Sigrún Davíðsdóttir's Icelog

A ruling in the so-called al Thani case is expected today at 3pm in Iceland. The Office of the Special Prosecutor earlier charged Kaupthing top managers – Sigurður Einarsson, Hreiðar Már Sigurðsson, Magnús Guðmundsson – and the second largest Kaupthing shareholder, Ólafur Ólafsson, for market manipulation and breach of fiduciary duty. The case derives its name from a member of the Qatar-ruling al Thani family, involved in the case but not charged.

Involving both management and a shareholder this case is one of the most extensive cases brought by the OSP. So far, the District Court has tended to be more lenient than the Supreme Court in cases brought by the OSP. All of the OSP cases have gone to the second and highest court, the Supreme Court. No matter the outcome, this case will almost certainly be appealed by either party.

The OSP had demanded a six year unsuspended imprisonment for Einarsson and Sigurðsson and four years for the other two. See here for earlier Icelogs on the al Thani case.

UPDATE: Sigurðsson has been sentenced to 5 1/2 years, Einarsson 5 years, Ólafsson 3 1/2 years and Guðmundsson 3 years.

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Compared to the skepticism of many Icelandic economists (except those who worked on the debt relief or were somehow connected to it), it was surprising to see how positive Fitch Ratings review of the Icelandic debt relief plan is: Fitch deemed the program “appears” to be “fiscally neutral” but added that “another round of write-downs may dent investor perceptions of Iceland’s business environment, and the prospect of foreign bank creditors in the failed banks bearing most of the cost may make it more difficult to remove capital controls.” The program amounts to ISK150bn, 8.5% of GDP (see earlier report on Icelog).

As Fitch points out the government aims to “fully finance the plan, via as-yet-unspecified budget adjustments, and tax increases – primarily an increase in the levy on Icelandic banks’ balance sheets from 0.145% of total outstanding debt to 0.366%. This bank tax is levied on Iceland’s new banks as well as on its failed banks, Kaupthing Bank, Glitnir Bank, and Landsbanki Islands, through their winding up committees.”

The often-stated aim of the government was not to finance the plan itself but that is indeed what it turns out to be: government funded. The funding is to come from increasing levy on the balance sheets of banks, as pointed out earlier on Icelog, from 0.145% to 0.366% – not only on operating banks but on the failed banks as well.

The Winding-up Boards of both Glitnir and Kaupthing have both stated that they doubt the legality of posing a levy on estates as expressed in a written statement by Kaupthing. The levy will most likely be challenged. Maybe it is unlikely that the Supreme Court will dare to go against the government but the levy is by no means in the Treasury coffers yet.

Economists have also pointed out that the estimated effect on inflation in the government’s calculation is 3.7% over 4%, not a trivial number but others see this as an unlikely low number. To “correct” inflation some years ago by possibly increasing inflation in the coming years and thereby wiping out the effect seems unwise, to say the least.

The unavoidable negative effect on the Housing Finance Fund – this almost decade old unsolved disaster – makes the debt relief all the more worrying. This government, as the previous government, keeps throwing money at the fund – this year ca ISK5bn (€31.8m) – only to keep the fund going, without resolving the underlying problems.

Fitch points out that a levy could dent recovery of the estates (which is why it will most likely be challenged in court) “and may further dent international investor sentiment towards Iceland. This could have a negative impact on investment, growth, and external finances, and may make it even more challenging to unwind capital controls in an orderly fashion.”

This is of great concern for Iceland since foreign investment and expertise is greatly needed. And everything that makes it more difficult to unwind the capital controls poses a major problem for the Icelandic economy. In addition, as the Argentinians know all too well, demagogy and populism thrive in capital controls.

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Entrepreneurs come to Silicon Valley in search of its pixie dust, says Roelof Botha partner at Sequoia Capital. It is not easy for other places to emulate the Valley – it now has a story spanning almost a century. Over the years Sequoia has itself created a bit of pixie dust by being good at picking companies that later soar to success. Now that the Icelandic company Plain Vanilla has had funding from Sequoia Icelog met with Botha to learn about Sequoia’s investment strategy and get an insight into the mind of an investor who knows the start-up world inside out.

At this time of the year, the flaming red leaves in the grove by the offices of Sequoia Capital add glow to the low-key office space, built into the environment much like in Scandinavia or Japan. Sequoia is the legendary venture capital fund, which has seen so many of the companies it invested in at an early stage thrive and blossom ­­– companies like Apple, Oracle, Google, Jive (which earlier this year bought Clara, an Icelandic software company), Dropbox, Airbnb, Y Combinator, Evernote, Tumblr, Square and Instagram to name but a few.

Sequoia recently invested in Icelandic Plain Vanilla. Following its QuizUp fame Icelog had the opportunity to meet Roelof Botha who has been with Sequoia for a decade (and whose partners so far have not spent much time on giving media interviews).

In the interview (listen here; 15:02 min.) Botha outlines Sequoia’s vision: to be a leading investor and business partner for tomorrow’s enduring technology companies. Botha points out that unlike 40 years ago, venture capitalists of today must provide not only money but also expertise: today, venture funds need to be a business partner to the companies they invest in.

Founder of Plain Vanilla Þorsteinn Friðriksson, called Thor by non-Icelanders, is the type of founder Botha loves to meet: Þorsteinn has great energy and a clear vision of his company, says Botha.

In general, founders are the kind of people who can tear down walls when needed, not necessarily easy to get on with. Compared to even just twenty years ago, says Botha, entrepreneurs now are lucky enough to have a global market at their fingertips.

Starting in a small market like Iceland or the Scandinavian countries, which have a high density of talent, can even be an advantage because it pushes companies to look elsewhere for markets. The challenge in small countries is to find the expertise needed – the expertise found at all levels in an ecosystem like Silicon Valley. Starting a company in the Valley is not a prerequisite for success but this ecosystem attracts entrepreneurs from all over the world to the Bay Area in search of some of its pixie dust, says Roelof Botha.

