Sigrún Davíðsdóttir's Icelog

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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Cyprus is struggling with its capital controls, with no fixed abolition date in sight. Iceland has also discovered that the best way forward is to have a plan with benchmarks but no time limit. Here are some facts on the Icelandic controls, what is at stake and for whom. As Cyprus might find out – and Iceland is already experiencing – the longer the controls are in place, the stronger the forces against abolishing them.

Capital controls come in many shapes and sizes and capital controls in Iceland and Cyprus are of different nature, set to solve different problems. In Iceland, the controls were put in place end of November 2008. At the time, more capital was flowing out of Iceland than could ultimately be converted into foreign currency. The problem stemmed from ISK600bn, €3.76bn, owned by foreigners (or entities abroad), hence the name “offshore krona/ISK” – there was no way the Central Bank of Iceland could find enough foreign currency to convert these ISK investments into foreign currency. Like in Asia in the 1980s these investments, in Iceland called “glacier bonds,” were made to profit from high interest rates in Iceland.

With time, new sources of ISK that need to be paid out in foreign currency have piled up, in total creating a problem amounting to about ISK1200bn, €7.52bn, ca. 70% of the GDP of Iceland. The core of the problem is ISK assets, needing to be converted into foreign currency at some point and kept firmly in place for now by the capital controls. With the controls in place there are various restrictions on movement of assets in out and of the country. I.a., every Icelandic citizen in Iceland has to hand over to the CBI whatever they earn in foreign currency.

The situation in Cyprus, part of the Eurozone, is different. The Cypriot capital controls were needed to prevent a run on the banks, i.e. hindering that deposit holders would empty the banks. Consequently, the controls were more invasive and much more felt, with maximum withdrawal etc. The controls have gradually been eased but there is now, as far as I can see, no certainty as to when or exactly what conditions need to be in place to abolish them.

The laws on capital controls in Iceland expired last year but there is now no time limit. The CBI has certain benchmark needed to be reached.

In Icelandic, one way of describing a short-lived blessing is “peeing in one’s shoes” – it is a quick warmer but the effect does not last and ends up as a messy problem. That is exactly what capital controls are: a quick blessing, which in time turns out to be costly and eventually costlier than the benefits. It is well established that the longer capital controls are in place the greater the damage: they tend to create an asset bubble as too many currency units chase too few investment opportunities, they distort the business environment and eventually they are inductive to criminal behaviour and corruption and – as anecdotal evidence now shows in Iceland: capital controls create unjustified privileges.

The ISK1200bn problem held in place by capital controls

In Iceland, the capital controls now hold three more or less equally large batches of ISK seeking to be paid out in foreign currency. The glacier bonds now amount to ca. ISK400bn, €2.51bn. Those who own them may to a certain degree be patient investors, happy to enjoy Icelandic interest rates, still quite a bit higher than in the Eurozone.

The second ISK400bn batch consists of ISK exposures with direct or indirect state guarantees. The largest part, ISK270bn or €1.69bn, are bonds exchanged between the new and the old Landsbanki when the new one was set up. Other exposures here are loans of state owned companies like Landsvirkjun, the energy company.

The third ISK400bn batch consists of ISK assets in the estates of Glitnir and Kaupthing, which need to be paid out in foreign currency. Ca. 90% of these assets are owned by foreigners but Icelandic creditors like the CBI and Icelandic pension funds own ca. 10% of these assets, meaning that 10% would float back into Iceland when/if these assets (and the estates’ foreign assets) are paid out. It also means that whatever happens to these creditors (i.e. whatever measures used to dissolve the estates and pay out creditors), does not only apply to foreigners but also to Icelandic creditors. And 10% is not a trivial figure in proportion to the Icelandic economy.

In order to lift the capital controls it is necessary to solve the problems that keep the controls in place. This means that in Iceland the size of the problem is roughly 70% of GDP. That in itself would be no mean feat – but in addition, the government (or at least the Progressive Party) has declared that this process has to create a windfall of ca. ISK300bn, €1.88bn, which it wants to use for further debt relief for those who are too well off to have benefitted from earlier debt relief (which so far is the most extensive debt-relief in any debt-hit European country).

Basically every one who does not have debt at stake thinks this policy, first launched as an election promise by the Progressive Party before the election in April, is a bad idea (i.a. potentially inflation-fuelling; funds would be better used to pay down sovereign debt, i.e. benefitting the whole population), amongst them the CBI, OECD, and the IMF. As reported earlier on Icelog, Prime Minister Sigmundur Davíð Gunnlaugsson does not take seriously criticism from foreign “acronyms,” meaning the OECD and IMF – but that is another story.

The glacier bonds and the state-guaranteed assets – 2 x ISK400bn

Though the two estates pose the trickiest problem, the two other batches also need to be dealt with. The glacier bondholders may well get some offer inducing them to stay, such as unfavourable exchange rate/levy. Also, as mentioned above, some of these investors may be in no hurry to leave.

The CBI and others have indicated that the real problem of state-guaranteed ISK assets, though ISK400bn in total, is thought to be ISK250bn because there are ca. ISK150bn worth of foreign assets/revenues to offset it.

Part of the solution would be to extend the maturity of the Landsbanki bonds, now the topic of intense negotiations between the Landsbanki estate and the new Landsbanki. Due to Icesave, the Dutch and the UK guarantee deposit schemes are the estate’s largest shareholders. Dutch and British officials have a thing or two to say on this matter and they are not necessarily dripping with milk of human kindness after the EFTA Surveillance Authority and the EU unexpectedly lost the Icesave case at the EFTA Court.

The trickiest ISK400bn batch

It is clear that the funds for the debt relief should not come from just any of the three problem batches but from the one that mainly regards foreign creditors, i.e. the Glitnir and Kaupthing batch. Politicians, mainly from the Progressive Party, hoping for a windfall here, seem to hope that although the ISK400bn assets are not trivial, the foreign creditors might be willing to negotiate a write-down – or some other measure that would result in funds for the government (though these are assets of private companies) – in order for the creditors to get their hands on the foreign assets in these two estates, the equivalent of ISK1500bn, €9,40bn, close to 90% of Icelandic GDP.

These foreign assets are sitting there, ready to be handed over – ca. ISK1000bn, €6.26bn, in cash, the rest in assets. It is clear though that the CBI, which by law needs to agree to the estates’ composition (or whatever happens to them) will not grant any asset payout until the destiny of the ISK assets is decided. No piecemeal service here.

