that they had aroused envy abroad: British action was a punishment for being better than foreign competitors (yes, seriously; see for example Þorvaldsson’s book “Frozen Assets”).

The story told in the SIC report showed convincingly and in great detail how wrong all of this was: the banks had dug their own grave. Icelandic politicians and civil servants had tried their best to fool foreign countries and institutions how things stood in Iceland. Yes, the turmoil in international markets toppled the Icelandic banks but they were weak due to bad governance, great pressure by the largest shareholders and then weak infrastructure in Iceland, as I pointed out in a blog following the publication of the SIC report.

This understanding is at times heard in Iceland but the convincing and well-documented story told in the SIC report has slowly all but eradicated this view.

Court cases and political controversies

Some, but by far not all, of the dubious deals recounted in the SIC report have ended up in court. The SIC brought a substantial amount of cases deemed suspicious to the attention of the Office of Special Prosecutor, incidentally set up by law in December 2008. However, most if not all of these cases had also been spotted by the FME, which passed them on to the Special Prosecutors.

CEOs and managers in all three banks have been sentenced in extensive market manipulation cases – the bankers were shown to have directed staff to sell and buy shares in a pattern indicating planned market manipulation. In addition, there have been cases involving shareholders, most notably the so-called al Thani case (incidentally strikingly similar to the SFO case against four Barclays bankers) where Ólafur Ólafsson, Kaupthing’s second largest shareholder, was sentenced to 5 1/2 years in prison, together with the bank’s top management.

In total, close to thirty bankers and major shareholders have been sentenced in cases related to the old banks, the heaviest sentence being six years. The cases have in some instances thrown an interesting light on operations of international banks, such as the CLN case on Deutsche Bank.

The SIC’s remit was inter alia to point out negligence by civil servants and politicians. It concluded that the Director General of the FME Jónas Fr. Jónsson and the three Governors of the CBI, Davíð Oddsson, Eiríkur Guðnason and Ingimundur Friðriksson, had shown negligence as defined in the law “in the course of particular work during the administration of laws and rules on financial activities, and monitoring thereof.” – None of them was longer in office when the report was published in April 2010 and no action was taken against them.

The Commission was of the opinion that “Mr. Geir H. Haarde, then Prime Minister, Mr. Árni M. Mathiesen, then Minister of Finance, and Mr. Björgvin G. Sigurðsson, then Minister of Business Affairs, showed negligence… during the time leading up to the collapse of the Icelandic banks, by omitting to respond in an appropriate fashion to the impending danger for the Icelandic economy that was caused by the deteriorating situation of the banks.”

It is for Alþingi to decide on action regarding ministerial failings. After a long deliberation, Alþingi voted to bring only ex-PM Geir Haarde to court. According to Icelandic law a minister has to be tried by a specially convened court, which ruled in April 2012 that the minister was guilty of only one charge but no sentence was given (see here for some blogs on the Haarde case). Geir Haarde brought his case to the European Court of Human Rights but the judgment went against him. Haarde is now the Icelandic ambassador in Washington.

The SIC lacunae

In hindsight, the SIC was given too short a time. With some months more, the role of auditors in the collapse could for example have been covered in greater detail. It is quite clear that the auditing was far too creative and far too wishful, to say the very least. The relationship between the banks and the four large international auditors, who also operate in Iceland, was far too cosy bordering on the incestuous.

The largest gap in the SIC collapse story stems from the fact that the SIC had little access to the banks foreign operations. Greater access would not necessarily have altered the grand narrative. But court cases have shown that some of the banks’ criminal activities, were hidden abroad, notably in the case of Kaupthing Luxembourg. – As I have time and again pointed out, it is incomprehensible that authorities in Luxembourg have not done a better job of investigating the banking sector in Luxembourg. The Icelandic cases are a stern reminder of this utter failure.

As mentioned above, only excerpts of the report were translated into English. To my mind, this was a big error and extremely short-sighted. Many of the stories in the report involve foreign banks and foreign clients of the Icelandic banks. The detailed account of what happened in Iceland throws light on not only what was going on in Iceland but also in other countries where the banks operated. The excerpts are certainly better than nothing but by far not enough – publishing the whole report in English would have done this work greater justice and been extremely useful in a foreign context.

Why the SIC report’s importance has grown with time

It is now just over eight years since the publication of the SIC report. Whenever something related to the collapse is discussed the report is a constant source and the last verdict. The report established a narrative, based on extensive sources, both verbal and written.

Some of those mentioned in the report did not agree with everything in the report. When they sent in their own reports these have been published on-line. However, undocumented statements amount to little compared to the report’s findings. Its narrative and conclusions can’t be dismissed without solid and substantiated arguments to counter its well-documented conclusions.

This means the story of the 2008 banking collapse cannot easily be reshaped. This is important because changing the story would mean undermining its conclusions and lessons to be learnt. In a recent speech, Tory MP Tom Tugendhat mentioned the UK financial crisis as the “forces of globalisation.” These would be the same forces that caused the collapse of the Icelandic banks – but from the SIC report Icelanders know full well that this is far too imprecise a description: the banks, both in the UK and Iceland, collapsed due to lack of supervision and public and political scrutiny, following year of lax policies.

Lessons for other countries

In order to learn from the financial crisis, countries need to know why there was a crisis – with no thorough analysis no lessons can be learnt. Also, not only in Iceland was criminality part of the crisis. Though not a criminal investigation, many of these stories surfaced in the SIC report, another important aspect.

Greece, Cyprus, UK, Ireland, US – five countries shaken and upset by overstretched banks, which needed to be bailed out at great expense and pain to taxpayers. However, all of these countries have kept their citizens in the dark as to what happened apart from some tentative and wholly inadequate attempts. The effect of hiding how policies and actions of individuals, in politics, banking etc, caused the calamities has partly been the gnawing discontent and lack of trust, i.a. visible in Brexit and the election of Donald Trump as US president.

Although Iceland enjoyed a speedy recovery (Icelog Sept. 2015), I’m not sure there are any particular economic lessons to be learned from Iceland. There were no magic solutions in Iceland. What contributed to a relatively speedy recovery was the sound state of the economy before the crisis, classic but unavoidably painful economic measures, some prescribed by the IMF, in 2008 and the following years – and some luck. If there is however one lesson to learn it is the importance of a thorough analysis of the causes of the crisis.

The SIC was, and still is, a shiny example of thorough investigative work following a major financial crisis, also for other countries. It did not alleviate anger; anger is still lingering in Iceland. An investigative report is not a panacea, nothing is, but it is essential to establish what happened and why, with names named.

There are never any mystical “forces” or laws of nature behind financial crisis and collapse. They are caused by a combination of human actions, which can all be analysed and understood. Without analysis and investigations it is easy to tell the wrong story, ignore the causes, ignore responsibility – and ultimately, ignore the lessons.

This is the second blog in “Ten years later” – series on Iceland ten years after the 2008 financial collapse, running until the end of this year.

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Written by Sigrún Davídsdóttir

June 14th, 2018 at 2:28 pm

Posted in Uncategorised

What is Deutsche Bank hiding in Iceland?

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Deutsche Bank has studiously tried to hide some transactions with Kaupthing in 2008 – and in December 2016 probably thought it had succeeded when it agreed to settle for €425m to Kaupthing and two now bankrupt BVI companies set up in 2008 by Kaupthing. The story behind these deals figured in two Icelandic court cases and one of them, the so-called CLN case, has now taken an unexpected turn: the Supreme Court has ordered the Reykjavík Country Court to scrutinise the transactions as it reopens the CLN case. But what is Deutsche Bank hiding? “It’s not unlikely that an international bank wants to avoid being accused of market manipulation,” said Prosecutor Björn Þorvaldsson in Reykjavík District Court on October 11.

In early 2008 Kaupthing managers were rightly worried about the sky-rocketing credit default swap, CDS, spreads on the bank; in spring of 2008 the spreads had crept up to 900 points, a wholly unsustainable rate for any bank. According to multiple sources over the years, Deutsche Bank came up with a simple plan: Kaupthing should buy CDS on itself linked to credit linked notes, CLNs, Deutsche Bank would issue. Except Kaupthing should not be seen doing it: finance it, yes – but through two BVI companies owned by trusted clients in deals set up by Deutsche Bank. Thus, the market manipulation was neatly out of sight.

Only later did it transpire that Deutsche Bank was not only the broker in deals it knew were set up to manipulate the market – hence the remark by Prosecutor Björn Þorvaldsson – but it was actually on the other side of the CDS bets, a player in that market. Consequently, the bank profited handsomely, both from fees and from the actual CDS deals.

In the Deutsche Bank universe this unglorious saga of transactions to manipulate the market etc is however not at all true. Yes, Deutsche Bank admits it was the broker but it knew nothing of the purpose of the transactions, had no idea Kaupthing did finance the two BVI companies and certainly was not on the other side of the bets. This is what Deutsche Bank has stated in a London court and in witness statements in criminal proceedings Iceland (where Deutsche Bank is not being charged).

However, outside of the Deutsche Bank universe (and well, probably in some hidden corners inside Deutsche given the email trail that has surfaced in Icelandic court) there is abundant evidence showing the Deutsche Bank involvement. Certainly, Icelandic prosecutors are in no doubt Deutsche Bank was involved in the planning, knew of the Kaupthing funding and made money from the funds.

Kaupthing had poured €510m into the CDS bets. Early on, the administrators of Kaupthing and the two BVI companies eyed an interesting opportunity to claw these funds back. Until December last year, the administrators, in separate actions, have been suing Deutsche Bank in various places over these transactions.