The above and much more can be heard here (15:02) where I started by asking Roelof Botha to describe Sequoia’s investment strategy.

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The “Correction” – that is the nickname now given by the Icelandic government to its planned debt relief. It could potentially cut ISK150bn, ca 9% of GDP, 920m, off the private mortgage stock; the maximum amount on each mortgage will be ISK4m (cf press release here in English). Of the ISK150bn ISK80bn is expected to be written off, according to certain criteria, whereas ISK70bn is estimated to come from tax relief as the Treasury waives taxes on payments used to pay down mortgages instead of paying towards a private pension. It effectively means that the Treasury is guaranteeing to pay the mortgage companies ISK150bn over the next four years.

At a press conference today to introduce the long-awaited and much promised debt relief prime minister Sigmundur Davíð Gunnlaugsson said that these measures will herald a new beginning for Icelandic families. However, Iceland did indeed turn to growth already by mid 2011 and has been in growth since.

Minister of finance and leader of the Independence Party Bjarni Benediktsson estimated that the cost of the collapse of the Icelandic banks now amounted to ISK200bn (GDP ca 1700bn). Since the cost is so great – and more could be coming – something should be done for homes, or so he said, to correct the hit that households took when the inflation rose, as a consequence of the sinking króna 2007-2010. Much was said about justice and fairness at the meeting, less on how this is going to be funded.

So far, the focus has been on not increasing the sovereign debt or risking the Icelandic credit rating. This is what the press release states on the funding: “The action requires the Treasury to serve as an intermediary in financing and implementing it. There is no need to establish a debt relief fund, as the action will be fully financed.”

This stipulates that contrary to what the government has said before, the state is indeed responsible for financing the new plan. And contrary to what the prime minister has been saying for a long time the funding is not coming from the winding-up process of the estates of Glitnir and Kaupthing. Funds he has earlier said could easily and justifiably be within the reach of the government.

According to (as I understood it) Benediktsson and chairman of the debt relief working group Sigurður Hannesson (here are his slides, in Icelandic) the methodology is that after calculating the amount each loan can be written down by, this amount is put apart – by middle of next year – and will then be paid off over 4 years by the Treasury. Thus, from mid next year each mortgage holder, fulfilling the criteria, will only paying off the written-down mortgage.

As to the Treasury, this new liability will be paid off with a new banking tax, levied on both operating and defunct (i.e. estates) banks. For operating banks deposits are the base, for estates the claims. The tax on the estates was tentatively announced when the 2014 budget was presented this autumn. At the time, the outline was unclear. The estates have indicated that there is no tax base in estates of collapsed banks and will most likely challenge the proposed tax.

As Benediktsson pointed out, some years ago a new bank tax was put on operating banks, annually bringing ISK1bn in for the Treasury. In comparison, the proposed tax is calculated to bring the Treasury ISK37.5bn next year.

It may all come down to semantics but a plan that partly relies on a disputed tax, which might be ruled illegal, can to my mind not be judged to be funded. And since the Treasury is an intermediary in a potentially unfunded plan it is taking on some risk – some added risk. Also, if the estates are to be used as a tax base for the next four years, the government seems to be underlining that they will not be wound down and assumedly the capital controls kept in place.

As to the effect on the economy it is both said to be only mild – and to be beneficial for consumption and growth. It will add 3.7% to inflation over 4 years, not trivial in a country with chronic inflation. Greater consumption will increase imports, with the unavoidable negative impact on the current account and the króna rate. It is forecast to stimulate the property market, which some already see as showing signs of overheating. That is good for the construction sector but less for other sectors. The measures are not thought to stimulate investment and the export sectors, which is what is needed to boost the current account, which again is needed to abolish the currency controls. – So far, there is no comparative analysis of what these ISK150bn could do for the country if used i.a. to pay off sovereign debt or for some infra structure projects.

Still plenty of question marks, these are just my first impressions – and they might change as more is revealed of the plan.

As pointed out on Icelog earlier, some Independence Party MPs had earlier indicated skepticism. I have heard of some discontent within the party. An ex-leader of young conservatives has already said the plan is worse than he expected. How the plans fare in parliament will not be clear immediately since the Bills needed to put this plan into action are not yet written.

Update 1.12. 2013: 

*Clarifications: the mortgages now being “corrected” are not currency loans but indexed loans that jumped up when inflation rose 2007 to 2010. Currency loans (or some types of currency loans) have earlier been deemed illegal. Banks, which had issued these loans, have had to recalculate them and write-down substantial amounts. The two ministers introducing the new measures have said that it now is time that the banks, which behaved so badly before the collapse, should shoulder some of the burden. In reality, the banks have already been hit by write-downs resulting from the currency rulings. – The banks now functioning are not the old banks but new banks created with deposits from the old banks.

*Here is the legal opinion from the Kaupthing estate to the Icelandic parliament re taxing bank estates. Given that both Glitnir and Kaupthing doubt the estates constitute a legal base the coming measures will most likely be challenged in court. It will be intriguing to how the courts, first the Reykjavík District Court and then the Supreme Court, rule in a case where the government has already acted on its own assessment of the legality of these actions.

Update 4.12. 2013:

According to IFS Greining, the Icelandic CDS has jumped up 11% since the weekend. That is at least an indication of how market forces outside of Iceland view the ,,correction.” Unfortunately, I do not have a link to this since the IFS website is behind a payment wall. – It is most likely that the fact that the funding is not secure, that it will hit the Housing Finance Fund, already deemed a sovereign risk by IMF and others and that the Treasury is a de facto guarantor has an effect on the CDS.

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The hacker website Cyber War News announced today that servers and domains of Vodafone, Iceland have been hacked. Vodafone has acknowledged that the company has been hacked. The hacking can potentially touch the 77.000 Vodafone accounts in Iceland. The hacker(s) have now also placed material online.