The possible measures and solutions re Kaupthing and Glitnir are now being furiously pondered on and discussed among those who have a skin in this game – meaning the administrators of the two estates, the creditors (or their ad hoc creditor committees and their representatives), the CBI and the government, probably mostly within the ministry of finance.

Bjarni Benediktsson minister of finance and leader of the Independence Party is well positioned to make an enlightened choice since he has all relevant experts at his fingertips. Also, IP is traditionally well connected to the ministerial administration. Gunnlaugsson, who no doubt will want to follow this closely – given the election promises at stake for him and his party, ultimately his credibility – might find himself in a more difficult position in terms of access to the same kind of expertise, if he wants to make his own independent assessment. The PP, out of government from 2007 to 2013, might not have the same access as the IP.

Why postponing a solution may be a costly option

Foreigners, who have had dealings with Icelanders, often mention that it is notoriously difficult to get Icelanders to make up their mind and commit to a final decision. The estates might be one such problem where the government will find it very difficult to make up its mind, not least because the PP, after their rhetoric and promises, have to present a solution that looks like a victory over the foreign creditors, with the funds to show.

These problems have been clear to everyone concerned for a long time and clearly all those involved with the two estates have been problem-crunching for months now. One of my sources pointed out to me that if this problem is not solved relatively quickly, i.a. a solution presented in the coming month (though the fine and final details make take some mulling-over) this might drag out for quite a while because it would suggest a fear to bite the bullet rather than a lack of informed options.

But can’t the government just wait around until it has found the perfect solution for the two estates? Not necessarily because without a solution the capital controls stay in place. And the longer it takes to solve the issues of the two estates the harder it is to solve. Delays of half or whole years might burden Iceland with added costs of the capital controls.

A delay can have two-fold effect on the estates: the assets will change – and claims will most likely be sold to a different category of investors compared to present creditors.

As to the assets, unsold assets give scope for negotiation of value. The more assets sold and turned into cash, the less scope to negotiate on value. The thinking among some in Iceland is that the creditors of Kaupthing and Glitnir could just solve the problem by giving the ISK assets to the state (for example, handing the over the CBI), in order to get at least the ISK1500bn foreign assets. Negotiating a write-down is more or less the rule in this situation but a pure gift sounds more than wishful since all creditors have to maximise their recovery. Amongst them are the CBI and Icelandic pension funds, which might find it difficult to justify this kind of magnanimous action.

That said, the creditors may in due time well show some creativity and present a solution that indicates they understand the problems Iceland faces. Remains to be seen.

As time passes, it will be more difficult for creditors to show any kind of creativity because more assets will be sold and converted to cash, leaving only the currency rate to be negotiated.

Thus, it can be argued that time is not on the side of the state. The creditors will not be happy to wait but they can get out of the situation if they want to and they, being professional investors and institutions, have seen all of this before.

Here is what delays might do to the creditor group. For now, the original bondholders in Kaupthing and Glitnir own more or less half the claims, with the other half having been sold off to those who specialise in distressed debt. The division is not quite clear-cut because banks and big creditors often invest with the buyer when they sell off their claims in order to get a cut of the up-side if there is any.

If creditors start to think that the assets will be dealt with “sub specie aeternitatis” they will sell their claims – and the more hopeless it seems the more the write-off and the more virulent the buyers. The vulture kind, prepared to sue everyone to hell in order to get as much out of the claims as possible. – This potential change of creditors will of course not happen over night but yes, over time if creditors start to lose hope and just want to get however little out of what they have.

Consequently, the longer it takes to find a final settlement re Kaupthing and Glitnir the greater the difficulties in finding a solution, bringing on losses for domestic creditors as well. And, worst of all, the capital controls stay in place.

The destructive effect of capital controls and the rise of a new Icelandic nomenklatura

In several reports, i.a. on financial stability, the CBI has in no unclear terms spelled out the cost of capital controls for the Icelandic economy brought on by a potential asset bubble and distorted business behaviour. The CBI deems that these are potential risks, which have not yet happened.

It is notoriously difficult to tell when there is bubble, i.e. when assets are mispriced and asset prices have been rising fast in Iceland, i.a. property prices and shares of listed companies. Both the CBI and financial analysts say that so far, these price increases are in tune with the economy, not a bubble.

The no less worrying effect is, I think, that capital controls are potentially fertile ground for corruption. With time, they create a booming industry seeking to avoid the controls. And with time this industry will do what it can to keep the controls in place.

This is a general course of events in countries with some kind of capital controls. In addition, the capital controls in Iceland are slowly creating its own special kind of a privileged nomenklatura that can buy assets at a cheaper price than other Icelandic mortals.

In order to relieve the pressure of the offshore ISK, the CBI came up the with the idea of offering offshore ISK owners a way of investing this money, given certain terms and conditions, if they bring in foreign currency in addition to the offshore ISK. This seemed like a reasonable way to attract foreign investment to Iceland. The problem is that this has, apparently, not attracted foreign investors but gives Icelandic investors, with foreign assets (which have to be since before the capital controls) and offshore ISK, the possibility of buying assets in Iceland, be it property or financial assets, at a ca. 20% discount to Icelanders who have nothing but their hard-earned not-worth-much ISK.

This new nomenklatura is now pretty clear and known to everyone though it is hardly ever mentioned in the Icelandic debate. I can certainly not remember ever having heard a politician mention this (but here I might be wrong since I don’t follow the Icelandic debate in detail).

Another sneakier way is less well known but indeed existing, I’m told.

It is always presumed that the glacial bondholders are foreigners. That is probably how it was in the beginning of time, i.e. when these investment objects were created and up to the collapse. What I now hear from various sources is that there are Icelanders in this group. No, not necessarily the notorious billionaire “Viking raiders” but wealthy Icelanders, in Iceland, who have bought the bonds after the collapse and now hold them through foreign companies or “nostro” accounts of foreign banks. Out of the total ISK400bn these may not be high sums but, again in Icelandic context, quite a bit of money.

Here is the trick: the law on capital controls allow glacial bondholders to convert the interest rate of glacier bonds into foreign currency and move them abroad. Icelandic glacial bondholders can then take this foreign currency and bring it back to Iceland through the CBI investment offer, to buy Icelandic assets, meaning they get the Icelandic assets at ca. 20% discount, as mentioned above.

It would be very interesting to know who these alleged Icelandic glacial bondholders are. It would throw light on how privileges are meted out in the regime of capital controls and clarify the stance that certain individuals may take in the public debate.

Waiting is not an option – if the cost of capital controls matters

As argued above, there are various reasons why waiting is costly, why waiting compounds the problem of the capital controls and makes the ensuing problems more engrained over time. Needless to say it is extraordinarily difficult to say exactly at what point the cost is greater than the benefits of the controls. Also, assessing the cost of the corruption the capital controls create is particularly hard to evaluate.