When the legal fights were about to come up in court Deutsche Bank relinquished: to avoid having the whole well-documented saga exposed in court, with evidence running counter to the Deutsche Bank version of the CDS saga, Deutsche Bank finally agreed to pay €425m, around 85% of the millions that went through Deutsche Bank into the CDS schemes.

Intriguingly, in 2010 the Serious Fraud Office, SFO, had its eyes on Deutsche Bank’s CDS transactions with Kaupthing but this case seems to have evaporated as so many of the suspicious deeds in UK banks.

The story of these CDS transactions is a central part in the still on-going so-called CLN case. Kaupthing bankers have been charged for fraudulent lending and breach of fiduciary. Below, the focus is on the role of Deutsche Bank in the CDS transactions – what its real role was and why Deutsche Bank was in the end so keen to settle when nothing in the original 2008 agreements obliged it to pay anything back.

DB’s own version

In June 2012, Kaupthing hf, an Icelandic stock corporation, acting through its winding-up committee, issued Icelandic law claw back claims for approximately € 509 million (plus costs, as well as interest calculated on a damages rate basis and a late payment rate basis) against Deutsche Bank in both Iceland and England. The claims were in relation to leveraged credit linked notes (“CLNs”), referencing Kaupthing, issued by Deutsche Bank to two British Virgin Island special purpose vehicles (“SPVs”) in 2008. The SPVs were ultimately owned by high net worth individuals. Kaupthing claimed to have funded the SPVs and alleged that Deutsche Bank was or should have been aware that Kaupthing itself was economically exposed in the transactions. Kaupthing claimed that the transactions were voidable by Kaupthing on a number of alternative grounds, including the ground that the transactions were improper because one of the alleged purposes of the transactions was to allow Kaupthing to influence the market in its own CDS (credit default swap) spreads and thereby its listed bonds. Additionally, in November 2012, an English law claim (with allegations similar to those featured in the Icelandic law claims) was commenced by Kaupthing against Deutsche Bank in London (together with the Icelandic proceedings, the “Kaupthing Proceedings”). Deutsche Bank filed a defense in the Icelandic proceedings in late February 2013. In February 2014, proceedings in England were stayed pending final determination of the Icelandic proceedings. Additionally, in December 2014, the SPVs and their joint liquidators served Deutsche Bank with substantively similar claims arising out of the CLN transactions against Deutsche Bank and other defendants in England (the “SPV Proceedings”). The SPVs claimed approximately € 509 million (plus costs, as well as interest), although the amount of that interest claim was less than in Iceland. Deutsche Bank has now reached a settlement of the Kaupthing and SPV Proceedings which has been paid in the first quarter of 2017. The settlement amount is already fully reflected in existing litigation reserves and no additional provisions have been taken for this settlement. (Emphasis here and below is mine).

This is Deutsche Bank’s very brief story of the CNL saga and the settlement in the bank’s 2016 Annual Report. – Not admitting anything and yet, for no reason at all judging from the Annual Report, it paid Kaupthing an undisclosed sum, now known to be €425m.

Sigurður Einarsson’s letter to friends and family January 2009: the first tangible evidence of the CDS transactions

As recounted in an earlier Icelog there were rumours soon after the October 2008 banking collapse that Kaupthing had funded transactions connected to the bank’s CDS in order to manipulate the spread, thus lowering the bank’s ominously high financing cost.

At the end of January 2009 former chairman of the Kaupthing board Sigurður Einarsson told his side of the various stories swirling in the media. Yes, it was true that Kaupthing had funded transactions by what he called Kaupthing’s “trusted clients” to influence the bank’s CDS spread but it had done so on advice from Deutsche Bank.

The SIC report April 2010, the CDS story in some details

The story was told in greater detail in the 2010 report by the Icelandic Special Investigations Committee, SIC (p. 26-28, Vol. 2; in Icelandic). It was clearly stated and documented that Deutsche Bank came up with and concocted the plan. Summarised, the SIC recount of the CDS transactions is the following:

Kaupthing set up two BVI companies, Chesterfield and Partridge, for the sole purpose of carrying out the CDS transactions. Chesterfield was owned by three companies, in turn owned by four Kaupthing clients: Antonios Yerolemou, Skúli Þorvaldsson and the fashion entrepreneurs Karen Millen and Kevin Stanford, respectively owning 32 %, 36% and 32%. The Icelandic businessman Ólafur Ólafsson owned Partridge, also through another company.

Kaupthing lent funds to the four companies owning the two BVI companies that acted in the CDS transactions – all the companies were in-house with Kaupthing, which carried out all the transactions. The beneficial owners were only asked for consent to begin with but were not involved in the transactions themselves.

All of the owners were, as Einarsson said in his letter, longstanding and “trusted clients” of Kaupthing. In 2001, Yerolemou, a Cypriot businessman prominent in the UK Cypriot community and a Conservative donor, had sold his business, Katsouris, to Exista, Kaupthing’s largest shareholder and stayed close to Kaupthing, also briefly as its board member. Stanford had a long-standing relationship with Kaupthing as with the other Icelandic banks and Ólafsson was the bank’s second largest shareholder.

Like Einarsson, the SIC report traced the origin of the transactions to Deutsche Bank:

At the beginning of 2008, Kaupthing sought advice from Deutsche Bank as to how it could influence its CDS spreads. In a presentation in early February, Deutsche Bank advised Kaupthing, for instance, to spend all liquid funds it received to buy back its own short-term bonds in an attempt to normalise the CDS curve. In the summer the idea of a credit-linked note transaction appeared in an email communication from an employee of Deutsche Bank. It states that this would mean a direct impact on the CDS spreads rather than an indirect one, as in the case of buy backs of own notes. It also states that this transaction will be financed. The message concludes by stating that the issue has to be timed right to get the ‘most “bang” for the buck’. In e-mail messages exchanged by Sigurdur Einarsson and Hreidar Mar Sigurdsson following this, the two agree that they do not need to involve pension funds, but that there is ‘no question’ that they should do this. 


Sigurdur Einarsson said that the initiative for the transaction had come from Deutsche Bank. ‘It involved getting parties to write CDSs against those who wanted to buy them. This was to create a supply of CDSs, of which there were none. Because what we saw was happening on the market, or what we thought we saw, was that the screen price was always rising and there were certain parties, certain funds that put in a specific bid, no transaction, raised the bid, no transaction, raised it, raised it, raised it, raised and raised.‘” (As translated in Akers and Anor v Deutsche Bank AG 2012.)

According to the SIC the CLN transactions “can be assumed to have actually made an impact on the CDS spreads on Kaupthing.” The SIC report came up with the total amount lost by Kaupthing on these trades: €510m, all of which had been paid to Deutsche Bank as the broker of the underlying deals.

The administrator of Partridge and Chesterfield also wondered about Deutsche Bank’s role

Further information came up in a London Court in 2012: soon after Kaupthing failed, Partridge and Chesterfield unavoidably went bankrupt; after all, their only assets were the CLN linked to the failed CDS bet. Their administrators, Stephen Akers from Grant Thornton London and his colleague, quickly turned to Deutsche Bank to get answers to some impertinent questions regarding the two companies. When Deutsche Bank was not forthcoming Akers took a legal action demanding from Deutsche Bank documents related to the transactions. A decision was reached in February 2012.

In his affidavit in the 2012 Decision, Akers said: It is very difficult to see how the transactions made commercial sense for the Companies. This request for information is in part to explore how the Companies might have expected to benefit from the transactions, to identify what the Companies’ purposes and objectives in entering into the transactions were and how the Companies were expected to repay the loans from Kaupthing if there was movement in the market in the ‘wrong’ direction (as transpired). … The Joint Liquidators are keen to understand, through requests for information and documents from key parties, why these particular transactions were entered into by these particular companies. 

46. From the information that the Joint Liquidators have been able to gather about the transactions …, it seems possible that the Companies were involved in a wider package or scheme, although it is too early to comment definitively on the purpose of such scheme, contemporaneous reports and documents suggest that the purpose might have been to manipulate the credit market for Kaupthing.

In his Decision, Justice Newey holds up the “possibility of market manipulation” quoting the above statement from the SIC report, noting the report’s conclusion “that the CLN agreements “can be assumed to have actually made an impact on the CDS spreads on Kaupthing.””

In the 2012 Decision it’s pointed out that “Deutsche Bank strongly denies any suggestion that it entered into the CLN transactions in order to manipulate the market. In other respects, too, it takes issue with the picture painted in the Icelandic report. Among other things, it says that the CLNs were not in any way unusual or commercially unreasonable transactions; that it was not aware that Kaupthing was itself financing the purchase of the CLNs, if that is what happened; and that it did not act as adviser to Chesterfield, Partridge or Kaupthing.”

DB was right that the CLNs were not in any way unusual – but the CLNs per se were not the problem that drove Akers to collect information but the whole transactions. However, there is abundant documentation, inter alia emails to and from Deutsche Bank etc. to show that Deutsche Bank was indeed aware that Kaupthing was financing the two companies’ bet on the Kaupthing CDS. And Deutsche Bank definitely advised Kaupthing in this set up, again born out by emails.

The “bang for the buck” email, quoted in the SIC report was written by Venkatesh Vishwanathan, a senior Deutsche Bank banker who oversaw the CDS deal with Kaupthing. In his witness statement in the Akers 2012 case he gave his interpretation: “I say the way to proceed would involve ‘hitting the right moment in the market to get the most bang for the buck’ because an investor investing in a CLN product would want the best return and the coupon available over the term of the CLN, should it run to maturity, is set when the CLN is issued. That was why market timing was important. I was not suggesting, as Mr Akers says, that Kaupthing would get ‘bang for its buck’ by Deutsche selling CDS protection.”

Vishwanathan’s interpretation runs contrary to what Akers claimed and other sources support: that the transactions were set up for Kaupthing, via the two companies, in order to influence the market.