Rúv, the Icelandic public broadcaster has already reported (in Icelandic) that among the material now online there are text messages from Icelandic politicians. By looking up numbers of mobile phones it is possible to read messages from three days from three different years. Many politicians have their mobile numbers online and mobile numbers are in general not a well guarded secret in little Iceland where trust is high and few people are worried about privacy.

According to Cyber War News a Turkish hacker/hacker group that goes by the Twitter name @AgentCoOfficial has already announced on Twitter that this has happened and that he/they did it, as can be seen here.

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Press conference on planned debt relief will be broadcast live here now at 4pm, GMT, in Icelandic. The chairman of the working group responsible for the plan, Sigurður Hannesson, has said that the working group is not responsible for finding the funding for it. A priori, that is baffling since finding a plan is a lot easier than coming up with funding that does not increase the debt burden of the state. Bjarni Benediktsson minister of finance has said that he does not want to see a solution that burdens the sovereign with further debt, already 98% of GDP.

The key thing to watch out for will be the funding for the plan. Senior people at the Central Bank of Iceland have already aired their worries re the funding but have been assured that no, the funding will not fall on the state. Others struggle to understand how this could be done – but yes, soon we will know for sure.

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Tomorrow is a big day in Icelandic politics: the long awaited debt relief measures, promised by the Progressive Party during the election campaign and then taken up in the coalition government’s manifesto are ready. The plan is the work of an expert working group set up by the prime minister, lead by Sigurður Hannesson a mathematician who now works for MP Bank. In little Iceland it is known that Hannesson is a long-time friend of the prime minister. After being discussed during a cabinet meeting this morning the plan is being presented to the coalition parties today. Tomorrow there will be a press conference to introduce the new measures, which prime minister Sigmundur Davíð Gunnlaugsson has called the most radical measures of its kind anywhere in the world.

During the election campaign Progressive’s leader and now prime minister Gunnlaugsson repeatedly said that in order to wind down the estates of Kaupthing and Glitnir there would have to be “a scope” – apparently created by ISK assets, which can’t be converted into foreign currency any time soon and would then be available to the state through some never-defined way. These funds should be used for debt relief for those who have not benefitted from earlier measures. This would be a “correcting” measure to “correct” loans that shot up because of the inflation shot up after the collapse of the banks when the króna collapsed. The most common loans in Iceland are inflation-indexed loans and currency basket loans, both of which were affected by the events of October 2008.

Ever since the coalition government, Progressives with the Independence Party, was formed in summer, it has been clear the two parties do not agree on the fundamentals of a debt relief. The conservatives lean towards using any surplus to lower the public debt and are opposed to creating more debt in order to spread out money to a certain group of people. Also because the planned debt is aimed not at those who can’t pay but those who although with high debt are able to service their debt. Earlier measures by previous government were aimed at those who could not pay off their debt. The clearest disharmony between the two parties on this issue was brought to light earlier this week when leader of young conservatives urges Independence Party parliamentarians to vote against the planned measures. (Little Iceland: in Icelandic media it is noted that the leader of the young conservatives, Magnús Júlíusson has been dating the daughter of the leader of the Independence Party, Bjarni Benediktsson, for the last three years.)

The prime minister has been notoriously vague on the planned relief but has used ever grander words to describe it. To begin with the estates were the chosen source of funds. Lately – as it became clear that these funds would not be available any time soon, if at all – he has talked about tax measures, which is more in line with ideas aired earlier by the Independence Party. The prime minister has also denied these measures will somehow be funded by the government.

This morning, in parliament one opposition MP, Guðmundur Steingrímsson leader of Bright Future asked the prime minister: “Where does the money come from?” According to Rúv (in Icelandic) the prime minister “answered that it was not possible to compare the scope that needs to be created in winding down the fallen banks and the money used in direct state expenditure. The scope was created by diminishing the amount of money in circulation so the currency control could be abolished. “And when the air is being let out of the asset bubble it is natural to let the air out of the debt bubble at the same time. This is all about taking out of circulation money for which there is no funds. Such money can’t be used to buy goods and services.” Guðmundur found the answer not worth much and said he would be lying if he said he understood this and he did not intend to lie.”

The MP is hardly the only one who will struggle to make sense of this answer but as the prime minister said, people will now only have to wait until tomorrow to know all about the planned debt relief.

The big question will be how the long-awaited plan will be funded – and how the Independence MPs will react if the plan, contrary to earlier promises, does indeed rely on state funding, guarantees or anything that in any way depend on the state. As the chief economist of the Central Bank of Iceland, Þórarinn G Pétursson, said at a hearing with a parliamentary committee recently: a debt relief plan that smacks of government funding is the surest way to a rating downgrade.

*For more background on these measures and other topics related to the Icelandic economy see here.

PS Accidentally, there has been a long silence on Icelog but I now hope to be more active again. No lack of interesting topics, that is for sure.

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Thinking back to five years ago, Iceland was forced to take the right decisions, not saving the big banks. But that was perhaps the easy decision: after all, the major part of creditors in these banks were foreigners. Later on, frantic attempts were made to save the very Icelandic banks, i.e. Saga Capital, VBS and some saving societies. Now, the idea is to tax estates where foreigners are ca. 90% of creditors whereas other failed financial companies are not taxed. “Fuck the foreigners” was a policy after the collapse – and it still seems to be the only policy five years after the collapse.

Last week, in the policy speech by prime minister Sigmundur Davíð Gunnlaugsson Icelanders were told that Iceland is a country almost too good to be true. However, for basic principles Iceland is less good. One of the basic principles is that property rights are inviolable. Some wonder if such principles still count in Iceland.

Part of the budget proposals, put forth last week, is that estates of the failed banks should be taxed. Taxing debt is a novel thing, remains to be seen how that idea fares. The proposal is vague as to how and what is being taxed. The proposal mentions the estates of Kaupthing, Glitnir and Landsbanki. The justification is that these three banks caused a lot of damage to Iceland – another novelty: tax is based on the principle of damage and the perceived good and evil.

