Sigrún Davíðsdóttir's Icelog

According to Rúv, prime minister Sigmundur Davíð Gunnlaugsson (Progr.) will next week appoint someone to a new post to oversee work towards the abolition of the capital controls and be in charge of contacts with the creditors of the failed banks. The idea is to simplify the work regarding the capital controls and failed banks since this work concerns many ministries and institutions. This person will lead a group of experts who all will work towards abolition of the capital controls.

The really interesting thing is of course who this person is. Will this be a person who is undisputedly qualify to lead this work in a convincing and professional way and likely to succeed? Will it be a politician but professionally unconvincing? Someone with close ties to the Progressive Party and the prime minister? Or someone who has little pondus and is unlikely to achieve much?

We will have to wait until next week, unless the name leaks out, in which case I will update this post.

 

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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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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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Free flow of capital is one of the four freedom pillars on which the European Union rests. A country with capital controls cannot become a member of the European union. Ossur Skarphedinsson Iceland’s minister of foreign affairs is wholly aware of the problem the capital controls cause. And it is also clear to Stefan Füle EU’s commissioner for enlargement, both of whom I interviewed in Brussels Tuesday following the EU and  Iceland 8th intergovernmental conference on accession.

The EU negotiations are going well. Six negotiation chapters were opened this time, one was provisionally closed. In total 27 out of 33 chapters have now been opened and 11 are provisionally closed. The negotiation is moving beyond matters included in the European Economic Area. One chapter now opened concerns the environment where Iceland has stated 14 topics of particular interest. One of them is whaling, which arouses heat and passion on both sides of the negotiation table. Skarphedinsson, holding a folder made of seal skin, underlined that whaling is not of much economic interest to Icelanders but was of cultural importance, as is seal hunting and gathering eiderdown from the eiders.

However, no matter how well the negotiations proceed the capital controls are well and firmly in the way of membership. In September, an ad hoc working group was set up, with Icelandic civil servants and representatives from the IMF, the ECB and the EU Commission, from Directorate General for Economic and Financial Affairs and from DG Enlargement. This group will now work together with the Icelandic Central Bank to find a viable way to abolish the capital control. Or, as Skarphedinsson said, the best brains in this field will now be working to solve this problem.

There is continuous political rumbling in the Althing, among eurosceptics, against the negotiations. It was probably no coincidence that today, on the day of a successful intergovernmental conference, MPs in the Althing foreign affairs committee discussed putting up for a vote that the negotiations should be stopped until the nation had voted on continuing the negotiation or not. The coalition Government is, and has been from the beginning, split on this issue with the social democrats in favour of joining the EU and the Left-Green against.

Among other access-negotiating countries voting on membership negotiations is unprecedented. It remains to be seen if there really is a political will to stop a democratic process, which will end with a referendum on a negotiated treaty. This is not the first time these voices are heard among the MPs. It is not clear if or how the matter will be pursued by eurosceptic MPs.

Another aspect of the capital controls is how to pay out creditors of the two collapsed banks, Glitnir and Kaupthing. It is fair to say that these two banks are the core of the biggest wrestle of assets there ever has been in Iceland. But that is another story for another day and another blog.

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Now that Greece has controls on outtake from banks, capital controls, many commentators are comparing Greece to Iceland. There is little to compare regarding the nature of capital controls in these two countries. The controls are different in every respect except in the name. Iceland had, what I would call, real capital controls – Greece has control on outtake from banks. With the names changed, the difference is clear.

Iceland – capital controls

The controls in Iceland stem from the fact that with its own currency and a huge inflow of foreign funds seeking the high interest rates in Iceland in the years up to the collapse in October 2008, Iceland enjoyed – and then suffered – the consequences, as had emerging markets in Asia in the 1980s and 1990s.

Enjoyed, because these inflows kept the value of the króna, ISK, very high and the whole of the 300.000 inhabitants lived for a few years with a very high-valued króna, creating the illusion that the country was better off then it really was. After all, this was a sort of windfall, not a sustainable gain or growth in anything except these fickle inflows.