DB placed Wishwanatahn on leave in 2015, in autumn 2016 he had sued the bank for unfair dismissal. According to his LinkedIn profile, Wishwanathan now lives in Mumbai (he has not responded to my messages).

Additional evidence: the Icelandic CLN case

In 2014, Sigurður Einarsson, Kaupthing’s CEO Hreiðar Már Sigurðsson and head of Kaupthing Luxembourg Magnús Guðmundsson were charged of breach of fiduciary duty and fraudulent lending to the two BVI companies, Partridge and Chesterfield, causing a loss of €510m to Kaupthing.

The charges (in Icelandic) support and expand the earlier evidence of Deutsche Bank role in the CDS trades. Deutsche Bank made for example no attempt to be in contact with the Kaupthing clients who at least on paper were the owners of the two companies. Deutsche Bank was solely in touch with Kaupthing. When the two companies needed for example to meet margin calls its owners were not averted; Deutsche Bank sent all claims directly to Kaupthing, apparently knowing full where the funding was coming from and who needed to make the necessary decisions.

But who was on the other side of the CDS bets, who gained in the end when the Kaupthing-funded companies lost so miserably?

According to the Icelandic Prosecutor, the three Kaupthing bankers “claim they took it for granted that the CDS would be sold in the CDS market to independent investors and this is what they thought Deutsche Bank employees had promised. They were however not given any such guarantee. Indeed, Deutsche Bank itself bough a considerable part of the CDS and thus hedged its Kaupthing-related risk. Those charged also emphasised that Deutsche Bank should go into the market when the CDS spread was at its widest. That meant more profit for the CLN buyer Chesterfield (and also Partridge) but those charged did not in any no way secure that this profit would benefit Kaupthing hf, which in the end financed the transactions in their entirety.”

DB fees amounted to €30m for the total CDS transactions of €510m.

The oral hearings in the CLN case were in Reykjavík in December last year. I attended the hearings, which further not only supported the story of Deutsche Bank’s involvement but provided ample tangible evidence as witnesses were questioned and emails and other documents projected on a screen.

The side story in the al Thani case

A short chapter in the CDS saga is the fact, already exposed in the SIC report, that Kaupthing had indeed planned with Deutsche Bank to set up yet another company to trade on Kaupthing’s CDS. Kaupthing issued a loan of $50m to Brooks Trading Ltd, via another company called Mink Trading, both owned by Sheikh Mohamed Khalifa al Thani. The purpose was to invest in CLN linked to Kaupthing’s CDS, via Deutsche Bank, identically structured as the CDS transactions through Chesterfield and Partridge. CDS transactions through Brooks were however never carried out.

Sheikh al Thani played a role in another Kaupthing case, the so-called al Thani case; the Sheikh was not charged but the three Kaupthing managers, charged in the CLN case, and Ólafur Ólafsson were sentenced to three to 5 ½ years in prison. The bankers for fraudulent lending, breach of fiduciary duty and market manipulation; Ólafsson was sentenced for market manipulation.

The 2008 last minute CBI loan to Kaupthing

The evidence brought out in the CLN case – the tracing of the transactions, emails, phone calls etc. – shows that the Kaupthing managers were extremely focused on exactly these transactions. Kaupthing was teetering and yet they never wavered from paying to Deutsche Bank, the agreed sums and the margin calls that followed. It almost seemed as if nothing else mattered in their world, a sense further strengthened by some back-dated documents related to the CDS transactions.

The last payments were made just as the bank was collapsing, 7 October 2008; the bank went into administration 8 October. During these last weeks, foreign currency was scarce at the bank in Iceland where the payments originated. On 6 October, prime minister Geir Haarde addressed the stunned nation on radio and television at 4pm, to announce the Emergency Act enabling Icelandic authorities to deal with collapsing banks in an orderly manner. – Hreiðar Már Sigurðsson, then CEO of Kaupthing but only for 48 more hours, has said in court that when he heard of the Emergency Act he knew it was over for the banks.

At noon of 6 October, Geir Haarde and the governor of the Central Bank, CBI, Davíð Oddsson, who both knew the Emergency Act was coming later that day, agreed the very last lending to the banks: Kaupthing would be given a loan of €500m. This, to permit Kaupthing to meet payments the Bank of England and the FSA were demanding as a guarantee for the bank’s UK subsidiary, Kaupthing Singer & Friedlander.

The reasons for this loan have never been completely clarified (see Icelog on this story): documents and an audio of the phone call between Oddson and Haarde remains classified in spite of valiant attempt by the Icelandic media to unearth this evidence. The CBI has promised a report on the Kaupthing loan “soon” but so far without a publication date.

Whatever the motivation, the CBI issued the loan directly to Kaupthing without securing it would be used as promised, i.e. to strengthen Kaupthing’s UK subsidiary. Instead, part of it was used 7 October when Kaupthing paid, via the two BVI companies, the last €50m CDS transactions to Deutsche Bank.

This is how much the CDS transactions mattered to the Kaupthing managers who never, not even in the mid of the cataclysmic events engulfing the bank these early days in October 2008, took their eyes off the CDS transactions with Deutsche Bank.

When the Deutsche Bank December 2016 agreement surfaced…

In January 2016, the Reykjavík District Court acquitted the three Kaupthing managers of the fraudulent lending and breach of fiduciary duty they had been charged with in the CLN case. In February this year, the Office of the Special Prosecutor (now Office of the District Prosecutor, encompassing the earlier OSP and other duties), appealed that decision to the Supreme Court.

In March 2016, I reported on Rúv (in Icelandic) that Deutsche Bank had indeed come to an agreement with Kaupthing: on-going legal cases, mentioned in Deutsche Bank’s annual reports 2015 and 2016 (but not in earlier reports), had now been settled with Deutsche Bank agreeing to pay Kaupthing more than €400m.

The agreement had been sealed in December 2016. Kaupthing made no big deal of the millions accruing from Deutsche Bank – no press release, just silence.

I pointed out that what Deutsche Bank had stated in the 2012 court case in London was not in accordance with other sources. Also that the bank had mentioned the Kaupthing claims in its 2015 Annual Report but stated it had filed defence and continued to defend them.

I concluded that Deutsche Bank 1) refuted it knowingly participated in transactions knowing set up to mislead the market 2) refuted that Deutsche Bank planned the transactions 3) denied knowing Kaupthing was itself financing the transactions aimed at lowering its CDS spreads. Further, I pointed out that statements from the Prosecutor in the CLN case showed that Deutsche Bank was not only the broker in these transactions but was actually on the other side of the bet it set up for Kaupthing and gained handsomely when Kaupthing failed.

I did at the time send detailed questions to Deutsche Bank regarding the bank’s statements in the 2012 London court case and its version of the case in its annual reports. Deutsche Bank’s answer to my detailed questions was only that bank was not commenting “on specific aspects of this topic,” only that “Deutsche Bank has reached a settlement over all claims relating to credit-linked note transactions referencing the Icelandic bank Kaupthing. The settlement amount is already fully reflected in existing litigation reserves.”

In my email exchange with Deutsche Bank I mentioned that this matter had wider implications – Deutsche Bank has stated in court and in its annual reports that it had nothing to do with the CDS trades except selling the CLN related to it. Thus, it could be argued that the stance taken by Deutsche Bank, compared to abundant evidence, has been misleading and that has much wider implications than just being a matter between Deutsche Bank and Kaupthing. – The answer was, as before: settlement reached, no further comments.

It’s interesting to note that at the time Deutsche Bank reached an agreement of paying €425m to Kaupthing it was struggling to reached its required capital level, looking for €8bn. That did allegedly force the bank to finish several outstanding cases, the Kaupthing case being one of them.

Why did Deutsche Bank change its mind and meet 85% of the Kaupthing claims?

Following my March reporting on the agreement between Deutsche Bank and Kaupthing where Kaupthing did indeed recover around 85% of its CDS transactions with Deutsche Bank the three Kaupthing managers charged in the CLN case, now fighting an appeal by the Prosecutor, turned to the Supreme Court asking for the case to be dismissed: according to them, the basis of the claims had been the €510m loss to Kaupthing – and now that there was apparently hardly any loss the case should be dismissed.

Their demand for dismissal came up at the Supreme Court 11 October where the Court stipulated that in order to understand the demand for dismissal the Court needed to get a deeper understanding of the Deutsche Bank agreement with Kaupthing. The District Prosecutor had obtained a copy of the agreement handed to the Court but not made public in its entirety.

During the oral hearings that day Prosecutor Björn Þorvaldsson maintained that the agreement did not change the charges in the CLN case to any substantial degree: the loans had been illegal, no matter if the money was then much later clawed back. He said that according to the agreements in 2008, Deutsche Bank had been entitled to the funds and Kaupthing had no claim for clawing them back.

So what did then change, why did Deutsche Bank decide to meet the Kaupthing claims and pay back €425m of the original €510m it got from the CDS transactions?

The Prosecutor said one could only guess: 1) Perhaps Deutsche Bank wanted to hide that the Kaupthing loans to the two companies did indeed end up with Deutsche Bank 2) Did Deutsche Bank see it as harmful to the bank’s reputation that the details of the transactions would be exposed in a court case? 3) Was it accusation of being part of market manipulation that irked Deutsche Bank?

As Þorvaldsson said in court 11 October: “It’s not unlikely that an international bank wants to avoid being accused of market manipulation.”

The Supreme Court ruling on issues related to the Deutsche Bank Kaupthing agreement

The Supreme Court decided on the dismissal request 19 October. According to the Decision, Deutsche Bank signed two agreements in December 2016 regarding the 2008 CDS transactions. One was an agreement with the two companies involved, Chesterfield and Partridge. The other one is with Kaupthing.