There are however other failed financial institutions that did indeed cause a lot of harm and cost: Saga Capital and VBS, to mention just two, in addition to SpKef, Byr and others: the government did indeed try to save the two first ones and lost a lot of money on the attempt.

The intention seems clear enough. It would indeed be much more clear-cut if the definition was plainly to tax “estates where major part of creditors are foreign.”

Now on the fifth anniversary of the bank collapse politicians have been reminding Icelanders of the harm foreigners have caused Icelanders, i.a. the British actions five years ago against Kaupthing and Landsbanki. Less has ben said of what went on in the years before these few fateful days. And no mention is made of the fact that Icelanders, contrary to most other crisis-struck countries do actually know what happened and why: there is the SIC report that gives a clear and concise account of what happened.

The prime ministers is untiring in telling Icelanders what a great nation Iceland is. It is interesting to keep in mind the political rhetoric in Argentina. In any free country, i.e. a country, which is not locked up inside capital controls, citizens can vote with their currency, in the sense that if they do not like the policy they can go abroad. In Iceland – and in Argentina – that is not possible.

Both in Argentina and Iceland politicians constantly remind their countrymen of the unfair foreigners. In Argentina, this has been going on for almost 13 years. In Iceland, it is just beginning.

Qui vivra verra – but so far, Iceland seems to be emulating Argentina in trying to be a country that writes its own rules, forcing these rules on its citizens because they cannot go anywhere else and acting as if the outer world does not matter. Argentina, after almost 13 years, is waking up to the fact that this may not be that easy. Iceland still has years to find out if isolation matters. As one economist puts it, capital controls strangle the economy.

The weather has been glorious these days of the fifth collapse anniversary, as seen on the photo, taken on the outskirt of Reykjavík (for those who know Reykjavík it was taken out on the tip of Seltjarnarnes last night), truly if feels as a view of forever. In truth, the view here seems to be the view into populism, the only fast-growing thing within Iceland of capital controls.

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There is yet no clear plan in sight as to how to deal with the estates of the failed banks and, eventually, lifting the capital controls in Iceland. However, the fact that the government has declared it intends to use a given “wind-fall” from the estates indicates that there is a certain wish(ful thinking). The question is how this “wish” will materialise – and most of all, if the creditors will stage some counteraction, either as a group or single creditors, to seek to claim their foreign assets in foreign courts.

“I hope to see you and your money! in Iceland,” said prime minister Sigmundur Davíð Gunnlaugsson at the end of his speech at “Iceland Investment Forum” in London September 19. His words were met with laughter, more nervous than merry. Many of those present are creditors to the Icelandic banks, possibly not eager to invest more in Iceland until the fate of their last investment is clear.

In his speech the prime minister sought to stress that Iceland was keen to receive foreign investors in Iceland. “My government understands that vibrant business and industry is the basis of growth and welfare. We, therefore, welcome investments in Iceland and are willing to create an environment that is conducive to your needs as investors.”

Interestingly, last Saturday the prime minister said on Rúv that Iceland was not necessarily in need of foreign investments. Although foreign investment might in some cases bring the added value of knowledge, it was essentially a foreign loan; foreign investors just intended to get more out of their investments than they put into it. – An interesting insight into the PM’s business acumen.

In his London speech the prime minister did air his so oft repeated statements of the “leeway” in the estates of the fallen banks:

This brings me to my fourth point, namely the necessary settlement of debts of failed financial undertakings and assets of insolvent estates. My government intends to take advantage of the leeway, which inevitably will develop in tandem with the settlement of the insolvent estates, to address the needs of borrowers and persons who placed their savings in their homes. I have described this as a win-win situation as these settlements will allow us to lift the capital controls to the benefit of the creditors and borrowers alike.

The intriguing question for creditors is what this means for their recovery.

Spending time in Iceland recently I sought to gather impressions on a possible plan regarding the estates. My feeling is that this win-win situation will mostly apply to the government. For the creditors it might be more lose-lose in terms of their Icelandic assets though everyone with interests in Iceland will eventually win-win by having the capital controls lifted.

No doubt the creditors are aware of this – and might be contemplating their next move. In total, the claims against the three estates run to ISK7836, €47.6bn. The three estates hold ISK2750bn, €16.7bn. The difference is what the creditors have already lost.

So far, the estates’ foreign assets amount to ISK1793 bn, €11bn (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii). Of this sum, 57% is liquid funds. Although these are foreign assets, to a large extent held abroad and do not threaten the financial stability of Iceland, the CBI has not allowed them to be paid out, thus securing that Icelandic authorities keep an upper hand in the wrangle over the estates.

The Icelandic upper hand could however quickly turn limp if the foreign creditors, either as a group or single creditors, would choose to test their luck abroad. The fact that the government has only yesterday levied tax on the estates, could possibly instigate legal action, in this case from the estates themselves.

Below, I will try to go through issues related to the capital controls as things stand now. The topics of interest are the Landsbanki bonds, a recent Supreme Court ruling in Iceland regarding old Landsbanki, LBI, guesses as to what the government might be contemplating and what the creditors might be contemplating.

The reality behind the Landsbanki bonds

The three failed banks – Kaupthing, Glitnir and Landsbanki – were, each of them, split in two parts. Not bad and good bank, as might have been logical, but into an domestic operating bank, overtaking domestic, i.e. Icelandic, deposits and other domestic assets and liabilities and then an estate holding foreign deposits and other foreign assets and liabilities. Thus there are the three estates – LBI, Glitnir and Kaupthing – and respectively the new operating banks, Landsbankinn, Íslandsbanki and Arion Bank. The two latter are owned by the estates, i.e. the largest assets of the tow old banks are the two new banks whereas the state owns Landsbankinn.

Because of Icesave – the Landsbanki internet accounts set up in the UK and the Netherlands 2006 and 2008 – the main creditors of LBI are the deposit guarantee schemes of these two countries, both with priority claims. To some degree there is an overlap between the general creditors of the three banks. Around half of the creditors are the original bondholders; the rest has bought claims on the secondary market.