The capital controls in Iceland have been in place for the best part of five years – in Cyprus only for five months. Although the controls in the two countries are of different nature, put in place to solve different problems, Iceland can be an interesting example for Cyprus – and possibly, with time, an example of what to avoid.

*Here are some earlier Icelogs on capital controls.

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Under the demanding eyes of the IMF, the Icelandic Left Government turned the economy around – growth returned and unemployment went down. But Iceland is far from being on top of things. Both the sovereign and some of the big corporations have to meet tough payments in foreign currency in the next few years, several times more than the current account surplus. This gap can only be met with extended maturity and/or foreign loans. If the Icelandic Government is, at the same time, going to spirit money from the pockets of foreign creditors – in some cases the big banks that will most likely be asked for loans – it is difficult to see a happy ending to this saga.

“Iceland Chamber of Commerce recommends that Iceland stops comparing itself to the Nordic countries since we are way ahead of them in most respect.”  Instead, Iceland should compare itself to champions such as Ireland, Cyprus and Greece.

This statement, from a 2006 report on “Iceland in 2015” was published by the Icelandic Chamber of Commerce, at a time when it seemed Icelandic bankers and the business leaders closest to them could both fly and walk on water. The matter-of-fact statement perfectly captures the hubris in the Icelandic business community during the few years of expanding financial sector and is often quoted to demonstrate the mind-set at the time. Most of the apostolic twelve who wrote the report are tainted by the collapse in October 2008 and one of them has been charged with serious financial misconduct.

Now, anno 2013 the outlook for 2015 is rather different. In 2015, Iceland needs to have at hand current account surplus of ISK120bn, €787m, in order to cover exposure of some large enterprises like the national energy company, Landsvirkjun and Orkuveita Reykjavíkur, the Reykjavík Energy Company, OR. At present, a realistic sum to expect is ISK30-40bn, €197-262m. The outlook for the three following years is similar. The situation is carefully explained in the most recent financial stability report from the Central Bank of Iceland, CBI (so far, only in Icelandic; expected in English this coming week).

Fish and aluminium are the largest components of Icelandic exports – and since both of these are finite resources, i.a. cannot be produced ad infinitum, it is out of the question that increased exports can cover the lack of funds. Something more is needed – and this “something more” should at best be some combination of extended maturities and borrowing.*

During the election campaign, the leader of the Progressive Party Sigmundur Davíð Gunnlaugsson told Icelanders that ISK300bn, ca. €2bn, could be wrenched out of foreign creditors of the two collapsed banks, Kaupþing and Glitnir, and distributed to indebted households – nota bene, not households struggling to pay, just indebted households, which are in fact mostly the best off households (the household debt is explained in a CBI report from June 2012). Fetching this money – never quite explained how (the estates are private companies, unrelated to the sovereign) – would be easy since the foreign creditors were in great hurry to get their money out of a country with capital controls. And consequently, the capital controls would be abolished pretty soon.

None of the other parties in Alþingi, the Icelandic Parliament, wanted to follow this path. Some critics pointed out this debt-relief paid out in cash, would only fuel the already too high inflation. However, this is the promise the Progressives are working on winning support for now that they are conducting coalition talks.

No matter the outcome, finding a way to abolish the capital controls as well as solving the lack of foreign funds is the largest, most complex and most pressing task awaiting a new Government in Iceland. There is no lack of ideas in the public debate, many of them utterly unrealistic bordering on the dangerous, often aired by businessmen who never declare their own personal interests.

But who is really in hurry – and what are the issues at stake? In short, Icelandic entities are under huge financial pressure. This pressure can only be solved by foreign loans – which have to come from financial institutions some of which are creditors to the estates of the two banks, Kaupthing and Glitnir.

The claims, the creditors and the “glacier bonds”

Roughly half of the creditors of Kaupthing and Glitnir – there is quite an overlap – are the original bondholders, most of them big financial institutions. The other half are investors who bought claims post-collapse. The division is not clear-cut – bondholders often put forth some of the financing as they sell the claims in order to have a stake in the possible upside.

The original bondholders lost ca. 5-6 times the Icelandic GDP – at present ca. ISK1600bn, €10bn – the moment the three banks folded. Their losses were no doubt greatly diminished by credit insurance and most likely many of them incurred little losses. Anecdotal evidence indicates that some large loans in 2007 from foreign lenders to Icelandic entities did indeed cause losses because the lenders could not sell them on as they intended to.

Just after the collapse, the claims were sold for a song but the price rose quickly. Much is made of the astronomical profit of the creditors, often called vulture-funds in the Icelandic parlance even by those who should know that vulture funds pray on sovereigns in or facing default (trying to squeeze the sovereign to pay its bonds in full), not creditors to private companies (where the value of the estate depends on the recovery). During the election campaign Gunnlaugsson stated that there was no harm in squeezing the creditors who all, according to him, had bought their claims at 95% write-down and consequently made so much money that they had to accept some write-down. Though far from true, this statement seemed music to the ears of the voters.

For the time being Icelandic experts on the issue think the price of the claims is too high. There is a great turnover in the market for Icelandic claims – one claim has for example allegedly been sold over 60 times – but that seems to have little to do with value and more to do with incentive-structures in funds dealing in claims. The Landsbanki estate recently seized the opportunity and sold its claims in Glitnir.

In addition to the creditors of Glitnir and Kaupthing there are the owners of the so-called “glacier-bonds” – bonds sold in the years up to 2008 to profit from high interest in Iceland. The largest issuer was Toronto Dominion.

The assets at stake – and the core of the problem: ISK assets owned by foreigners

The creditors own assets worth roughly ISK2500bn, ca. 150% of GDP, whereof ISK-denominated assets amount to ca. ISK800bn. The foreign part, ISK1700 consists of ca. ISK1000bn in foreign currencies, cash and roughly ISK700bn in foreign assets, such as stakes in retail, foreign property etc. The “glacier-bonds” amount to ca. ISK400bn. All in all, the ISK “problem” amounts to ca. ISK1200bn (and could well be ISK100-200bn more, depending on valuation etc).

When the split between the old banks and the new banks was effectuated, the old banks were made to lend assets to the new banks in order to make them sustainable. This means that the estates of Glitnir and Kaupthing own the new banks almost entirely, their stakes valued at ca. ISK250bn – the Icelandic state owns 5% in Íslandsbanki and 13% in Kaupthing.