The aim was to effectively end three court cases where Kaupthing was suing Deutsche Bank in addition to cases brought by the two companies against Deutsche Bank. According to the agreement the two companies and Kaupthing agreed to put an end to their legal proceedings against Deutsche Bank – and Deutsche Bank concurred to pay €212.500.000 to Kaupthing and the same amount to the two companies, in total €425m. Further, the agreement stipulated that Kaupthing (as the largest creditor of the two companies) would get 90% of the Deutsche Bank payment to the two companies. In total, Deutsche Bank paid €425m to end all dispute, whereof over €400m would go to Kaupthing.

The thrust of the arguments, on one side the Prosecutor, on the other side the three defending bankers was that the Prosecutor said that issuing the loans was the criminal deed, that’s what the three were being charged for – whereas the three defendants claimed that since Deutsche had now paid most of the transactions back it showed that the bank felt legally obliged to pay on the basis of the 2008 contracts.

In its Decision the Supreme Court scrutinised the final settlement of the CDS transactions concluded at end of October 2008, which indicated that Deutsche Bank did indeed not feel obliged to pay anything back to the owners of the CLNs. Same when Icelandic police interrogated two (unnamed) Deutsche employees: nothing that indicated Deutsche Bank thought it was obliged to pay anything back.

The Supreme Court concluded that based on the information at hand on the December 2016 settlement it was neither clear “why the bank (DB) agreed to issuing these payments, what the arguments were nor what material was the basis for the claims by Kaupthing and the two companies in their legal actions against Deutsche Bank. It is also not clear what was the nature of the (December 2016) payments, if they related to earlier contracts (i.e. the 2008 contracts) or if they were damages and if they were damages then what was their nature.

Based on this, the Supreme Court then decided against dismissal, as demanded by the three bankers, sending the case back to the Reykjavík District Court for a retrial where questions regarding the December 2016 settlement should be clarified in addition to the charges brought by the District Prosecutor.

This means that although Deutsche Bank settled with Kaupthing and the two companies the actions of Deutsche Bank will be scrutinised by Icelandic Court, probably already next year.

A short revision of dodgy Deutsche Bank transactions

As other international banks, Deutsche Bank has had a lot to answer for over the last few years and paid billions in fines for its rotten deeds. Contrary to Iceland, bankers in the UK and the US, have mostly been able to wipe the cost of their criminal deeds on shareholders (and why on earth have shareholders such as as pension funds and other public-interest organisations been so patient with banks’ criminal deeds?)

In April 2015 Deutsche Bank settled LIBOR manipulation cases with US authorities, paying $2.175bn and £226.8m to the UK Financial Conduct Authority, FCA as mentioned in the bank’s 2015 Annual Report.

In January this year it paid £163m to the FCA, the largest fine ever paid to the FCA, for “serious anti money-laundering controls falings” in the so-called mirror trades, where $10bn were sent out of Russia to offshore accounts “in a manner that is highly suggestive of financial crime.” At the same time, US authorities fined the bank $425m for the same offense, pointing out that “Deutsche Bank and several of its senior managers missed key opportunities to detect, intercept and investigate a long-running mirror-trading scheme facilitated by its Moscow branch and involving New York and London branches.” – Many years ago, a source said to me Deutsche Bank really should be called Russische Bank.

In May, the US Fed fined Deutsche Bank $41m “for failing to ensure its systems would detect money laundering regulations.”

In additions, there have been fines for violating US sanctions. Lastly, there is focus on Deutsche Bank and its tight connection to US president Donald Trump. And so on and so forth.

Summing it up – seen from Iceland: why Deutsche Bank would want to settle

In this context it is interesting that Deutsche Bank has decided to pay €425m to Kaupthing, a high sum in any context, even in the context of fines Deutsche Bank has had to pay over the years.

From all of these various sources it is easy to conclude as did the State Prosecutor in October that yes, one reason why Deutsche Bank would want to bury it involvement in Kaupthing’s CDS trades in the summer of 2008 is that this looks like a market manipulation by a major international bank. Further, Deutsche Bank has questions to answer regarding its own involvement in the market, i.e. it did not only broker the CDS deals, knowing full well who financed the two BVI companies, but it was actually a player in that market, making a lot more from the deal than only the fees.

Updated 14.6.2018: a retrial has been ordered, the case will come up next winter. This time, there will also be some focus on DB’s role in order to understand the context better though neither DB nor any DB bankers are charged. 

Follow me on Twitter for running updates.

Written by Sigrún Davídsdóttir

November 3rd, 2017 at 9:38 pm

Posted in Uncategorised

When Kaupthing tried to move its CDS (in 2008) with a little help from a friend

with 13 comments

Yet another case from the Office of Special Prosecutor v Kaupthing’s three top managers is up in Reykjavík District Court these days. As in several other cases, the charges centre on breach of fiduciary duty, ultimately causing the bank a loss of €510m. The loans went to two companies owned by Kaupthing clients that used the funds to buy credit linked notes and enter into credit default swaps related to Kaupthing in order to lower the bank’s collateral debt swap spread. Does this sound like market manipulation? Deutsche Bank seems to think it might, strongly denying any involvement in the scheme except as the issuer of the notes though Icelandic sources tell a different story.* – But who made a killing on the other side of the CDS bet? Partly Deutsche Bank, according to the OSP but this part of the CLN saga is still not entirely clear, which is one of the reasons why the court hearings might be interesting.

Soon after the collapse of the three largest Icelandic banks in early October 2008 there were plenty of allegations, also in the Icelandic media, of possible wrongdoing in the banks. One of the stories told centred on Kaupthing funding transactions connected to the bank’s CDS.

At the end of January 2009 former chairman of the Kaupthing board Sigurður Einarsson wrote a letter to friends and relatives explaining his side of the media reports. The first matter he dealt with was the CDS story: it was true that Kaupthing had funded transactions by what he called “trusted clients” of the bank to influence the bank’s CDS spread, following a proposal from Deutsche Bank, DB.

This story was told in greater detail in the 2010 report by the Icelandic Special Investigations Committee, SIC: also here, the idea is said to have originated with DB.

Further information came up in a London Court in 2012: the two BVI companies set up for the transactions, Partridge and Chesterfield, went bankrupt soon after Kaupthing failed. Their administrators, Stephen Akers from Grant Thornton London and a colleague, quickly turned to DB to get answers to some impertinent questions regarding the two companies.

Now, the CDS saga is summed up in the OSP charges (in Icelandic) against Einarsson, Kaupthing’s CEO Hreiðar Már Sigurðsson and head of the bank’s Luxembourg operations Magnús Guðmundsson in a case of breach of fiduciary duty and causing a loss of €510m to Kaupthing, some of it paid out on Kaupthing’s last day of trading.

In orchestrating the loans the three managers took great care that DB would get paid, i.e. the deal would not fall through due to lack of funds at a time when Kaupthing had practically no foreign currency left and was running out of liquidity.

According to the charges DB not only organised the transactions but also took part of the opposite bet. What is still lacking in this saga is who, together with DB, was on the other side of the bet the two companies lost?

Einarsson’s letter 2009 and transactions with “trusted clients”

In his letter to friends and family 26 January 2009 Einarsson pointed out that although the UK Financial Services Authority, FSA, had in the third week of August 2008, ascertained that Kaupthing’s UK operation, Kaupthing Singer & Friedlander, KSF, was well funded the CDS spread on Kaupthing stayed high. Unreasonably so according to Einarsson who claimed having heard from foreign journalist that false rumours on Kaupthing were being spread, even by PR firms. There were also rumours, wrote Einarsson, that the CDS market was being manipulated, not only in relation to Iceland. (The letter was later leaked to the Icelandic media, see here, in Icelandic; excerpts below, my translation).

Following a proposal from Deutsche Bank it was decided to test what would happen if the bank itself (i.e. Kaupthing) would buy such insurance. This was however not a trivial matter since the bank could not issue insurance on itself. The solution was to get our clients we trusted well and with whom we had had a long relationship, built on trust and loyalty, to make these transactions on behalf of the bank. Of course we would never have entered into these transactions except for the particular circumstances. These transactions were made with the interest of the bank at heart and in full accordance to law and regulations.”

Following Lehman’s collapse September 15 2008 the CDS spread on Kaupthing increased; not only Kaupthing but the international banking system felt under siege, wrote Einarsson.

As the bonds (i.e. credit linked notes), that we at Kaupthing and our business partners had purchased, were leveraged and had now gone down in price there were only two options. To hand over further funds or give up, have the bonds sold and lose a part of or all the original investment. The latter option was to my mind simply preposterous. Kaupthing enjoyed good liquidity and nothing indicated the bank would not withstand the pressure, just as it had done in 2006 and in spring 2008. If on the other hand the bonds had been sold the bank would have suffered a loss and the risk was that the increased offer of bonds would have undermined the bank and diminished its access to credit lines.”

This had been the rational behind these transactions, wrote Einarsson, made to maintain Kaupthing as a going concern contrary to media reports that funds had been taken out of the bank before it collapsed.

The SIC report April 2010

One of the many interesting stories in the SIC report was the story of the Kaupthing transactions regarding the CLNs. Two BVI companies, Chesterfield and Partridge, were set up by Kaupthing. The former was owned by three companies under the ownership of Antonios Yerolemou, Skúli Þorvaldsson and Karen Millen and Kevin Stanford, respectively owning 32 %, 36% and 32%. Ólafur Ólafsson owned the latter, through another company.

All of the owners were, as Einarsson said in his letter, longstanding clients of Kaupthing. Yerolemou, a Cypriot businessman prominent in the UK Cypriot community and a Conservative donor, had sold his business, Katsouris, to Exista, Kaupthing’s largest shareholder, in 2001 and stayed in touch, i.a. as a board member of Kaupthing in 2007. Stanford had a long-standing relationship with Kaupthing as with the other Icelandic banks and Ólafsson was the bank’s second largest shareholder.