Due to uncertainties regarding Landsbanki assets, the new bank, Landsbankinn, eventually issued two bonds to LBI, to be paid in 2014-2018, mostly in foreign currency. It has been clear for a while that the scheduled repayments are too steep for the economy, i.e. LBI does not holds enough foreign currency to cover the repayment and there is not enough left on the current account for it to buy from the CBI.

The payment schedule is: 2014 ISK17bn, €100m, then ISK60-74bn, €360-450m, the next three years, having then paid the bonds in full 2018. It is disputed how much is needed. The numbers flying around have ranged from ISK50bn, €300m to 200bn, €1.21bn. This does not mean the new bank doesn’t have the funds to pay. It does, but not in foreign currency.

Under normal circumstances, a bank never pays up all its debt in full but refinances. As things are now, that is not a realistic option for any Icelandic financial firm – Icelandic financial companies do not have access to sustainable funding. That could change but for the time being the option is not there.

The Landsbanki bonds, its stakeholders and a step towards abolishing capital controls

After some wrangling between Landsbankinn and LBI, echoing in the Icelandic press this summer, the two entities have now entered into negotiations “on possible adjustments” to earlier settlement regarding the bonds (press release here).

The outcome will be interesting for several reasons: it will remove a certain threat, explained above, to Landsbankinn and its owner, the Icelandic state; it will indicate positions of those negotiating the bonds – and it is a first big step, regarding the estates, towards abolishing the capital controls. The numbers at stake here are considerable: the expected recovery of LBI is now ISK1531bn, €9.29bn with priority claims at ISK1325, €8.04bn. This leaves ISK206bn, €1.25bn, for general claims.

The management of Landsbankinn seems to have felt that LBI was not being very forthcoming in negotiating. On the LBI side the priority creditors, essentially the Dutch and the British governments, certainly have a lot to say on this issue.

The Dutch and the British governments stand to recover their Icesave compensations, i.e. minimum compensation of €20.000 for each depositor. They have already recovered 53.9% of what they expect to get, paid out in three instalments. However, it makes quite some difference to them if they recover everything by 2018 or have to wait considerably longer.

From what I understand there is still some pent-up Icesave irritation among the Dutch and the British negotiators. But the general creditors have also been vocal on rescheduling. Although they stand to get “only” ISK206bn, this is money as well. But since general claims are not paid out until priority claims have been paid out in full, any extension of the Landsbanki bonds will mean that their waiting is prolonged.

The CBI views the rescheduling as the first firm step towards abolition of the capital controls. Many of the general creditors are also creditors to the two other banks, making the Landsbanki bond negotiation interesting in terms of issues that need to be settled re the two other estates. The Landsbanki negotiations can thus be seen as a dress rehearsal for the full performances to come.

Landsbanki bonds – possible solutions

It is clear to everyone involved that the Landsbanki bonds need to be extended. The prospect of the Icelandic economy will be debated, in terms of what could possibly be set aside of foreign currency towards bond payments but also to what extent Landsbankinn could possibly refinance its debt. All of these issues will be mulled over by those negotiating the rescheduling, in addition the more specific terms and conditions of the bonds themselves.

In Iceland, it has officially be mentioned that the rescheduling needs to be “a few years” but that seems far too optimistic. Ten or 15 years seems a more reasonable number. As it is now, the interest rates are low, which means that interest rates will no doubt be negotiated.

Landsbankinn and its owner, the state, are obviously unwilling to see the bank fail. With the bonds being a sizeable chunk of the LBI assets, its creditors are no doubt adamant to secure that the bonds get paid – if not on time then in the foreseeable future.

It is however very difficult to imagine that LBI will agree to any extension unless the creditors get something substantial in return. The intriguing question is what this “substantial” could be. An obvious bit would be a substantial up-front payment. Steinþór Pálsson CEO of Landsbankinn has already mentioned (in Icelandic) a sum of ISK70bn, €420m.

Another – and a truly interesting “substantial” – would be for the LBI to get a permission from the CBI (which has to agree to all payments) to pay out all the foreign assets of the LBI. The reason this is so interesting is that so far, none of the estates have paid out any of the foreign assets, although they, as pointed out above, to not threaten financial stability in Iceland.

At a meeting in London September 26 possible solutions were introduced. It is a pure guess as to what exactly has been offered to the LBI but it is difficult to imagine that the creditors will not try to use their bargaining position to get their foreign assets paid out.

And it is also clear, that the prime minister and Bjarni Benediktsson minister of finance, representing Landsbankinn’s owner, will need to accept whatever solution is negotiated. It must be equally likely that only a solution that the owner accepts a priori will be seriously discussed.

The two tales of a Supreme Court judgment re LBI

September 24, the Icelandic Supreme Court ruled in a case (553/2013) brought by creditors of LBI, both priory and general claimants and the Icelandic state against the LBI. The case centred on how partial payments in foreign currency should be calculated, i.e. what ISK exchange rate should be used. The LBI had used the exchange rate on April 22 2009, the date when the winding-up proceeding commenced. The Reykjavík District Court had originally ruled in favour of LBI but the Supreme Court reversed that ruling.

This case has been interpreted in two distinctly different ways in Iceland, basically spinning two different tales.

The first one is a low-key tale: this ruling brings no fundamental changes. It points out, what was already known, that once the winding-up proceedings starts the assets in an estate holding foreign assets are converted into ISK, for accounting purposes. An estate can – but does not need to – pay out in foreign currency. The exchange rate for payment in foreign currency should be the rate on the day of the payment. This is how several lawyers have interpreted the ruling in the Icelandic media.

The other interpretation is a more sensational tale, so far mostly heard from politicians, i.a. the minister of finance: this ruling is a fundamental confirmation that the estates are in ISK and should only pay out in ISK.