Because of the Icesave problem, Landsbanki (owned by the Icelandic state) is in a category of its own. When the new Landsbanki was founded, the new bank got a forex loan worth ca. ISK350bn, from the old bank, which it has to start repaying in 2014 but the largest repayments come in four instalments, 2015-2018. The loan being a forex loan it is a forex liability and has to be paid back in foreign currency.

The general understanding amongst those working on these issues in Iceland is that the repayment problems rising from the repayment of the Landsbanki bond, as it is generally called, have to be solved first, i.e. before the problems related to the foreign creditors. Some extension might be possibly but it is essential for new Landsbanki to refinance the loan by borrowing, obviously in foreign currency, i.e. borrowing abroad.

The core of the problem is assets owned by foreigners in Icelandic króna, these ca. ISK1200bn (though of different origin, the Landsbanki bond is part of this sum) – because there is not enough foreign currency to pay out the ISK assets. Although the scale of the problem was not clear, capital controls were put in place – weirdly late, not until November 27, 2008, almost two months after the collapse. Until the CBI and the coming Icelandic Government have figured out how to secure an orderly solution – most discussed is some sort of an exit levy, a write-down through the currency rate or a combination of both – the capital controls cannot be lifted unless greatly jeopardising the financial stability in Iceland.

None of this is news to most of the creditors many of whom follow things in Iceland closely, i.a. by being part of “Informal Creditors Committees of Kaupthing and Glitnir,” the ICCs, represented by restructuring firm Talbot Hughes McKillop Partners and the law-firms Bingham McCutchens and the Icelandic Logos Legal Services. There is now also an ad hoc committee with members from the IMF, the ECB and Icelandic institutions to discuss various ways of solving these problems. The ad hoc committee is not part of the process of solving the issues but is expected to come up with thoughts and ideas, so sorely needed. – In the end, the CBI and the Icelandic Government will have to solve the problems related to the capital controls.

But the creditors do not only have an eye on their ISK assets – they are very much vying for getting hold of their foreign assets, worth in total ISK1700bn, whereof there is ISK1000bn in foreign currency, ready for picking. Since these are foreign assets in foreign currency, they do not affect the stability of the Icelandic economy. However, the CBI will hardly want to let go of these assets until it is clear how the ISK assets are dealt with and eventual haircut.

The feeling is that the foreign creditors are ready to accept some write-down on the ISK assets against getting the entire foreign assets. As in any other Western country, the creditors are protected by property rights – and should be rather sure of their right to the foreign assets. The ISK assets are more problematic – there is not the currency to pay it out.

Composition or bankruptcy?

During 2012 creditors in both banks worked on terms of the compositions of Glitnir and Kaupthing. Because of the capital controls the CBI needs to agree to the composition. Both estates had hoped to have the composition in place by the end of last year but the CBI was not ready to negotiate the final terms. The feeling is that the CBI wanted to wait until new Government was in place; there might be some Icelanders quaking in their boots at taking these vital decisions that will affect the Icelandic economy for years to come.

With changes to laws on capital controls, made just before the Alþingi went into recess, the CBI now has to confer with ministers. When new Government is in place this will be one of its first tasks. As to time, it is difficult to imagine this will go speedily. Once source said it could take as much as 5-8 years – and obviously the repayment of the ISK assets might stretch over a very long time indeed.

There are clearly huge interests at stake but there are wheels within wheels here. The creditors want composition, which means that the estates (now holding companies not banks) will operate in the coming years to maximise recovery of assets, most noticeably the stakes in the two new banks, Íslandsbanki, owned by Glitnir creditors and Arion, owned by Kaupthing creditors. According to this plan, the banks would be sold when good buyers were found. The CBI has aired the view that it would be best to sell the banks to foreigners, or at least for foreign currency, not króna.

There are forces at large in Iceland who have been airing the opinion that the two estates should be denied composition and instead should go into bankruptcy. A bankrupt company cannot own assets, meaning that the two banks would be sold right away at an accordingly low price. This is very much against the interest of the creditors and very much in the interest of whoever wants to buy a bank at a fire-sale price.

It is another saga but the idea of the two banks again being owned by a few Icelandic shareholders with controlling stakes makes me shudder. The battle for the ownership of the two banks will be the largest battle of interests and ownership ever to be fought out in Iceland, since the 13^th Century.

The unmentioned interest group: Icelandic owners of offshore ISK

During the election campaign the Progressives, who wanted to fetch money from the creditors for the party’s generous promise of debt relief, made much of their claim that the creditors were in a hurry to get their money and run.

Surely they would no doubt want to see their assets soon but these are financial institutions and investors, many of whom have great expertise in the field of distressed assets and will be familiar with the circumstances, even with operating inside capital controls. There is nothing to indicate they are in such a hurry that they have no patience for negotiating. On the contrary, they have both knowledge and experience to deal with whatever problem is thrown at them.

The development of the ISK rate in the CBI auctions indicates that investors who bought “glacier bonds” are satisfied with the high interest rates in Iceland, compared to rates in Europe and the US. It is safe to say that there is no particular rush among many or most of the owners of “glacier bonds.”

Those who might be in a rush to release their offshore króna are Icelanders who happen to own ISK, either legally or less so. Some Icelandic businessmen have been drumming on about the importance of solving all these issues – and abolishing the capital controls – as soon as possible. Preferably by a big haircut on the foreigners and preferably by bankrupting the estates, denying them composition. These people no doubt have the decency of having the interest of the country at heart but it is less clear where their own personal interests lie. Some of these people are rumoured, in Icelandic media, to be special advisers to the leadership of the Progressive Party.

And now to the real problem: Icelandic current account surplus doesn’t cover repayments in the near future

Capital control, the ISK assets that need to be paid in foreign currency and the Landsbanki bond are problems that need to be resolved in conjunction. But quite apart from this, Iceland is facing serious current account drought – there is not enough foreign currency coming into the country to meet outstanding obligations of payment.

This is very clearly described in the latest report on financial stability from the CBI (my translation):

Domestic entities, others than the sovereign and the CBI, are facing large payments on foreign loans until 2018. The expected payments rise from ISK87bn 2014 to ISK128bn 2015 when the repayment of the Landsbanki bond will start with full force. For comparison, current account surplus in 2012 is calculated to have been ISK52bn. If the surplus remains similar in the coming years, as it has been in the past years, ca. 3-3.5% of GDP, other entities than the sovereign and the CBI need to refinance what amounts to ISK265bn until 2018.