Suffered, because when uncertainty hit the flows predictably flowed out and Iceland’s foreign currency reserve suffered. As did the whole of the country, very dependent on imports, as the rate of the ISK fell rapidly.

During the boom, Icelandic regulators were unable and to some degree unwilling to rein in the insane foreign expansion of the Icelandic banks. On the whole, there was little understanding of the danger and challenge to financial stability that was gathering. It was as if the Asia crisis had never happened.

As the banks fell October 6-9 2008, these inflows amounted to ISK625bn, now $4.6bn, or 44% of GDP – these were the circumstances when the controls were put on in Iceland due to lack of foreign currency for all these foreign-owned ISK. The controls were put on November 29 2008, after Iceland had entered an IMF programme, supported by an IMF loan of $2.1bn. (Ironically, Poul Thomsen who successfully oversaw the Icelandic programme is now much maligned for overseeing the Greek IMF programme – but then, Iceland is not Greece and vice versa.)

With time, these foreign-owned ISK has dwindled, is now at 15% of GDP but another pool of foreign-owned ISK has come into being in the estates of the failed bank, amounting to ca. ISK500bn, $3.7bn, or 25% of GDP.

In early June this year, the government announced a plan to lift capital controls – it will take some years, partly depending on how well this plan will be executed (see more here, toungue-in-cheek and, more seriously, here).

Greece – bank-outtake controls

The European Central Bank, ECB, has kept Greek banks liquid over the past many months with its Emergency Liquid Assistance, ELA. With the Greek government’s decision to buy time with a referendum on the Troika programme and the ensuing uncertainty this assistance is now severely tested. The logical (and long-expected) step to stem the outflows from banks is limit funds taken out of the banks.

This means that the Greek controls are only on outtake from banks. The Greek controls, as the Cypriot, earlier, have nothing to do with the value or convertibility of the euro in Greece. The value of the Greek euro is the same as the euro in all other countries. All speculation to the contrary seems to be entirely based on either wishful thinking or misunderstanding of the controls.

However, it seems that ELA is hovering close to its limits. If correct that Greek ELA-suitable collaterals are €95bn and the ELA is already hovering around €90bn the situation, also in respect, is precarious.

How quickly to lift – depends on type of controls

The Icelandic type of capital controls is typically difficult to lift because either the country has to make an exorbitant amount of foreign currency, not likely, a write-down on the foreign-owned ISK or binding outflows over a certain time. The Icelandic plan makes use of the two latter options.

Lifting controls on outtake from banks takes less time, as shown in Cyprus, because the lifting then depends on stabilising the banks and to a certain degree the trust in the banks.

This certainly is a severe problem in Greece where the banks are only kept alive with ELA – funding coming from a source outside of Greece. This source, ECB, is clearly unwilling to play a political role; it will want to focus on its role of maintaining financial stability in the Eurozone. (I very much understand the June 26 press release from the ECB as a declaration that it will stick with the Greek banks as long as it possibly can; ECB is not only a fair-weather friend…)

Without the IMF it would have been difficult for Iceland to gather trust abroad in its crisis actions – but Greece is not only dependent on the Eurozone for trust but on the ECB for liquidity. Without ELA there are no functioning Greek banks. If the measures to stabilise the banks are to be successful the controls are only the first step.

*Together with professor Þórólfur Matthíasson I have earlier written on what Icelandic lessons could be used to deal with the Greek banks. – Cross-posted at Fistful of euros.

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The Icelandic government, or some parts of it, keep on its game of leaking key information always to the same journalist. Now it is the first big step towards lifting capital controls. As could be expected, this seems more about political posturing than a convincing solution. The coming measures may however provide creditors with their long awaited break to negotiate. If not, Iceland faces the same as Argentina: years of wrangling with ever more aggressive creditors – as the chief foreign adviser to Iceland should be able to inform the government on, from first hand experience.