It is interesting that both creditors and the Icelandic state supported the conclusion of the Supreme Court. The motive behind the state’s view is a remnant from the Icesave case where it held the view that the exchange rate on payment day should be used, hoping in due course to gain from ISK appreciation, as a set-off against the interest rates.

Is paying out the estates in ISK the way out of the ISK dilemma?

As mentioned above, the three estates hold ISK2750bn, €16.7bn, of which 2/3, ISK1800bn, €11bn is in foreign assets and 1/3 is ISK assets. This 1/3 is part of the problem that the capital controls keep at bay: there is not, and will not be in the foreseeable future, enough foreign currency to convert these (and some others) ISK assets, owned by foreigners. This problem is further crystallised by the fact that 5% of the claims are domestic, 95% foreign whereas 33% of the assets are domestic, 67% foreign (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii).

Listening to politicians following the Supreme Court judgment, it sounds as if paying out all of the assets of the estates in ISK, the total ISK2750bn, would be the solution to the ISK problem. A priori, as seen from the numbers above, paying all out in ISK can hardly be a solution to anything but only make a huge problem utterly humungous.

Unless, of course, something else is done as well, such as offering the creditors, now holding nothing but ISK, a certain exchange rate in order to exchange their Hvannadalshnjúkur (the highest summit in Iceland) of ISK into foreign currency, with the government then having found its frequently mentioned “leeway” there. More on that below.

As an Icelandic lawyer (not working for the creditors) said recently: “If Iceland wants to remain on good terms with the outer world the estates will be allowed to pay out their foreign assets in the foreign currency they own,” meaning that the ISK problem needs to be solved separately.

Glitnir, Kaupthing and composition

Glitnir and Kaupthing have both applied for an exemption from the capital controls, under the Foreign Exchange Act No. 87/1992 in order to proceed with composition. In this respect, composition means that the estates will be run as holding companies, working on recovering and realising assets on behalf of creditors and eventually paying out the funds recovered.

From the point of view of creditors this process is preferable to bankruptcy proceedings because a bankrupt estate needs to sell off assets in a shorter time. One of the comments heard in Iceland after the LBI ruling was that bankruptcy would allow for all assets to be paid out in ISK. This is however wrong. There is no difference as to payment between composition or bankruptcy.

Both Glitnir and Kaupthing sent an application for composition to the CBI before end of last year. CBI has not answered but following a query this summer from Glitnir, the CBI has now answered Glitnir in a letter September 23. The bank emphasises that analysis of the situation of the Glitnir estate is on-going, both within the bank and the estate.

Although a detailed analysis is not yet complete, it is clear that the Central Bank of Iceland cannot give a positive answer to the Glitnir winding-up committee’s exemption request without a solution concerning the assets that, other things being equal, will have a negative effect on Iceland’s balance of payments when they are disbursed to creditors, 93.8% of whom are non-residents, as is stated in Central Bank of Iceland Special Publication no. 9. Reference is made here to the classification of creditors, to Glitnir hf.’s króna assets (including shares in Íslandsbanki), and foreign-denominated claims against domestic parties. In order for the Central Bank to be able to grant an exemption for the above-mentioned composition agreement, there must be a solution concerning these assets, so that Iceland’s balance of payments and planned capital account liberalisation provide scope for disbursement to foreign creditors. It is important to emphasise that this is not a matter for negotiation. Either this condition is fulfilled, or it is not. Glitnir’s exemption request does not fulfil this condition at present.

In view of the foregoing, the Central Bank considers that there are no premises for setting up a process of the type proposed in the winding- up committee’s letter, and certainly not one subject to binding time limits. It is the role of the Glitnir hf. winding-up committee, in connection with its exemption request, to create the conditions that allow for the approval of an application for a composition agreement. As before, the Central Bank of Iceland is prepared to assess whether it is likely that specified options fulfil the above-mentioned conditions. If the Glitnir hf. winding-up committee has developed ideas of this type, as is asserted in its letter, the Bank is ready and willing to discuss them.

This letter indicates that the estate – and this would assumedly apply to Kaupthing as well – will need to come up with a solution on the ISK assets. The CBI is not going to negotiate though it seems to indicate willingness to engage in assessing if conditions are met or not.

Creative taxing: taxing estates of financial companies

The first action taken by the new coalition government, in power since May, regarding the estates of the fallen banks is a tax on the estates of failed financial companies, announced October 1 in the budget proposal for 2014. Bank tax will be increased from 0.041% to 0.145%, levied on all licensed financial companies, operating or in winding-up proceedings.

At first sight, this might seem to indicate all financial companies in winding-up proceedings, i.e. the three estates but also other failed financial companies such as Saga Capital, VBS, Icebank and some saving societies. However, according to the FME (Icelandic FSA) website over licensed financial companies there is only one such licensed company, now in winding-up proceedings, LBI. The other failed financial companies have all lost their licensed status and are mere holding companies.

The idea was hardly to tax only LBI but as the proposal stands, the tax apparently only hits LBI. If the tax should cover the other estates the proposal, as far as can be seen, needs to be rewritten or clarified along the lines of “companies, which were once licenced/licensed before/after anno XXX as financial companies…”

Taxing estates is, I’m told, normally not done and has, to my knowledge, never been the practice in Iceland, anymore than in other countries. Lawyers have mentioned that a tax on failed companies could be seen as an expropriation. The ministry of finance has definitely shown remarkable creativity here.*

What the government wants – all of the ISK assets and/or even more?

It is safe to conclude that the Progressive Party was voted to power on the basis of its election promises of finding a “leeway” in the estates of the collapsed banks in order to provide what the prime minister has called the most extensive debt-relief in the world. He has been unwilling to mention any numbers but one persistent number is ISK300bn, €1.8bn.

The debt-relief has been widely criticised, i.a. because of inflationary effects, by economists. It also goes against promises of the Independence Party of a sustainable fiscal policy and paying down public debt.

The government and some businessmen have been pointing out lately that it is wrong to portray the problem of capital controls as touching solely creditors locked in with their assets in Iceland. All Icelanders are locked in. Consequently, drastic moves are needed to abolish the controls.