The repayment of the Landsbanki bond is too heavy for the economy as a whole. Its maturity must be extended or it must be refinanced. Without extended maturity or considerable refinancing it is clear that there is no scope in the coming years for using the surplus to release ISK assets owned by foreigner. The interaction between abolishing the capital controls and the repayment of foreign loans is the greatest risk in the system.

Really, the risk facing the Icelandic economy cannot be stated more clearly than this. And for foreigners holding ISK assets this is bad news. Again, the creditors are highly aware of the situation – the dire situation.

Iceland has been seen as the first of crisis-hit European countries to recover. True, the economy is in its third year of growth and unemployment has peaked. But until these issues of refinancing payment obligation are safely solved, Iceland is not free of the problems that hit when the three banks collapsed in October 2008.

Now, it is also pretty clear who is in a hurry to solve the issue of refinancing debt – it is Icelanders themselves, the sovereign and others who need to repay debt in foreign currency. As pointed out in the CBI report, it is important – really of vital importance to the Icelandic economy – that foreign financial markets stay open for Icelandic entities. Arion recently borrowed money in Norway. But with interest rates above 6% this loan was more to show it could borrow than this being some sustainable solution. OR borrowed recently from Goldman Sachs but it only seems to be a facility stretching over 18 months – again, no sustainable solution. Until we see loans of 10 years maturity with sustainable interest rates the problems facing Icelandic entities are not over.

The sovereign only has debt of 58% of GDP, below the European average. We all know that Ireland, Greece and Cyprus had to turn to the troika when they lost market access. The frosty reality in Iceland is that among the creditors of Glitnir and Kaupthing there are big financial institutions to whom Icelandic entities will have to turn sooner rather than later for refinancing. Election promises to fleece foreign creditors will hardly pave the way for the kind of sustainable solution Iceland needs – and in the end, these promises could turn out to be much more expensive than just their nominal value.

*Here is a video from Bloomberg where Sigríður Benediktsdóttir director of financial stability at the CBI explains the situation.

DISCLAIMER: please observe that these are complicated issues. Certainly, none of the above should be taken as advice for any financial transactions.

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As Cypriots get used to the idea of capital controls, the first indictments in a big alleged capital control fraud case surface in Iceland. But why did Iceland need capital controls?

Capital controls have been in place in Iceland since November 28 2008, almost two months after the emergency legislation was passed, on October 6 2008, marking the beginning of the collapse of the Icelandic financial sector. With its own currency, the krona/ISK, access to liquidity was not a problem but dwindling foreign currency reserve posed an acute problem.

“Glacier bonds” and other foreign-owned assets in Iceland

With high inflation and high interest rates in a world with low inflation and low interest rates in the years 2005 to 2008 Iceland was a popular destination for money looking for a place to collect interest rates. Foreign banks, notably Toronto Dominion, offered so called “glacier bonds” issued in ISK. At the time of the collapse, ca. foreign-owned ISK680bn, now €427m, were nesting on bank accounts in Iceland – the Icelandic GDP is now around 1600bn. This number is now believed to be about ISK400bn, 25% of GDP (CBI, see p. 12 here).

Although a part of these inflows were “patient money,” i.e. money being placed in Iceland to gather high interest rates for longer term, the sense was that ca. ISK 300bn was short-term investment. Foreseeing rapid outflow, causing major instability and draining the foreign reserves of the Central Bank of Iceland, the capital controls were put in place – and money could no longer flow freely in and out of the country.

Much of this money is in short and long term Icelandic sovereign bonds and other sovereign papers and on accounts with the CBI or the retail banks. Following recent change in the laws on capital controls the offshore krona investments are now greatly restricted.

In addition to the “glacier bond” overhang foreign creditors of the holding companies of Kaupthing and Glitnir (which own the new banks, Arion and Islandsbanki) own additional Icelandic assets, ca. ISK600bn. The plan now is to solve the underlying causes for the capital controls together with negotiations on composition of the two banks – but so far, it is unclear what happens. The CBI would like to see at least one of the two banks sold to foreigners so as to make the sale “currency neutral” but as I’ve written about earlier strong forces in Iceland favour a sale of both banks at knock-down prices to Icelanders.

Icelandic capital controls – no bother in daily life except for companies and investors

To begin with, Icelanders planning to go abroad had to visit a bank, with their flight ticket to buy foreign currency. People could no longer transfer money abroad from their bank accounts, as they had been able to earlier. Otherwise, ordinary people did not much sense the capital controls. Icelanders traveling abroad can use debit/credit cards.

Unlike Cyprus, there were no caps on how much money people could take out from their bank deposits in Iceland. The Icelandic capital controls were not put in place to hinder outflows from deposits in Iceland but strictly to hinder pressure on CBI’s forex reserves and to hinder that the offshore krona – krona owned by foreigners – could flow into the Icelandic economy.

As it is now, the capital controls permit only internal trading in offshore ISK among non‐residents, i.a. they restrict capital transactions between residents and non‐residents. Companies with regular foreign interaction can seek dispensation and many companies now operate under a dispensation scheme.

But with capital controls companies in Iceland are restricted in their investments abroad, all forex earnings by Icelandic companies abroad have to be repatriated, i.e. brought back to Iceland and placed with the CBI. Of course, companies have learnt the hard way to live with it but as someone said to me recently, it is the capital controls’ mentality that is so deadening – this restriction of activities that the controls bring.

Efforts to lift the capital controls – so far, little progress

The CBI has outlined the long-term risk of capital controls. Too many krona chasing too few investment opportunities can lead to an asset price bubble and this might already be happening. Corruption may very well grow around dispensations and other forms of exemption, as well are around attempts to circumvent the laws.

The CBI policy to lift the capital controls was introduced in August 2009 but without any time limits:

This first phase of the strategy was implemented in late October 2009, but at the same time a strengthening of the regulatory framework was aimed at prohibiting inflows of offshore krónur, which were the main channel for circumvention until that time and had greatly undermined the foreign currency repatriation requirement. Subsequently, controls on long‐ term holdings – which were already held to a large extent by long‐term investors or would soon find their way into the hands of such investors (such as domestic pension funds) – were to be lifted gradually. Finally, controls on short‐term assets would be lifted, in part through auctions where market prices would determine which investors could convert ISK assets to foreign currency first. The strategy assumed that this problem would not be addressed until late in the liberalisation process, as a vast amount of highly liquid assets were owned by non‐residents likely to want to or be forced to sell them at the first opportunity. It was also assumed that the offshore krónur problem would eventually diminish to some extent through internal trading by non‐residents, where investors with a longer horizon and more tolerance for distress would acquire ISK assets from distressed investors willing to sell at lower prices.