The SIC report traced the origin of the transactions to DB but earlier in 2008 than Einarsson said in his letter. The SIC report states:

At the beginning of 2008, Kaupthing sought advice from Deutsche Bank as to how it could influence its CDS spreads. In a presentation in early February, Deutsche Bank advised Kaupthing, for instance, to spend all liquid funds it received to buy back its own short-term bonds in an attempt to normalise the CDS curve. In the summer the idea of a credit-linked note transaction appeared in an email communication from an employee of Deutsche Bank. It states that this would mean a direct impact on the CDS spreads rather than an indirect one, as in the case of buy backs of own notes. It also states that this transaction will be financed. The message concludes by stating that the issue has to be timed right to get the ‘most “bang” for the buck’. In e-mail messages exchanged by Sigurdur Einarsson and Hreidar Mar Sigurdsson following this, the two agree that they do not need to involve pension funds, but that there is ‘no question’ that they should do this. 


Sigurdur Einarsson said that the initiative for the transaction had come from Deutsche Bank. ‘It involved getting parties to write CDSs against those who wanted to buy them. This was to create a supply of CDSs, of which there were none. Because what we saw was happening on the market, or what we thought we saw, was that the screen price was always rising and there were certain parties, certain funds that put in a specific bid, no transaction, raised the bid, no transaction, raised it, raised it, raised it, raised and raised.‘” (As translated in Akers and Anor v Deutsche Bank AG 2012.)

According to the SIC report the CLN transactions “can be assumed to have actually made an impact on the CDS spreads on Kaupthing.”

Akers v Deutsche Bank

Stephen John Akers works at Grant Thornton in London and has a fearsome reputation as a diligent administrator. On being appointed a liquidator in 2010 of the two BVI companies, Chesterfield and Partridge, together with his colleague Mark McDonald, the two quickly set about to understand the nature of the transactions in the two companies.

They turned to DB with two impertinent key questions: 1) How did the transactions make commercial sense for the two companies? 2) How were the two companies expected to repay the loans from Kaupthing in case the markets moved against them, as indeed did happen?

When answers were not forthcoming from DB Akers sued the bank to get access to documents related to the transactions. In February 2012 a judge ruled DB should hand over the information asked for.

As to the purpose of the companies Akers states in his affidavit that “it seems possible that the Companies were involved in a wider package or scheme, although it is too early to comment definitively on the purpose of such scheme, contemporaneous reports and documents suggest that the purpose might have been to manipulate the credit market for Kaupthing (Emphasis mine).

In court, DB strongly denied suggestions “it entered into the CLN transactions in order to manipulate the market” and took “issue with the picture painted in the Icelandic report. Among other things, it says that the CLNs were not in any way unusual or commercially unreasonable transactions; that it was not aware that Kaupthing was itself financing the purchase of the CLNs, if that is what happened; and that it did not act as adviser to Chesterfield, Partridge or Kaupthing.”

Further, in a witness statement, Venkatesh (nick-named Venky) Vishwanathan, the DB employee who wrote the email the SIC report quotes, supported the DB position. His interpretation of the “bang for the buck” is: “I say the way to proceed would involve ‘hitting the right moment in the market to get the most bang for the buck’ because an investor investing in a CLN product would want the best return and the coupon available over the term of the CLN, should it run to maturity, is set when the CLN is issued. That was why market timing was important. I was not suggesting, as Mr Akers says, that Kaupthing would get ”bang for its buck” by Deutsche selling CDS protection.”

Thus, Vishwanathan claims the email was not referring to Kaupthing getting the timing right for the most bang but the two companies investing in the CLN.

The OSP charges

According to the charges the first round of loans was made end of August 2008 to the three companies funding Chesterfield, in total €130m. However, these late August loans were issued so the companies could repay an earlier money market loan from Kaupthing Luxembourg, which already in early August had been used to instigate the transaction organised by DB in return for CLN as the company entered into a CDS with DB on Kaupthing; €125m were used on the CLN transaction but DB got €5m in fees. In September 2008 Kaupthing issued further loans of €125m to Chesterfield to meet margin calls from DB.

The Partride loans were issued in September, first €130m, of which €125m were used on the same kind of CLN transactions as Chesterfield though with the difference that DB only got a fee of €3.625.000 with apparently the rest, €1.375.000 left behind in Ólafsson’s company (the charges do not clarify why or for what purpose these funds were left in Ólafsson’s company or why DB settled for a lower fee than on the other transaction for the same amount). Also here there were margin calls from DB, for which Partridge got a further loan of €125m.

In total, Kaupthing lost €510m on these transactions. As Akers pointed out this loss was entirely predictable if the market turned and Kaupthing went out of business – after all, the two companies were unhedged. In other words, the two companies had little or no assets beyond the CLNs meaning that it was, according to the OSP, clear from the beginning that the companies should never have received the loans they got.

Urgency and faulty documentation

The charged Kaupthing managers steered the operations of the two companies and followed closely that the loans were paid to DB. According to emails between Sigurðsson and Einarsson as the scheme was being planned, quoted in the SIC report, the two seemed to have at first planned to ask some pension funds to participate but instead opted for the trusted clients.

The two were adamant that payments should go through to DB no matter what. In one instance, payment was due on 2 October 2008 but the managers made sure it was paid already on 22 September.

The most remarkable part of these loans is that they were being paid to DB literally up to the last hours of Kaupthing. Almost the only un-told saga (my account of this is here) from these last days relates to a rather incomprehensible loan of €500m given to Kaupthing by the CBI at noon on October 6 2008, hours before prime minister Haarde addressed the stunned nation to spell out the catastrophe in view: the banks could all fail, necessitating Emergency Law.

The CBI loan was given, as far as is known, to meet demands by the FSA for funds to strengthen KSF: the funds were ear-marked to prevent the failure of KSF in order to prevent cross-defaults, which would bring down the mother-bank in Iceland. However, nothing indicates the funds were used for that purpose and the CBI does not seem to have made any safeguards as to how the loan would be used.

Sigurðsson has later said that the Kaupthing management was unaware of the imminent Emergency Law as the loan was issued; as soon as he was aware of the Law, later in the afternoon, he knew the banks would not survive.

Yet, next day October 7, €50m were paid to DB in connection with the CLNs transactions, which were based on the premises that Kaupthing would be a going concern in five years time. The OSP charges state that the CBI loan enabled this last payment to DB. – On October 8 the Kaupthing board resigned; the day after Kaupthing in Iceland was taken over by administrators.

Further, the OSP charges show the loan documentation was lacking and the foreign owners were not entirely informed by Kaupthing of the transactions. Ólafsson says Sigurðsson asked him to participate; Sigurðsson claims Ólafsson or his representative asked for Ólafsson to be included.

According to the charges, documents related to these loans were changed twice after Kaupthing went into administration, first a few days after the collapse and again in December 2008.

Apart from this, the choice of clients to lend to was quite remarkably a direct challenge to complaints from the Luxembourg financial services authority, Commission de Surveillance du Secteur Financier, CSSF. In August 2008 the CSSF warned Kaupthing Luxembourg of the precarious position of some of its large debtors and shareholders. Choosing these clients for further loans was a direct challenge to the CSSF warnings, again a sign that the Kaupthing managers were willing to go to a great length to execute this plan.

The bang for the buck-writer – on leave since early 2015

The writer of the “bang for the buck” email, Venky Vishwanatha, later became DB’s head of corporate finance in Asia. Earlier this year he was put on leave, according to Bloomberg, as DB “faces civil court cases over alleged mis-selling of derivatives by a group he helped oversee, the people said, asking not to be named because the information is confidential. … The court cases relate to allegations that Deutsche Bank manipulated the market when it sold 450 million pounds ($700 million) of credit-linked notes in 2008 to two U.K. companies associated with the failed Icelandic lender Kaupthing Bank Hf, said the people. Vishwanathan was involved in the sale of the notes when he worked for Deutsche Bank in London and co-ran the bank’s western European financial institutions group at the time, one person said.”

Bloomberg quotes an e-mailed statement from DB saying the bank entered into credit linked transactions in 2008 with two counterparties, referencing Kaupthing. “Following Kaupthing’s bankruptcy, claims to recover funds have been brought against the bank. We will continue to defend ourselves vigorously against these claims.”

Did it make sense to try to influence the CDS via the CLN transactions?

The Kaupthing managers claim lending to influence the CDS spread was an understandable attempt, given the situation at the time. As mentioned above the BVI administrators could not quite see the sense.

Further, CDS spread is a measure of trust, the high spread indicated low trust. As it were, the transactions seemed to influence the spread for a few days. Considering the cost to Kaupthing and the risk, this was a high-wire act that resulted in losses and made absolutely no material difference to Kaupthing’s situation, except increasing the losses.

Also, these transactions were invisible to the market – of course Kaupthing did not advertise it was itself going into the market to finance the CDS linked transactions. If found out, this would definitely not have looked good, having a negative influence on the trust-factor the bank was trying to influence.

The large sums of money needed, the very little impact and the great risk might show the despair among the bank’s management. A sober scrutiny, also from the technical point of view, does not indicate this ever was a good idea. And then there is the market-manipulation angle DB contests.

The result was that the bank lost €510m by setting up a trade with remarkable little influence on the bank’s CDS spread, which at the same time created a hell of a good deal for those on the other side of the bet.

Who was on the other side of the bet?

As referenced above DB denies all involvement in the CLNs transactions apart from issuing the CLNs. Yet, according to the charges DB was much more heavily involved.