In March, the Ministry of Finance published three links to regulation and documents regarding duty of silence of advisers, parliamentarians and civil servants who might be in possession of information related to the lifting of capital controls. This was part of a concerted effort to keep under wraps anything related to the lifting of the capital controls – until that day came when the government announced its plans. Whatever the source, DV’s journalist Hörður Ægisson, who over the last few years has been a diligent receiver of government information, published on Friday the outline of this plan, introduced at a cabinet meeting that day, most likely to be made public at a press conference on Monday. The question is if the Ministry of Finance will now look into this leak, considering the measures it took in March.

The Icelandic media landscape is a sorry sight: independent media is weak, the money is where the special interests are. This will no doubt be made clear yet again in the coming weeks as the details of the capital controls plan-to-come will be discussed and debated.

The estates will now have a few weeks to negotiate a composition agreement. If creditors do not accept the parameters the government has in mind the estates will be put into bankruptcy proceedings. So far, the estates and their creditors have been hoping for a composition, since creditors can then run the estates and resolve it when they deem best contrary to bankruptcy proceedings, which are time-limited. Both proceedings do though have the same aim: to maximize the creditors’ recovery.

The problem at the core of this is the foreign-owned ISK: assets worth ISK320bn in Glitnir, ISK160bn in Kaupthing, which means that the size of the ISK problem is different for the two banks – also making it respectively a different case for the two estates for find a solution. The Icelandic government seems to want to get hold of these ISK assets, remains to be seen how it goes. An expected stability tax of 40% can hardly be on priority claims, because that would then hit the UK claims, not the intention. It is difficult to see that the tax could be put in place sooner than 2017, which means no lifting of controls for Icelandic entities until after that, which means still years of capital controls. However, this is speculation until the plan is published.

Among themselves, the hardliners have been talking about getting creditors with their back to the wall facing a gun, i.e. with no options but to follow the government’s diktat. However, Iceland has a rule of law and creditors have legal options in Iceland and abroad. It remains to be seen, as the Icelandic saying goes, who laughs last.

The worrying thing for Iceland is if protracted legal dispute keeps going for years, hindering the lifting of the capital controls. The government seems to be taking the risk of just kicking the process off, in this way, then seeing where it leads to.

Lee Buchheit, advising the government on these issues as on Icesave earlier, brings with him experience, which hopefully will not be relevant. Cleary Gottlieb, the firm he represents, is adviser to the Argentinian government (not Buchheit though but his colleagues). At a conference in Buenos Aires recently, Buchheit foresaw that Argentina’s dispute with creditors might run for at least a decade. Probably not what Cleary envisaged for its stubborn Argentinian client – and hopefully not what is in spe for Iceland.

It certainly has to be kept in mind that Argentine’s problem is sovereign debt and a mismanaged restructuring whereas Iceland has a balance-of-payment problem vs estates of failed private banks. It would take quite a few wrong steps to put the Icelandic government in the situation where it would be directly in dispute with creditors, as is the Argentinian government. So far, no one has really believed the government could end there.

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Four more years – that’s the perspective on capital restrictions in Iceland. Today, the Icelandic Central Bank published its long awaited report on capital restrictions in Iceland. In tune with the general tendency for a positive spin on things the title is ‘Capital account liberalisation strategy.’ The Icelandic title is less sophisticated and more down-to-earth; literally translated it’s ‘A plan to abolish currency restrictions.’ An upcoming bill in Althingi will allow the CBI to extend the capital restrictions for four years.

For those of us who breathlessly follow the Icelandic economy this report has been long awaited. It was due on March 11 but was delayed because, according to Governor of the CBI Mar Gudmundsson, it was cooked up by many cooks who all wanter to add their touch. The new report discusses previous strategy, the various conditions needed for lifting capital controls and sets out a plan for easing the country out of the restrictions into the real world.