It now seems that one of the solutions possibly contemplated by the government is to “take over” all the ISK assets and possibly some of the foreign assets – though how this would be possible is still unclear. The motive for this drastic move is that the Icelandic current account will not, for the many coming years, allow for any foreign currency to be used to convert ISK assets of foreign creditors.

Those who propose this “take over” seem to feel that the “ISK-isation” of the estates, i.e. regarding all the assets as ISK assets and paying them out in ISK, is an essential move. Writing the assets down via the exchange into foreign currency would then be one possible way of achieving this “take over.”

Although – as far as I can see – creating quite a number of problems, this would however solve two fundamental problems for the coalition government: it would provide the Progressive Party with the ISK300bn, or whatever it will decide is needed for the debt relief – and it will placate those within the Independence Party who think that “estate-windfall” should benefit Icelanders in paying down public debt.

From the numbers above, it is possible to guess at the numbers involved: all the ISK debt is about 1/3 of the estates, ISK950bn, €5.76bn, meaning there would be something like ISK650, €3.94bn, out of this process, a third of Icelandic GDP, to pay down public debt. Given that the Icelandic public debt to GDP is forecasted to be just below 100% of GDP this year, this sum would reduce the debt by a third.

Will the government proceed with these ideas? Time will tell. Relevant ministries and the CBI all have legal opinions at hand, underlining Icelandic law on property right, the importance of keeping all actions within Icelandic law etc. But if the wishful thinking becomes so strong, fuelled by little sympathy for foreign creditors, one never knows. All solutions can be made pretty in an excel document – but to turn them into something that withstands legal challenges and doesn’t just solve the problem like warming one’s toes by peeing in the shoe is quite another matter.

What the creditors could do

Five years from the collapse in Iceland, the capital controls are still in place and the foreign creditors have not yet received any of their assets, apart from the priority creditors to Landsbanki. The priority claimants to Kaupthing and Glitnir have already been paid out, respectively ISK130, €790m and ISK54bn, €330m.

Faced with the possibility that their assets will now be gnawed into by tax, it is seems likely that the estates will take a legal action to challenge the new taxation.

It has taken some years to clarify various legal issues. From the point of view of the foreign creditors, the cash part of the foreign assets – ISK1029bn, €6.24bn, of the ISK1793bn, €10.88bn or 57% – is just waiting there to be paid out.

However, that is not happening as long as the fate of the ISK assets has not been settled. And after a change in the foreign currency law in March 2012, the CBI has to agree to, give exemption to, all payments of the estates.

The bondholders and other creditors may eventually lose patients and sell their claims. In Iceland, much is made of the huge profits made by creditors. That is somewhat misleading. The bondholders have already incurred huge losses though large institutions have no doubt sought shelter behind CDS. Depending on when the buyers in the secondary bought some of them will profit handsomely.

Invariably when creditors lose hope and patience claims get sold and the buyers are those who specialise in difficult assets. These creditors use the courts as much as they can. From small creditors in the Icelandic banks I have heard that there is no lack of suitors from this pack.

It is difficult to avoid the thought that at some point the creditors might lose patience – either as a group or single creditors – and seek legal action against the Icelandic state. That would then most likely start with proceedings where the foreign assets are, to get the assets frozen, after which the creditors would try to prove that they have been waiting needlessly long and nothing is being done to solve the issues.

The Icelandic government has, until earlier this year, not been party to the fate of the estates. With a change in the foreign currency law (nr. 87/1992), the minister of finance and minister of banking have to agree to CBI exemption regarding companies with a larger balance sheet than ISK400bn, €2.42bn, which includes the estates.

This might prove to be a double-edged sword in the sense that the government now risks to be sued because of the estates of the collapsed banks.

The creditors are much vilified in the Icelandic debate, seen as vultures and predators and no politician mentions them without these words. It is ironic that now on the fifth anniversary of the collapse there are again foreigners to blame, thus clouding the fact that the creditors are there as a result of actions taken by a group of ca. thirty Icelanders.

There is much at stake for the creditors, as there is for everyone who stands to gain from the abolition of the capital controls. But those who can gain most from a successful abolition – and consequently stand to lose most from mishaps and delays – are Icelanders themselves. Hopefully, all those involved will recognise this and have the good sense to seek constructive solutions. As an economist said recently: “Capital controls are a slow death.”

*At a closer look, the three estates – of Kaupthing, Landsbanki and Glitnir – are named in the budget proposal (the budget proposal, in Icelandic). As mentioned above, there are other estates of failed financial companies in Iceland but apart from size, the real difference between these other estates and the three big estates is that in the small ones most of the creditors are Icelandic whereas the creditors to the three big ones are 93% foreign entities. – The text seems ambiguous and will most likely be clarified at some later stage.

These are all complicated issues. I hope I haven’t made mistakes, will correct them if found. However, I hope Icelog readers do check the sources if needed.

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Again and again prime minister Sigmundur Davíð Gunnlaugsson has been asked about his exact plans for the abolition of the capital controls. But so far, it is entirely unclear how the government plans to proceed on debt relief, the estates of Glitnir and Kaupthing, the issues concerning Landsbanki and ultimately the abolition of the capital controls. There are by now some indications that the two coalition parties find it difficult to advance on these issues because the two parties disagree much more fundamentally than has appeared hitherto.

During the election campaign Sigmundur Davíð Gunnlaugsson leader of the Progressive Party and now prime minister said there was scope to get a considerable sum of money out of the estates of Glitnir and Kaupthing. These funds were to be used for a “correction fund” to finance debt relief for those whose loans had gone up but who had not profited from the extensive debt relief, the so-called 110% way (explained here), put in place by the previous government.