The Kaupthing managers assumed, according to the charges that DB would go into the market to find those willing to take the opposite position but, according to the charges, the managers did not do anything to inquire into the matter.

As it turns out, according to the OSP charges, DB did indeed take part of the position for itself. It is however unclear if DB was the end beneficiary here or if it was possibly acting on behalf of clients. In the end, DB turned out to be one of the largest creditors in all the failed Icelandic banks.

The interesting side saga looming in the coming court case is what role DB did play – and who made the handsome profit from the trades that caused Kaupthing such losses.

*Obs: neither Deutsche Bank itself nor any DB employees are charged in the Icelandic case but the outcome in Iceland might have ramification for civil cases related to the scheme.

The above is not based on accounts at the court case, but as stated above, mainly on Einarsson’s 2009 letter, the 2010 SIC report, the 2012 Aker ruling and lastly the OSP charges in the present case. I will be blogging in the coming days on what has transpired at the court case. – The CDS saga was one of the first cases related to the banking collapse that caught my attention so I’ve been following it for over six years.

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Written by Sigrún Davídsdóttir

December 8th, 2015 at 11:57 pm

Posted in Uncategorised

New indictments against Kaupthing managers

with 6 comments

Last week, the Office of the Special Prosecutor initiated criminal proceedings against three Kaupthing managers for breach of fiduciary duty. The managers are Sigurður Einarsson formerly chairman of Kaupthing, its CEO Hreiðar Már Sigurðsson and Kaupthing Luxembourg managers Magnús Guðmundsson.

At stake are loans to four companies, in total €510m, owned by Ólafur Ólafsson, the bank’s largest shareholder, Conservative party donor and at one time a Kaupthing board member Tony Yerolemou and two big clients of the bank, Kevin Stanford and his ex-wife Karen Millen. The loans were used to fund two companies, which traded in Kaupthing’s CDS, in order to encourage a fall in the CDS and reduce the bank’s financing cost. These CDS deals were done in cooperation with Deutsche Bank. None of the clients nor Deutsche are under investigation at the OSP in relation to this scheme.

The loans were issued to BVI companies with little or no other assets than the financial assets, which were being funded. In some cases Kaupthing issued loans to these companies without the knowledge of their owners. According to the claims, the loans were not taken up in the bank’s credit committees nor were credit committees told of previous loans to these companies.

Although there are higher sums at stake in two large market manipulation cases against Kaupthing and Landsbanki managers – cases that consist of actions stretching over some time, this latest case is the largest single case so far and is likely to remain so. So far, all the OSP cases relating to the collapse of the banks are stories already known from the SIC report, published in April 2010 and this CDS case is no exception.

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Written by Sigrún Davídsdóttir

May 12th, 2014 at 10:13 pm

Posted in Iceland

Cyprus and the loss of faith in unified Europe

with 3 comments

Five European sovereign bailouts, five ways of doing it – but one thing is common to them all: reckless lenders are spared (except in the last Greek round) and hedge funds rewarded. This time, even the smallest deposit holders are hit. One clear consequence: the European Union is rapidly losing support in its member states.

Now, with the experience of five European bailouts it is safe to say they come in different sizes – from the Greek one now totalling €240 to the latest, €10bn for Cyprus. Apart from the Greek haircut (finally after two attempts to stabilise Greece) bondholders have not been touched. In Cyprus where 48% of public sector debt is held by domestic banks, a haircut à la grecque would have felled the banks and not been of much help.

One particularity of the Cypriot banks is that although their assets are roughly eight times the island’s GDP they are mostly funded by deposits, not by whole-sale loans like i.a. the Icelandic banks were. After being badly hit by the Greek haircut last year – more like the last drop rather than the real reason for their troubles – equity in Cypriot banks has evaporated.

Laiki Bank is a case in point: its assets and liabilities is €30.4bn, its equity paltry €1bn. By turning 10% of deposits into equity, as the stability (or more sweetly, solidarity) levy roughly does – bingo, the equity is miraculously a much more sustainable 8% and the troika doesn’t need to provide lending to save the banks. Assuming there will be any deposits left in the Cypriot banks when banking resumes after an, apparently, prolongued bank holiday later this coming week (the banks were due to open on Tuesday, after a long weekend, but there is now rumour they will not open until Wednesday or even later).

By looting bank accounts the total sum needed is brought down: instead of a bailout sum of one Cypriot GDP, ca €17bn, “only” €10bn will be needed.

This is a drastic measure. If this could solve the problem it might have some merit – it would be a quick stab instead of the lingering pain in Greece – but that is more than uncertain. I find it very difficult to stomach that there was not a minimum sum left untouched. Let us say a pensioner with €30.000 would have kept his savings unscathed. Or even holding a sum equivalent to the minimum deposit guarantee of €100.000 untouched but putting a levy of 15% on everything above that. Perhaps none of this would have sufficed to bring the total loan down but yes, I still find this measure extremely brutal and this measure needs to be strongly underpinned and justified. The FT (paywall) has an account on how the deal was reached – it will not make the Germans more popular and it is still incomprehensible how this part of the bailout packet could end where it did.

It follows from the way Cypriot banks were funded that they have been stuffed with money, not from Cypriot pensioners and small savers but with Russian money and other foreign money hiding from attention. It has been known for a long time and what did the European Union or the ECB do about it? Not very much or at least nothing that drove this money away. Now, both Russian oligarchs and a Cypriot olive farmer are hit by the same measure. How fair is that?

One frequently mentioned thing over the last months is if Cyprus should chose the Icelandic way in terms of deposit holders. This advice normally comes without any explanation as to what was done in Iceland and seems to imply that deposit holders should or could be treated differently according to nationality. However, what was done in Iceland can’t possibly apply to Cyprus.

The deposits the Icelandic Government refrained from saving were deposits in Icelandic branches abroad, in reality so-called Icesave internet accounts in Landsbanki branches in the UK and the Netherlands. When deposits were moved into the new banks, where deposit holders could then access the funds previously held with the old banks, only deposits in Iceland were moved. – The Cypriot Government could not, on the basis of the Icelandic way, differentiate between, let us say foreign and Cypriot depositors in Cyprus. For the Cypriot Government, the problems relate to deposits in Cyprus, not abroad. Suggesting that the Cypriots follow the Icelandic course of action seems based on some ignorance about or misunderstanding of what was done in Iceland as the three banks collapsed in October 2008.

Interestingly, I am told that Greek and the Cypriot officials did ask the European Commission informally if the Icesave judgement – where the Icelandic state was not deemed to be obliged to guarantee the Deposit Guarantee Fund nor was it seen to have discriminated against deposit holders abroad (because deposits in Iceland were moved to the new banks, without the use of the Icelandic DGF) – could be of any consequence, i.e. use for them. The answer was a succinct “no.” The EU and the ECB firmly believe that the sovereign is the last guarantor of the financial system in each country – and now, in one case, a state has been allowed to confiscate money from depositors, olive farmers and oligarchs alike.

Cypriots are understandably furious – but the Cypriots, just like Icelanders some years ago, should be furious with their own politicians. There is little point in talking about neo-colonial powers. The EU, the ECB and the IMF have a say over the Cypriot economy because the way things were run in Cyprus. Being mired in debt – no matter if it is a person or a sovereign – leads to a loss of independence. That is the harsh and painful reality.

That said, it is interesting to reflect on the role of the European Union in the five bailout countries. All these countries, as well as some other Eurozone countries, made a huge effort during the 1990s to meet the EMU criteria and join the euro. But once these countries had cut off a heel there and a toe here, to fit the euro shoe the EU stopped being strict. As late as 2011, Mario Monti wrote a brilliant article in the FT, blaming the euro troubles on the EU being too deferential and too polite to its member states. The powerful states, i.a. Germany, have time and again intervened to prevent monitoring etc. (Icelog on Monti’s article here.)

Five countries have suffered from this laxness in the EU, apart of course from mistaken domestic policies. As Mervyn King wrote to his Icelandic opposite number in April 2008, explaining that the Bank of England refused to do a swap: “among friends it is sometimes necessary to be clear about what we think.” – Brutal clarity is sometimes needed but the EU failed to behave like a true friend.

And yet, there was all the time abundant evidence of things heading in the wrong direction. Olivier Blanchard, the chief economist of the IMF, lately berated by EU commissioner Olli Rehn for unhelpful additions (read “clarity”) to the debate, ended an article on Portugal in 2007 thus:

I began by arguing that Portugal faced an unusually tough economic challenge: low growth, low productivity growth, high unemployment, large fiscal and current account deficits.

I then examined various policy choices, from reforms increasing productiv- ity growth, to coordinated decreases in nominal wages, and the use of fiscal policy in this context. I want to end on a more positive note. There is a large scope for productivity increases in Portugal, and a set of reforms which could achieve them. A decrease in nominal wages sounds exotic, but is the same in essence as a successful devaluation. If it can be achieved, it can substantially reduce the unemployment cost of the adjustment. Fiscal policy can also help. While deficits must be reduced, temporary fiscal expansion could be part of an overall package, facilitating the adjustment of wages. The challenge is there. But so are the tools needed to meet it.

The first decade of the new millennium – and incidentally the first decade of the euro – is turning into a lost decade for Europe. The European Union, with its new currency, allowed the periphery – earlier with understandably high interest rates – suddenly to bask in low euro rates with the unrestrained banking systems in i.a. Germany and France only too happy to lend. When worst came to the worst, the lenders have (mostly) been spared and the inhabitants punished. No wonder the European Union is losing popularity in all of Europe as fast as the money flows out of Cypriot banks. It is painful to see that in spite of its rich intellectual heritage, Europe is now governed by extremely by narrow-minded policies and no understanding for their social consequences.