The first two steps regard the offshore krona, now estimated to be ISK400-500bn, a quarter of the estimated 2011 GDP of Iceland. In phase I, CBI will offer currency to those who hold offshore krona, through an auction process. In phase II, CBI, then the happy owner of  possibly 400-500bn of OS krona, will auction the OS krona to owners of foreign currency who are interested in longterm investment in Icelandic state bonds or in Icelandic companies. In addition, owners of OS krona will be offered to bring their OS krona to Iceland for the same kind of investment though under some restrictions: the OS krona amount can only amount to half the investment and the investment be kept in Iceland for a certain amount of time. – The use of OS krona in new investment in Iceland has been an issue lately. It’s been forbidden but there have been rumours that some investors have been trying to smuggle their cheap OS krona into investments in Iceland.

In phase III, those who hold OS krona but have neither participated in the auctions nor used it for investment in Iceland will be offered to exit by changing their holdings into longterm state bond in foreign currency or by paying an exit fee.

Obviously, the ultimate goal is to strengthen and stabilise the economy but how the measures will pan out is still unclear. The underlying problem with the OS krona is the divergence between the onshore and the offshore rate. It’s i.a. unclear how free the auctions will be, i.e. if the CBI will try to control the exchange rate in some way.

In the short term, the outcome of the Icesave referendum April 9 will have an impact on how speedily the strategy can be executed. If the Icesave agreement is rejected the execution of phase I and II will no doubt be delayed as a ‘no’ might cause great uncertainty in terms of Iceland’s legal status regarding the Icesave debt and other issues arising from the collapse of the banks in October 2008.

The biggest owners of foreign capital in Iceland are the pension funds. At a press conference today, Gudmundsson emphasised that the pension funds’ foreign capital will not be affected by the first easing. Their capital will be fenced in at home, leading some to believe that the funds, willingly or not, will bear some of the burden that the capital restrictions create.

Alexander Macgregor Bruce-Brand, an expert in the field with experience from South Africa and elsewhere, has worked on the new strategy. It remains to be seen how the strategy will be viewed by those part of the Icelandic business community worst hit by the restrictions. Though four more years of restrictions seems a long period of an anormal situation, the plan sets out a clear vision of how things will be done. So at least there is clarity – and clarity might cement some much needed trust in the CBI and Icelandic authorities. And that’s ultimately a positive thing.

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Banque Havilland has just celebrated its tenth anniversary: it is now ten years since David Rowland bought Kaupthing Luxembourg out of bankruptcy. A failed bank not only tainted by bankruptcy but severely compromised by stark warnings from the regulator, CSSF. Yet, neither the regulator nor the administrators nor later the new owner saw any reason but to keep the Kaupthing Luxembourg manager and key staff. In four criminal cases in Iceland involving Kaupthing the dirty deals were done in the bank’s Luxembourg subsidiary with back-dated documents. Two still-ongoing court cases, which Havilland is pursuing with fervour in Luxembourg, indicate threads between Kaupthing Luxembourg and Havilland, all under the nose of the CSSF.

“The journey started with a clear mission to restructure an existing bank and the ambition of the new shareholder to lay strong foundations, which an international private bank could be built on,” wrote Juho Hiltunen CEO of Banque Havilland on the occasion of Havilland’s 10th anniversary in June this year.

This cryptic description of the origin of Banque Havilland hides the fact that the ‘existing bank’ David Rowland bought was the subsidiary of Kaupthing Luxembourg, granted suspension of payment 9 October 2008, the same day that the mother-company, Kaupthing hf, defaulted in Iceland.

The last year of Kaupthing Luxembourg’s operations had been troubled by serious concerns at the Luxembourg regulator, Commission de Surveillance du Secteur Financier, CSSF, regarding the bank’s risk management and the management’s willingness to move risk from clients onto the bank.