On the introduction of this plan in August 2009 it was pointed out that it would take longer than anticipated to create the conditions necessary to lift the controls. Now, it has clearly taken much longer – because of Icesave, finalising the balance sheet of the new banks, restructuring, adverse conditions in international forex markets, Iceland’s low credit ratings etc – and there is no end in sight.

The capital controls gave rise to a manifest difference between the rate of ISK in Iceland and ISK offshore rate. As a step towards lifting the controls the CBI has held auctions where the rate is ISK/€ ~240 compared to bank rate of ISK/€ ~165. This indicates the still substantial spread between the offshore and onshore krona.

Capital controls and fraud

Shortly after the capital controls were in place it was rumoured that former bankers strategically placed both abroad and in Iceland were offering offshore krona deals too good to be legal. As the custodian of the controls CBI was to investigate alleged breaches.

It has, to say the least, taken time but last week the Office of Special Prosecutor in Iceland indicted four men who in 2009 are alleged to having facilitated trades amounting to ISK14.3bn in 748 transactions. The investigation opened in early 2010 and was announced, quite exceptionally, with fanfare and a press conference by the police. Those indicted – Karl Löve Johannsson, Gisli Reynisson, Olafur Sigmundsson, all former employees of Straumur Investment Bank and Markus Mani Maute – are all former bankers, aged between 39 and 50. Maute and Sigmundsson are living abroad, the former in the US, the latter in the UK.

According to the Icelandic media, this is the largest fraud case connected to the capital controls, but other 10-15 cases are being investigated. In the writ no mention is made of names of individuals or entities, 84 in total, that did business with the four. As I understand it, Icelanders in Iceland who made use of the service of the four would have violated the law as well but so far, it is unclear if any clients of the four will be indicted.

It seems that each of the four earned ISK164, just over €1m, on the transactions. It is assumed that the payments never came to Iceland – the charges indicate that the fees earned have not been found – but ended up in offshore companies owned by the four. It is known that a company or companies were set up on their behalf – most appropriately in Cyprus.

Cyprus and capital controls

Although Iceland is not a member of the EU it is a member of the single market through the EEA, which forbids capital controls. Iceland holds an exemption from the EEA and the IMF. With capital controls in Cyprus it is clear that many will try to find loopholes in the new law or directly violate them. If the authorities want to a) make them work b) avoid corruption the controls have been clear and easily enforceable. And it takes a specialised enforcement team to make sure the controls are not breeched. And in case of breeches, indictments have to follow.

As can be seen from the Icelandic experience, lifting capital controls is not easy. If things go as Cypriot authorities claim, there will be no reason for a deposit flight once the Bank of Cyprus has been restructured – and that is planned to take no more than a month, after which the controls can be abolished.

This sounds easy and straightforward but it remains to be seen if the plan works out. It has been indicated that the controls in Cyprus will be lifted in stages – as has been the plan in Iceland. The Cypriot authorities better make sure they know from the beginning what the aim is and how to get there. And they better take into account that fraud is an unavoidable part of capital controls.

*The two announcements from the Ministry of finance, Cyprus, regarding capital controls can be found here.

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Today, Althing – the Icelandic Parliament – in a flurry of Bills, which need to be finalised before the prime minister calls an election, changed the Law on capital controls.* Earlier, the Law was set to expire at the end of this year, meaning that the controls would expire. Now, that time limit has been removed, meaning the controls can stay forever. That is however not the intention. The Government, or rather the Central Bank of Iceland, is working on a plan to make them obsolete though it is clear it will neither happen today nor tomorrow. The appropriate minister will now have to report every six months on how that plan is going.

There are however two changes which, to my mind, are much more interesting. One is that from now on, it is not only the CBI that can give exemption from the controls. Any exemption will have to be accepted by the appropriate minister (most likely the minister of banking rather than the minister of finance though I’m not entirely sure – it doesn’t say outright), only the appropriate minister.

The other is the following (my translation; n.b. not legally binding): “The CBI can set rules on exemptions from the limitations in paragraph 1-3. The CBI can set conditions to the exemptions in the rule. These conditions can i.a. regard the origin of assets, ownership of assets, the purpose of the relevant transactions, the amount in the relevant transactions, the CBI’s supervision and reporting to the CBI. Before setting rules regarding exemption according to paragraph 1 relating to entities with a balance sheet over ISK400bn and that can have a considerable influence on the sovereign debt level and the ownership of retail banks, the minister (of finance?), as well as the minister responsible for the financial markets must be conferred with. The rules must be confirmed by the minister (of finance?).”

The reason I find this interesting is that I interpret this as the political powers wanting to meddle have a say in this matter. It could be entirely innocuous – but nothing is quite innocuous when it relates to the ownership of the two largest banks, Islandsbanki and Arion.

These two banks are now owned by foreign creditors (half of them had the mistaken belief that it didn’t matter though the banks’s balance sheet was many times the size of the economy; half have bought claims following the collapse in October 2008). There are strong forces in Iceland, very strong forces, that want to wrench the banks from “these foreigners” (as the saying goes in Iceland) and sell the banks at knock-down prices – no harm forcing more losses on “foreign banks and hedge funds” who only want to make money anyway, as if Icelandic owners would run the banks as charities. A fire-sale of the two banks would enable mostly moneyed men and pension funds to get the two banks for a song.

Those with money now in Iceland are mostly the same who had money before the collapse (with a few new names whose origin of wealth is not entirely clear) and this would enable the banks and the main businessmen and financiers to continue as if nothing had happen: own big stakes in banks and miraculously be the greatest beneficiaries of favourable loans, as was the pre-collapse custom.

This is, I admit, a rather cynic interpretation of what is going on and I would be very happy to change my mind but so far, there has not been much reason to. It is crystal clear that there is now a ferocious battle going on for assets in Iceland and the two trophy assets are these two banks: he/they who rule banks rule the country. That the political powers have now edged closer to the centre where all this will be decided is, to my mind, an indication of this ferocious battle. The battle for socially responsible banking is not lost in Iceland – not yet – but those with good political connections have won an important victory today.

*The Bill is here, in Icelandic. Earlier logs on the fate of the new banks see here.

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Fitch Ratings have upgraded Iceland’s status – it is now BBB instead of BBB-. The upgrade, as a similar move by Moody’s recently, partly stems from the EFTA Court’s Icesave ruling, which has removed uncertainty of possible state liabilities. Fitch underlines the improved economic situation, not least the debt status of the sovereign, all moving in a positive direction and gives Iceland a slightly higher rating than Moody’s and S&P.

The capital controls are the great unknowns. But first, a few words on the situation in Iceland here and now, relevant to the capital controls.