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Written by Sigrún Davídsdóttir

March 17th, 2013 at 8:03 pm

Posted in Iceland

Crisis and the manifold damage of cheap money

with 2 comments

Now that the financial markets have moved out of Euro crisis mode, at least for the time being, calm reigns again – or as much calm as you are likely to find in that testosterone driven sector. So far, not even a muddled election outcome in Italy has caused much market flurry. However, the Euro debts have not evaporated but with the enchanting words of Governor of the European Central Bank Mario Draghi and a EU banking union in spe debt-ridden Eurozone countries gain time to put its economies in order.

This calm allows us to reflect on the wider aspects of the financial crisis on both sides of the Atlantic, such as the contributing role of interest rates in the crisis. Normally, interest rates shot up in good times and sank in bad times but during the last twenty years the rates have more or less been low all the time in the US, the major European economies and, with the birth of the Euro, also in the Eurozone. Things tend to turn into laws of nature when they have been around for a while. The danger is that “chronic” low interests has turned into a law of financial nature, creating quite devilish problems of its own.

Let us look at interest rates in the US and the Eurozone.

united-states-interest-rate-2

Table 1. US interest rates January 1971-December 1989.

united-states-interest-rate

Table 2. US interest rates January 1990-March 2013.

euro-area-interest-rate

Table 3. ECB interest rates January 2000-March 2013.

In the US money has been cheap since 1990 and exceedingly cheap since 2000, compared to 1971-1990. The Euro, in existence from 2000, knows nothing but low interest rates. Consequently, funding cost in the developed world has been low. This has affected not only the behaviour in the financial sector but also sovereigns.

The 1990s and dotcom defying financial gravity

During the internet bubble of the late 1990s investment bankers, trying to be with it, took off their ties to bond with young dotcom visionaries brimming with bright but unproven ideas. When the tie-less bankers needed to calm their “tied” colleagues, who disbelieved that businesses with no profits in sight could be good investment, they explained that these new businesses were governed by new information age laws beyond the understanding of anyone except the dotcom-initiated.

Of course things proved to be less different than it had seemed. And so the new millennium started with the reaffirmation of the old rule that things are only worth as much as someone is willing to pay. Great losses ensued from the new age not being new and from other fallacies. In 1998, the demise of an obscure hedge fund called Long Term Capital Management – two of its board members, Myron S. Scholes and Robert C. Merton, won the Nobel Prize in economics in 1997 – threatened to bring down the US financial system. The New York Federal Reserve quietly organised a $ $3.625bn bailout by the fund’s largest creditors. Thus ended a decade with – in historical perspective – low interest rates. But yet lower rates were still to come – and even greater losses, this time not absorbed by creditors but tax-payers.

Cheap money, revolving doors, light/no-touch regulation

At the time it seemed like a good idea to start the new European currency with low interest rates; in making their decisions European central bankers looked to the US where interest rates had started to fall even before 9/11. The belief in light-touch, or almost no-touch, regulation inherited from the 1990s also took firm hold on both sides of the Atlantic.

The first decade of the new millennium was thus marked by historically low interest rates, pared down regulation and hands-off financial supervision. Another new feature was the revolving door between banks and their regulators. This back-and-forth enmeshed banks and their authorities in a spider web of cosy relations and friendships.

Money was so cheap that spending it poorly had little consequences. Banking was done like a Jackson Pollock painting: you took a really big canvas and splashed it with colours. It didn’t matter too much if it didn’t make sense – it looked fine in the annual reports written by auditors who knew how to make the balance sheets look good, with tools such as Lehman’s now so infamous Repo 105.

Cheap money, favours and the separation of debt and assets

When the appalling banking practises of the Icelandic banks were exposed in the Icelandic SIC report in April 2010, not only were widespread suspicions of shady dealing confirmed, but the report showed that what had gone on was much worse than anyone had imagined. Big international banks and auditors from the Big Four were also part of the new Icelandic saga of failed banks and extreme banking.

What the SIC report described, under the term “banking,” was in fact a double standard banking: while most clients were treated as any clients in an ordinary bank a small group of clients – the biggest shareholders and their satellites – were lent beyond legal limits, often against weak or no collateral. The financial rational was unclear but the bankers were certainly egged on by cheap money. Iceland has traditionally been a high-inflation high-interest country and when Icelandic bankers suddenly had access to almost unlimited low-interest loans abroad they behaved as if they were at an open bar for the first time in their lives: they binge-borrowed and binge-lent.

The last few years have shown that the favours during the boom years were greatly profitable to those who were allowed to binge-borrow. A mercenary army of specialised lawyers and accountants made sure that the cheap money turned into lasting favour. In galaxies of offshore companies debt was skilfully separated from assets. After 2008, one empty shell company after the other has collapsed, leaving behind astronomical debt and hardly any assets. The creditors, not only the failed banks but also pension funds, get next to nothing.

For every such bankruptcy it seems likely that previously underlying assets are tucked away offshore. Consequently, the Icelandic tycoons who profited from the binge-borrowing are, almost without exception, so far doing alright in spite of spectacular bankruptcies in companies previously owned by them.

Separating debt and assets was not unique to Icelandic tycoons. London remains one of the biggest offshore centres in the world with a large number of offshore specialists. The Irish media are following the gigantic asset struggle as Irish tycoons like Sean Quinn, Patrick McKillen and Derek Quinlan are fighting not to pay their debt to the public bodies that now hold debt from Irish banks, recapitalised by the state.

In all debt-ridden Euro-countries the crisis has exposed reckless – and often corrupt – lending that has enriched favoured clients who continue to profit. Lending fuelled by cheap money, made more reckless by securitisation as lenders did not need to fear the consequences of unsustainable lending.

The sovereign curse of the cheap

During the boom time of cheap money sovereigns like the UK were tempted to fiscal frivolity. Instead of cutting down borrowing, debts expanded. Even in frugal countries like Germany sovereign debt shot up. Cheap money meant there was little pressure on governments to think of necessary but difficult and complicated structural reform, such as labour market reform or competition.

In a recent article in Foreign Affairs, Fareed Zakaria sums up the effect of cheap credit in the US:

In poll after poll, Americans have voiced their preferences: they want low taxes and lots of government services. Magic is required to satisfy both demands simultaneously, and it turned out magic was available, in the form of cheap credit. The federal government borrowed heavily, and so did all other governments — state, local, and municipal — and the American people themselves. Household debt rose from $665 billion in 1974 to $13 trillion today. Over that period, consumption, fueled by cheap credit, went up and stayed up.

Pricing risk is now a much-discussed topic in finance. Under-priced risk in lending to countries like Greece is a case in point. Lending will always be seen as less risky in times of low interest rates – and with chronic low interest the risk assessment can be unhealthily affected.

The financial sector thrived and expanded with low interest rates and soft regulation. So much so that it became more powerful than the state bodies set to guard it. Certain financial institutions became too big to fail. Instead of punishing creditors it was mainly taxpayers in developed countries like the US and Europe who shouldered the losses of the financial sector. Debt from the private sector migrated effortlessly to the public sector. Now, the link between profit and risk was broken and those who pocketed profits no longer shouldered much risk.

There is no change in sight. In the present crisis-doomed atmosphere there are – for obvious reasons – few calls for higher interest rates. Yet, in Japan low interest rates have not solved the problem. All the money printed to sustain the low interest rates should have fuelled inflation but for some reason it has not happened. Maybe we are just postponing another even greater disaster with our low interest rates.

I am not arguing low interest rates is the only root to the troubles in the financial sector, that would be overly simplistic. But cheap money should be considered a contributing factor in the present financial misère and its curse takes on many forms.

Yes, we need proper structures to rein in the financial sector – splitting apart retail banking and investment banking, firm regulation and supervision, the next set of Basel rules etc – but all these measures with fancy names must do one simple thing: to prevent bankers from administering money as if were worthless.

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Written by Sigrún Davídsdóttir

March 4th, 2013 at 9:29 pm

Posted in Iceland

Could Bruno Iksil’s $100bn bet be related to JP Morgan’s own CDS?

with 3 comments

Sounds like a crazy idea? Kaupthing, advised by Deutsche Bank, organised trades in 2008 to lower its own CDS. Deutsche co-invested in the scheme.

JP Morgan’s trader Bruno Iksil is the latest banker to gain unwanted fame for trading astronomical sums. He’s now even famous enough to have nicknames – the London Whale or Voldemort, after the Harry Potter villain. Iksil seems to have been betting investing in corporate CDS, ie Markit CDX IG (Investment Grade) 9 credit index, an index of investment grade corporate CDS, based on 121 (previously 125) big US corporations, financial and others.

Iksil works in the bank’s chief investment office, which manages and hedges “the firm’s foreign-exchange, interestrate and other structural risks,” according to the bank’s spokesman, focusing on long-term “structural assets and liabilities.” Iksil has placed such hefty bets, guessed to have reached $100bn, that he seems to be moving the index and that’s been irritating some hedge funds that are affected.

Trading in that index surged 61 percent the past three months, according to data from Depository Trust & Clearing Corp.

The net amount of wagers on the index, which is tied to the creditworthiness of companies such as Wal-Mart Stores Inc. and now-junk-rated bond insurer MBIA Insurance Corp., soared to almost $145 billion at the end of March from $90 billion three months earlier, according to DTCC, which runs a central registry for credit-default swaps and reports weekly aggregate volumes.

Perhaps the hedgies have been muttering to Bloomberg, first out with the story April 5, just because Iksil is affecting their positions. More pondering, info and graphs re Iksil’s trades on the wonderfully informative FT Alphaville. And there is speculation if this type of trades will become part of financial history when the Volcker rules come to rule, in July.