Unperturbed by all of this, Rowland not only bought the bank but kept the key employees, including the bank’s Icelandic director, Magnús Guðmundsson, instrumental in selling Kaupthing Luxembourg to Rowland. Guðmundsson stayed in his job until 2010, when news broke in Iceland he was under investigation, later charged and found guilty in two criminal cases (two are still ongoing) in Iceland, where he has served several prison sentences. He was replaced by Jean-Francois Willems, another Kaupthing Luxembourg manager, CEO of Banque Havilland Group since 2017. Willems was followed by Peter Lang, also an earlier Kaupthing manager. Lang left that position when Banque Havilland was fined by the CSSF for breaches in money laundering procedures.

David Rowland’s reputation in his country of origin, Britain, was far from pristine ­– in Parliament, he has been called a ‘shady financier.’ However, all that seemed forgotten in 2010 when the media-shy tycoon was set to become treasurer of the Conservative Party, having donated in total £2.8m to the party in less than a year. As the British media revised on Rowland stories, Rowland realised he was too busy to take on the job and stepped out of the spotlight again.

In the Duchy of Luxembourg, Rowland was seen as fit and proper to own a bank. And the bank, CSSF had severely criticised, was seen as fit and proper to receive a state aid in the form of a loan of €320m in order to give the bank a second life.

Criminal investigations in Iceland showed that Kaupthing hf’s dirty deals were consistently carried out in Luxembourg. There were clearly plenty of skeletons in the Kaupthing Luxembourg that Rowland bought. Two still-ongoing legal cases connect Kaupthing and Havilland in an intriguing way.

In December 2018, the CSSF announced that Banque Havilland had been fined €4m and now had “restrictions on part of the international network” for lack of compliance regarding money laundering and terrorist financing, the regulator’s second heftiest fine of this sort. Eight days later the bank announced a new and stronger management team: a new CEO, Lars Rejding from HSBC. It was also said that there were five new members on the independent board but their names were not mentioned. An example of the bank’s rather sparse information policy.

KAUPTHING LUXEMBOURG: RISK, FRAUD AND FAVOURED CLIENTS

2007: CSSF spots serious lack of attention to risk in Kaupthing Luxembourg

On August 25 2008, the CSSF wrote to the Kaupthing Luxembourg management, following up on earlier exchanges. The letter shows that as early as in the summer of 2007, the CSSF was aware of the serious lack of attention to risk. The regulator’s next step, in late April 2008, was to ask for the bank’s credit report, based on the Q1 results, from the bank’s external auditor, KPMG. In the August 2008 letter, the CSSF identified six key issues where Kaupthing Luxembourg was at fault:

1 The CSSF deemed it unacceptable that Kaupthing Luxembourg financed the buying of Kaupthing shares “as this may represent an artificial creation of capital at group level.”

2 Analysing the bank’s loan portfolio, the CSSF concluded that the bank’s activity was more akin to investment banking than private banking as the bulk of credits were “indeed covered by highly concentrated portfolios (for example: (Robert) Tchenguiz, (Kevin) Stanford, (Jón Ásgeir) Johannesson, Grettir (holding company owned by Björgólfur Guðmundsson, Landsbanki’s largest shareholder, together whith his son, Björgólfur Thor Björgólfsson) etc.)” The CSSF saw this “as highly risky and we ask you to reduce it.” This could only continue in exceptional cases where the loans would have a clear maturity (as opposed to bullet loans that were rolled on).

3 Private banking loans should have diversified portfolio of quoted securities and be easy to liquidate, based on a formal written procedure as to how that should be done.

4 Personal guarantees from the parent company should be documented in the loan files so that the external auditor and the CSSF could verify how these exposures were collateralised in the parent bank.

5 As the CSSF had already pointed out in July 2007, the indirect concentration risk should not exceed 25% of the bank’s own funds. CSSF concluded that the bank was not complying with that requirement as the indirect risk concentration on Eimskipafélagið hf, owned by Björgólfur Guðmundsson, and on Kaupthing hf, the parent bank, was above this limit.