In the wake of the collapse of the Italian political system, following the corruption investigations in the early 1990s, old powers in the new centre around Silvio Berlusconi found ways of conquering the political vacuum. The collapse of the Icelandic banks set the scene for similar movements, not only for power but for assets as well. Shortly after the collapse of the banks a person with a great insight into Icelandic society said to me that we would, in the coming years, see a fierce battle for assets and power in Iceland.

This battle is now taking place, centered around the ownership of the holding companies which control the two banks, Islandsbanki and Arion. The owners of these two holding companies are foreign creditors, ca half and half original creditors and funds that have bought claims. The crux of the matter is if the two holding companies will go through an orderly composition and a sale of asset at the best possible time or if the companies will be brought into bankruptcy, forcing them to sell off assets in a relatively short time, assumedly at a knock-down price.

Mar Gudmundsson governor of the Central Bank of Iceland has expressed that the best solution would be to sell one of these banks for foreigners who brought in fresh foreign currency. The delicacy of the situation is partly that whichever bank is sold first will, in a sense, knock down the price of the remaining one, especially if there are only Icelandic buyers interested.

The latest is that a fund owned by Icelandic pension funds, in conjunction with major shareholders of MP Bank, are negotiating a purchase of Islandsbanki. The group is led by Skuli Mogensen, who after leaving a bankrupt IT company OZ ca ten years ago, made his fortune in Canada, and like in a novel, returned to his homeland a rich investor, keen on building his fortunes there again. In MP Bank he has allied himself with two investors, who have previous Icelandic ties – David Rowland and Joe Lewis.

However, the “ruler” in deciding the turn of events re selling the two banks is the CBI. The bank will have the last word on agreements re the composition, which have to be weighed against the pressure on the Icelandic krona due to lack of foreign currency in Iceland. The CBI is well aware of the problems and yet, some forces in Iceland are trying to undermine its authority by insisting on political control and the role of the Parliament in deciding the fate of the two holding companies.

Before the privatisation of the Icelandic banks they were run like political fiefdoms. Following the privatisation, fully in place by 2003, the banks were still run as fiefdoms, this time with the largest shareholders as the bank ruling class. The publication of the SIC report drew a concise, insightful and bleak image of these convoluted alliances and power structures.

One way of understanding the ongoing struggle in Iceland re ownership of the two major banks is to see it as the attempt of those who used to rule, before 2008, to reclaim their position. Others might say that this sounds like fiction – but lets wait and see. The outcome of the elections will be a decisive factor in constructing the future of Iceland.

Now, back to Fitch. Below is the Fitch press release, emphasis is mine.

Fitch Ratings has upgraded Iceland’s Long-term foreign currency Issuer Default Rating (IDR) to ‘BBB’ from ‘BBB-‘ and affirmed its Long-term local currency IDR at ‘BBB+’. The agency has affirmed the Short-term foreign currency IDR at ‘F3’ and upgraded the Country Ceiling to ‘BBB’ from ‘BBB-‘. The Outlooks on the Long-term IDRs are Stable.

KEY RATING DRIVERS The upgrade reflects the impressive progress Iceland continues to make in recovering from the financial crisis of 2008-09. The economy has continued to grow, notwithstanding developments in the eurozone; fiscal consolidation has remained on track and public debt/GDP has started to fall; financial sector restructuring and deleveraging are well-advanced; and the resolution of Icesave in January has removed a material contingent liability for public finances and brought normalisation with external creditors a step closer.

The Icelandic economy has displayed the ability to adjust and recover at a time when many countries with close links to Europe have stumbled in the face of adverse developments in the eurozone. The economy grew by a little over 2% in 2012, notwithstanding continued progress with deleveraging economy-wide. Macroeconomic imbalances have corrected and inflation and unemployment have continued to fall. Iceland has continued to make progress with fiscal consolidation following its successful completion of a three-year IMF-supported rescue programme in August 2011. Fitch estimates that the general government realised a primary surplus of 2.8% of GDP in 2012, its first since 2007, and a headline deficit of 2.6% of GDP. Our forecasts suggest that with primary surpluses set to rise to 4.5% of GDP by 2015, general government balance should be in sight by 2016.

In contrast to near rating peers Ireland (‘BBB+’) and Spain (‘BBB’), Iceland’s general government debt/GDP peaked at 101% of GDP in 2011 and now appears to be set on a downward trajectory, falling to an estimated 96% of GDP in 2012. Fitch’s base case sees debt/GDP falling to 69% by 2021. Net public debt at 65% of GDP in 2012 is markedly lower than gross debt due to large government deposits. This also contrasts with Ireland (109% of GDP) and Spain (81% of GDP).

Renewed access to international capital markets has allowed Iceland to prepay 55% of its liabilities to the IMF and the Nordic countries.

Risks of contingent liabilities migrating from the banking sector to the sovereign’s balance sheet have receded significantly following the favourable legal judgement on Icesave in January 2013 that could have added up to 19% of GDP to public debt in a worst case scenario. Meanwhile, progress in domestic debt restructuring has been reflected by continued falls in commercial banks’ non-performing loans from a peak of 18% in 2010 to 9% by end-2012. Nonetheless, banks remain vulnerable to the lifting of capital controls, while the financial position of the sovereign-owned Housing Finance Fund (HFF) is steadily deteriorating and will need to be addressed over the medium term.

Little progress has been made with lifting capital controls and EUR2.3bn of non-resident ISK holdings remain ‘locked in’. However, Fitch estimates that the legal framework for lifting capital controls will be extended beyond the previously envisaged expiry at end-2013, thereby reducing the risk of a disorderly unwinding of the controls. Fitch acknowledges that Iceland’s exit from capital controls will be a lengthy process, given the underlying risks to macroeconomic stability, fiscal financing and the newly restructured commercial banks’ deposit base. However, the longer capital controls remain in place, the greater the risk that they will slow recovery and potentially lead to asset price bubbles in other areas of the economy.

Iceland’s rating is underpinned by high income per capita levels and by measures of governance, human development and ease of doing business which are more akin to ‘AAA’-rated countries. Rich natural resources, a young population and robust pension assets further support the rating.

RATING SENSITIVITIES The main factors that could lead to a negative rating action are: – Significant fiscal easing that resulted in government debt resuming an upward trend, or adverse shocks that implied higher government borrowing and debt than projected – Crystallization of sizeable contingent liabilities arising from the banking sector. In this regard, the HFF represents the main source of risk.