Iksil seems to be doing all of this not as a rogue trader but with the blessing from JP Morgan’s commanding heights. Maybe this is a clever long-time hedge. Perhaps perhaps… At least, the management doesn’t seem to mind Iksil risking/investing $100bn moving the market.

But what market are JP Morgan’s commanding heights glad he is moving? Just the index? Or might it be JP Morgan’s own CDS? Perhaps this is a completely freakish development but JP Morgan’s CDS was painfully high at the end of last year, almost as high as in autumn 2008, when all financial CDS shot up:

The most recent peaks, indicated by the arrows, are Oct. 4 and Nov. 25 2011.

From the beginning of this year the JP Morgan CDS has been steadily falling, as the graph shows. Interestingly, it has fallen in the last three months, when the trades in the CDS index has surged, apparently due to Iksil’s diligence. As pointed out earlier: possible just a freak development. Other forces than Voldemort’s might certainly be at large.

But can anyone be so hubristic/daring/foolhardy/foolish to manually influence its own CDS? Well, the know-how to influence one’s own CDS has been out there for a while. In the summer of 2008 Kaupthing was suffering from murderously high CDS – the management felt it was all horribly unjust since the bank was, according to the key figures, doing incredibly well.

Kaupthing seems to have aired their concerns with Deutsche Bank, which came up with a brilliant solution: companies should be created to buy CDS on Kaupthing. Deutshce seems to have thought it was a brilliantly viable plan – it even invested in it. Kaupthing implemented the idea – not via its prop trading, a la JP Morgan, but by getting favoured clients (some of whom the bank was lending heavily to invest in Kaupthing shares so as to keep the share price from crashing) to lend their names as owners of companies, which Kaupthing and Deutshce lent into – and then these companies did the trades. Did it help? Well, for whatever reason Kaupthing’s CDS did move… downwards.*

The interesting tail to both to the Kaupthing and Iksil trades would be to know who is on the other end. In Kaupthing’s case we don’t know but whoever it was did very very well.

Kaupthing did meet its end in October 2008 – bankrupt, as happens when the wrong decisions are taken over some time. JP Morgan can happily bet in whatever crazy way. Its management has tried and tested the ground – so far, a bank like JP Morgan won’t have to face the results of bad/insane decisions and hubris. Will banks be able to bank on that forever?

*Deutsche’s plan is outlined in the SIC report, chapter 7.3.6.3 (only in Icelandic).: Deutsche put up a loan of €125m and harvested handsomely: it got a fee of €5m for the package. In June 2010 Reuters reported that the Serious Fraud Office was investigating this scheme but nothing has been heard of it since. More here from Icelog on the scheme and those involved in it, ia Kevin Stanford and Karen Millen.

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Written by Sigrún Davídsdóttir

April 9th, 2012 at 8:32 pm

Posted in Iceland

SFO wrestles with the Tchenguiz case

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Serious Fraud Office seems to have committed a major blunder in the handling of documents when Vincent Tchenguiz, together with his brother Robert, was arrested in March last year, together with Sigurdur Einarsson, ex-chairman of Kaupthing’s board and six others. The arrest was connected to an SFO investigation into the relationship between the Tchenguiz brothers and Kaupthing. According to the FT, a High Court judge has scolded the SFO for “sheer incompetence:” the SFO admits is has “no clear record” of the information it used to obtain search warrant. True, it seems pretty gross that the SFO can’t document the information used to obtain the search warrant – but this dispute doesn’t touch the substance of the charges, only the way SFO documented their case for making the arrests. And it seems only to relate to the warrant on Vincent Tchenguiz, not the others.

It is clear from the SIC report that Robert Tchenguiz was both Kaupthing’s largest borrower, with his loans of €2bn, and had stakes in the bank’s largest shareholder, Exista. He was on the board of Exista, whose founders and owners were Lydur and Agust Gudmundsson. This relationship – being a major shareholder and the largest borrower or among the largest borrowers – is the normal one in the most abnormal loans issued by the Icelandic banks: loans that ia broke the banks’ rules on legal limits exposure, had no or worthless collaterals, weren’t subjected to margin calls or paid by issuing new loans etc.

Vincent’s relationship to Kaupthing was far less extensive. He had a loan of €208m, which he seems to have taken/been offered as he put up an extra collateral for his brother. In court documents related to Vincent’s legal wrangle with Kaupthing over this collateral – a whole saga in itself, ended late last year with an agreement between Kaupthing and Tchenguiz’ entities – it’s clear that Vincent was of the understanding that Kaupthing wouldn’t claim the collateral.

Further, Vincent Tchenguiz also claims that Kaupthing knew the collateral couldn’t be claimed because of cross-default triggered if the assets changed hands. The value of an unenforceable collateral raises some intriguing questions, ia for the bank’s auditors since such a loan seems to be worth not much. Now, this is only Vincent’s side of the story. The Kaupthing managers haven’t told their story of this loan – nor of any of the loans, so abnormally favourable to the clients and abnormally unfavourable for the bank.

It seems pretty clear that the Kaupthing loans – as is true for the loans of Landsbanki and Glitnir to favoured clients – are far from normal. The question is why the banks decided these loans were a good idea for the bank. The Tchenguiz brothers have claimed that Kaupthing duped them into investing in the bank, that they didn’t know the bank was running a scheme, which could be seen as a market manipulation.

All these favoured clients, including the Tchenguiz brothers, are experienced businessmen. Same with Kevin Stanford, mentioned on an earlier Icelog: experienced business men must have known that the loans they were offered weren’t quite the run-of-the-mill loans any bank would offer. They would also know that borrowing from a bank doesn’t necessarily mean that the bank, as a side offer, peddles a loan to buy some of the bank’s shares. It’s normally not necessary to be a shareholder in order to borrow from a bank. Claiming to be a victim of Kaupthing managers’ duplicity makes these victims seem more than ordinarily naive.

Some of the favoured clients of the Icelandic banks have claimed that the offers were too good to refuse. The SFO seems to be investigating what the real relationship was between Kaupthing and the Tchenguiz brothers. If the SFO suspicions are valid it is unfortunate that they could possibly hinge on technical issues. Remains to be seen.

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Written by Sigrún Davídsdóttir

April 5th, 2012 at 4:29 am

Posted in Iceland

OSP: house searches in Iceland today, related to Landsbanki

with 2 comments

Today, the Office of the Special Prosecutor conducted house searches at several premises in Iceland, related to an investigation into Landsbanki. Seven people, among them the bank’s ex-CEO Sigurjon Arnason, are being questioned but it’s unclear if anyone will be held in custody.

According to Icelandic media today, the searches are related to four topics:

1. Alleged market manipulation related to shares in Landsbanki.

2. Loans to four companies Hunslow S.A., Bruce Assets Limited, Pro-Invest Partners Corp and Sigurdur Bollason ehf. to buy shares in Landsbanki.

3. Landsbanki Luxembourg’s sale of loans to Landsbanki only a few days before the bank collapsed in Oct. 2008.

4. The buying of shares by eight offshore companies that supposedly were set up to hold shares related to employees’ options.

Sigurdur Bollason is an Icelandic businessman, often connected to Baugur companies and a friend and associate of Magnus Armann, another Baugur associate. According to my sources Bollason, who imported UK high street fashion to Iceland over a decade ago, met Kevin Stanford, through business with Karen Millen, then Stanford’s wife. That’s how Stanford became connected to Icelandic banks and businesses, first with Baugur, where he was often a co-investor, and later with Kaupthing where he was involved in the financial high-wire acts that Kaupthing engaged in.

Hunslow S.A. was registered in Panama in Feb. 2008. In November 2009 two Novator companies (Novator is the investment fund of Bjorgolfur Thor Bjorgolfsson who was a major shareholder in Landsbanki and Straumur investment bank together with his father) were registered in Panama with the same law firm as Hunslow. The same five directors are on the board of the two Novator companies and Hunslow but there are probably hundreds of companies registered at this one law firm. I have no information on Bruce and Pro-Invest.

The loans moved from Landsbanki Luxembourg to Landsbanki Iceland on Oct. 3 2008 amounted to €784m. By far the largest loan had been assigned to Bjorgolfsson, €225m. (The complete list of the loans is here, from the SIC report, ‘Tafla 20’) but the four companies mentioned above are also on the list.

I find it interesting that the OSP is investigating the offshore companies that Landsbanki set up to own shares in itself. The first of these companies was set up in Guernsey in 2000, before the privatisation of Landsbanki in 2002 but later seven more were set up in the BVI and in Panama. To begin with, the bank financed these companies but later one was financed by Kaupthing and six by Straumur, from 2006 when Bjorgolfsson and his father were major owners in Straumur. Bjorgolfsson was Straumur’s chairman.

In total, these companies owned 13,2% of the shares in Landsbanki. Normally, similar structures holding shares for staff option usually don’t own more than 1-2%. The SIC report maps these companies but the weird thing is that although they were apparently set up to hold shares for options they don’t seem to have been used for that purpose. The ownership in each company was held below 5%.

With the bank owning 13,2% via these companies (above the 10% legal limit of own shares) and father and son owning around 45,8% of the bank the majority was assured. Another interesting aspect of these companies is that Straumur lent them against no collaterals. This isn’t the only example of the very close relationship between the two banks where father and son were the major shareholders. Neither of the two are being questioned today.

*Last October I reported on these offshore companies for Ruv. Bjorgolfsson was very upset, according to his spokeswoman, about my reporting and did eventually file a complaint to the Icelandic Press Complaints Commission. The PCC has dismissed the complaint. Here is a story about his spokeswoman when she wasn’t happy about Iceland Weather Report reporting on Bjorgolfsson.

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Written by Sigrún Davídsdóttir

January 13th, 2011 at 7:22 pm

Posted in Iceland