The voters seemed untroubled by the fact that the Progressive Party never clarified in detail how exactly this considerable sum could be extracted from the estates, which after all are the estates of two failed private banks. The fact that the government needs to agreed to terms of the composition of these two banks – due to the foreign-owned ISK assets (not enough foreign currency to exchange the ISK assets) – has been presented by the Progressive Party as a way to create this, in Progressive-speak, “scope” to gain funds.

In the coalition agreement the following (in my translation) is stated:

As indexed debt increased and asset prices fell, i.a. because of the effect of the collapse of financial firms and because of their appetite for risk leading up to the collapse, it is right to use the scope – which will most likely be created parallel to the winding down of the estates (of the collapsed banks) – to assist borrowers and those who put their savings towards their homes, just like the Emergency Law (passed on October 6 2008) secured that the assets of the estates were put to use to defend financial assets and to resurrect domestic banking. The Government keeps open the possibility to set up a special correction fund to reach it goals.

This was neither elegant nor clear (the clunky prose reflects the Icelandic original). Then came the opening speech of the prime minister as Althing gathered in early summer but the speech threw no light on how this “scope” would be created.

Last week, the prime minister was interviewed on Rúv’s morning programme where the two journalists asked the prime minister if he could clarify what people could expect in terms of debt-relief, the funding of the “correction fund” and how the estates would be treated. The prime minister said he now was much more optimistic than earlier, the “scope” was much greater than he had expected but unfortunately he did not share with listeners what his exact plans are. He did say that he had by now talked about these issues so often that it should be clear what he had in mind but as the journalists pointed out it is still not clear because it has never be clarified.

Yesterday, Althing gathered again after the summer recess. In his speech (in Icelandic) there was one sentence on the capital controls (my translation):

New plan on the abolition of the capital controls is forthcoming. A special consideration will be given to minimising the possible negative influence of the winding-up of the collapsed banks and to strengthening the framework of the financial system, which is one of the prerequisites of a successful abolition of the controls.

Tonight, the prime minister was interviewed on Rúv and yet again he was asked about the by now usual topics: the “correction fund,” the capital controls and what people could be expect in terms of debt relief. Again, no clarity, no detail but the prime minister said one rather remarkable thing: if people wanted to understand better what to expect they could calculate it from the coalition agreement. – Having read the agreement back and forth, I can’t possibly find anything in the agreement that gives any clear indication as to what people can expect. (I have sent an email to the prime minister’s spokesman asking what part of the agreement the prime minister is referring to and how that part can be used in the way the prime minister indicates.)

Clear what the creditors want – unclear what the government wants

During the election campaign earlier this year Bjarni Benediktsson leader of the Independence Party and now minister of finance repeatedly said that abolishing the capital controls was easy and would not take long. That might be true if there were a plan in place to abolish them. That plan does not seem to exist – or at least, nothing credible has been heard of it.

The Central Bank of Iceland has clearly done extensive work in terms of clarifying the macro economic aspects of the economy. The estates of Glitnir and Kaupthing, as well as the creditors have also done extensive analysis of the financial situation of the estates.

The prime minister has indicated that he is now waiting for the creditors to make a move. However, he seems to ignore that the creditors have already made a move: both Glitnir and Kaupthing have presented a detailed draft of composition to the CBI – but so far no answer. It is abundantly clear to the CBI what the creditors want. The only unclear thing is what exactly the government wants to do and how it wants to proceed.

Keep Icelandic banks Icelandic

The CBI has indicated that if one of the two new banks – Íslandsbanki and Arion, owned respectively by Glitnir and Kaupthing – could be sold to foreign investors the sale, in foreign currency, would facilitate solving the problem of the foreign-owned ISK assets. There is already news that Hong Kong investors have shown interest in buying Íslandsbanki and other offers might surface.

Without intending to launch some conspiracy theories it is safe to assume that parts of the political establishment and parts of the Icelandic business community want to keep ownership of the Íslandsbanki and Glitnir on Icelandic hands. If the government listens to these voices, as it well might do, it is highly likely that part of its equation is not only how to create the “scope” for finding the money for the “correction fund” but also how to keep the two banks in Icelandic ownership.

This angle of the whole controls conundrum does not make it any easier to solve and it adds yet another political non-financial hurdle to the process.

Landsbanki – a special case

Landsbanki is owned by the Icelandic state because the two major creditors of old Landsbanki – the Dutch and the UK government (harking back to the old Icesave saga) – were not willing to assist in setting up the new bank, in the same way the creditors of Glitnir and Kaupthing agreed to when Íslandsbanki and Arion came into being. Therefor the state had to step in to capitalise the new bank.

There is now the problem that new Landsbanki owes the old one ca ISK270bn, €1.67bn, in two bonds, due in foreign currency by the end of 2018. The first step towards resolving the capital controls is to find a solution to the Landsbanki bonds, i.a. extending maturity of the two bonds, changing interest rates etc. The new bank has mentioned it needs a “few years” – 15-20 years seems a more realistic solution but nothing near this number has been mentioned officially.

Is there really a majority for the Progressive’s debt relief?

As explained in an earlier Icelog, many have criticised the debt relief ideas but that does not deter the prime minister from advocating this with great fervour. However, there is also strong criticism from some members of the Independence Party parliamentary group. The last few days I have heard musings that there really might not be a majority in parliament for the kind of debt relief the Progressive Party has been advocating. At least one IP parliamentarian, Vilhjálmur Bjarnason, has aired his views openly, saying he could not support the kind of debt relief the Progressives have in mind.

In addition, there seems to be disharmony at the core of the coalition government as to how to proceed regarding the capital controls. Some weeks ago it was announced that the government was just about to appoint “abolition coordinator” who would oversee the process towards abolishing the capital controls. Two names were mentioned as the most likely ones, one from each party. So far, nothing has been done because it seems the two parties cannot agree on whom to choose.

So far, there is a complete lack of clarity as to how the government will go about solving the problems that have to be solved in order to abolish the capital controls. The feeling is that since the government does not know where it is going it is not likely to get there any time soon.

*Here is an earlier Icelog explaining the financial aspects of the capital controls.

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