– A disorderly unwinding of capital controls leading to significant capital outflows a sharp depreciation of the ISK and a resurgence of inflation. The main factors that could lead to a positive rating action: – Greater clarity about the evolution capital controls and, in particular the mechanism for releasing offshore krona.

– Enduring monetary and exchange rate stability.

– Further signs of banking sector stabilisation accompanied by continued progress of private sector domestic debt restructuring.

– Continued reduction in public andexternal debt ratios.

KEY ASSUMPTIONS In its debt sensitivity analysis, Fitch assumes a trend real GDP growth rate of 2.5%, GDP deflator of 3.5%, an average primary budget surplus of 3.2% of GDP, nominal effective interest rate of 6% and an annual depreciation of 2% (to capture potential exchange rate pressures resulting from the lifting of capital controls) over 2012-21. Moreover a recapitalization of HFF equivalent to 0.7% of GDP is assumed in 2013. Under these assumptions, public debt/GDP declines from its current level to 69% of GDP in 2021. The debt path is sensitive to growth shocks. Under a growth stress scenario (0.2% potential growth), public debt would remain on a downward trajectory but it would stabilise at a markedly higher level (90% of GDP) by 2019. While Iceland’s debt dynamics appears to be resistant to an interest-rate stress scenario, a sharp deterioration in the exchange rate (possibly associated with a disorderly unwinding of capital controls) would have a more adverse effect.

Similarly, a scenario with no fiscal consolidation (primary deficit of 0.3% of GDP in the medium-term) would reverse the debt downward path: debt would reach 100% of GDP in 2015 and would remain above that level for 2015-21.

Fitch assumes that contingent liabilities arising from the banking sector (mainly through HFF) will be limited. Under a scenario where contingent liabilities arise due to the recapitalisation of HFF and they account for 4% of GDP each year from 2014 to 2016, public debt would still remain on a downward trajectory. However, it would reach 81% of GDP by 2021 (versus 69% under the baseline).

Fitch assumes that capital controls will ultimately be unwound in an orderly manner.

Fitch assumes that the eurozone remains intact and that there is no materialisation of severe tail risks to global financial stability.

 

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Before the end of January the EFTA Court might have ruled on Icesave. The largest battle for assets ever to take place in Iceland (since the 13th century) – ultimately for the power over Arion bank and Islandsbanki – will be, by far, the biggest issue in Iceland. At the core of it are the negotiations on composition for the holding companies of Kaupthing and Glitnir, the owners of the two respective banks. The capital controls are one variable in this equation. In addition, the Office of the Special Prosecutor will continue to churn out charges during 2013.

1) It now seems likely that the EFTA Court will rule on Icesave in or around the third week of January. As Icelog has explained earlier, there really are two questions that the Court is ruling on: Did Iceland breach the Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes – Has Iceland ‘breached the prohibition on discrimination on grounds of nationality under Article 4 EEA?’

Considering the fact that deposit guarantee schemes are a contagious topic in the EU right now, with a pan-European scheme being planned as part of the European Banking Union in the making (but the Directive has been changed since autumn 2008), it seems plausible that the EFTA Court justices will rule on this issue as narrowly as possible, so as not to plant on the EU the definite understanding of this directive. But then, justices don’t always do the plausible. In any case, it is less the Directive and more the discrimination that could rattle Icelandic stoicism.

The EFTA Court is not ruling on the dispute with the UK and the Netherlands regarding the cost these two countries think they have born by paying out the Icesave deposit holders in the two respective countries (UK in full, the Dutch Government up to €100.000). If the ruling – on one or both matters (more serious financial consequences if the discrimination goes against Iceland, see the link above) – shows that Iceland was in breach, the two countries will no doubt come knocking to recover their cost. Then the Icesave dispute might start all over again, another round of negotiations – or, the three countries would agree to hold on to the last agreement.

So much for Icesave – one way or another it might be resolved this year. Otherwise, there is the 6th Icesave Christmas in sight for next year.

2) Although Icesave did take up much space in Iceland in the last few years the agreements regarding the composition of Glitnir and Kaupthing do not only revolve around assets and money but around power in the Icelandic financial sector. There is a huge suspicion against foreign ownership of the banks and this fear is being played on by those who favour a bankruptcy of the two estates and a fire sale of the two banks.

Those who whip up this fear of foreign ownership seem to ignore that nothing will happen regarding the composition except with the blessing of the Icelandic Central Bank. This is not an issue that is about to wreck the Icelandic economy. It is an issue under control, albeit without a solution so far. The CBI will focus on the stability of the Icelandic economy. The solutions sought aim at resolving a few matters at once, together with the composition: the capital controls, the overhand of foreign currency (stemming from the carry trade going on up to the collapse of the banks in October 2008) – and, as the CBI sees it, preferably selling one or both banks to foreigners, in order to have at least one bank sold for foreign currency. In addition, there is the Landsbanki bond – debt rising from the constitution of the new Landsbanki, owed to the Landsbanki estate: it has a 6 year maturity but that now seems an unreasonably short time.

This is, in short, the bundle of problems that needs to be resolved in one go – or at least all these issues need to be solved and settled considering the interaction between them. Not a trivial project – on which there is now an ad hoc working group pondering, with experts from the ECB, IMF and the EU as well as Icelandic civil servants.

3) The original plan of the Office of the Special Prosecutor was that all charges regarding the collapse of the banks should be brought by 2014. Exactly how many the cases will be is not yet clear. The Icelandic Financial Services Authority, FME, has passed on ca 80 cases the OSP, just to given an idea of numbers but the OSP makes an independent assessment of cases.

On December 28 the Icelandic County Court ruled in a case brought against the Glitnir managers, ex-CEO Larus Welding and Gudmundur Hjaltason former head of Glitnir’s corporate finance. The charges related to a complicated loan structure ultimately benefitting Milestone, one of the large Icelandic holding companies, owned by Karl Wernersson and his siblings. The OSP reckoned the loans caused Glitnir a loss of €50m and had asked for a 5 1/2 year and 5 year prison sentence. Instead, the Count Court sentenced both men to nine months in prison, six of which are suspended for two years. Legal bills are divided between the two men and the state. – The State Prosecutor is likely to appeal. The Milestone ruling is the first ruling concerning the big banks and leading bankers.

So far, managers from Kaupthing and Glitnir have been charged by the OSP, as well as major shareholder in the two banks, respectively Olafur Olafsson and Jon Asgeir Johannesson, but no one from Landsbanki has (yet?) been charged.

Updated:

It’s worth adding that the Icelandic economy is growing – not like during the pre-2008 boom years but at around 2%. Here is the latest IMF report on Iceland, with an overview of the Icelandic economy.

 

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