6 At last, CSSF stated that only quoted securities could be easily liquidated, meaning that securities illiquid in a stress scenario, could not be placed as collateral. CSSF emphasised that securities like Kaupthing hf, Exista hf and Bakkavor Group hf, could not be used as a collateral, exactly the securities that some of Kaupthing’s largest clients were most likely to place as collaterals.

It is worth keeping in mind that the regulator had been studying figures from Q1 2008; in August, when CSSF sent its letter, the Q2 figures were already available: the numbers had changed much for the worse. Unfazed, Kaupthing Luxembourg managers insisted in their answer 18 September 2008 that the regulator was wrong about essential things and they were doing their best to meet the CSSF concerns.

What the CSSF identified: the pattern of “favoured clients”

The CSSF had been crystal clear: after closely analysing the Kaupthing Luxembourg operation it did not like what it saw. Kaupthing’s way of banking, lending clients funds to buy the bank’s shares and absolving certain clients of risk and moving it onto the bank, was not to the CSSF’s liking. What the CSSF had indeed identified was a systematic pattern, explained in detail in the 2010 Icelandic SIC report.

This was the pattern of Kaupthing’s “favoured clients”: Kaupthing defined a certain group of wealthy and risk-willing clients particularly important for the bank. In addition to loans for the client’s own projects, there was an offer of extra loans to invest in Kaupthing shares, with nothing but the shares as collateral. In some cases, Kaupthing set up companies for the client for this purpose, or the bank would use companies, owned by the client, with little or no other assets. The loans were issued against Kaupthing shares, placed in the client’s company.

How this system would have evolved is impossible to say but over the few years this ran, these shareholding companies profited from Kaupthing’s handsome dividend. The loans were normally bullet loans, rolled on, where the client’s benefit was just to collect the dividend at no cost. In some cases, the dividend was partly used to pay off the loan but that was far from being the rule.

What the bank management gained from this “share parking,” was knowing where these shares were, i.e. that they would not be sold or shorted without the management’s knowledge. Kaupthing had to a large extent, directly and indirectly funded the shareholdings of the two largest shareholders, Exista and Ólafur Ólafsson. In addition to these large shareholders there were all the minor ones, funded by Kaupthing. It can be said that the Kaupthing management had de facto complete control over Kaupthing.

All the three largest Icelandic banks practiced the purchase of own shares against loans to a certain degree but only Kaupthing had sat this up as part of its loan offer to wealthy clients. In addition, Kaupthing had funded share purchase for many of its employees.* This activity effectively turned into a gigantic market manipulation machine in 2008, again especially in Kaupthing, as the share price fell but would no doubt have fallen steeper and more rapidly if Kaupthing had not orchestrated this share buying on an almost industrial scale.

The other main characteristic of Kaupthing’s service for the favoured clients was giving them loans with little or no collaterals. This also led to concentrated risk, as pointed out in para 2 and 3 in the CSSF’s letter from August 2008 and later in the SIC report. As one source said to Icelog, for the favoured clients, Kaupthing was like a money-printing machine.

Back-dated documents in Kaupthing

After the Icelandic Kaupthing failed, the Kaupthing Resolution Committee, ResCom, quickly discovered it had a particular problem to deal with. The ResCom had kept some key staff from the failed bank, thinking it would help to have people with intimate knowledge working on the resolution.

A December 23 2008 memorandum from the law firm Weil Gotschal & Manges, hired by the ResCom, pointed out an ensuing problem: lending to companies owned by Robert Tchenguiz, who for a while sat on the board of Exista, Kaupthing’s largest shareholder, had been highly irregular, according to the law firm. As the ResCom would later find out, this irregularity was by no means only related to Tchenguiz but part of the lending to favoured clients.

The law firm pointed out that some employees had been close to these clients or to their closest associates in the bank and advised that all electronic data and hard drives from Sigurður Einarsson, Hreiðar Már Sigurðsson and seven other key employees should be particularly taken care of. Also, it noted that two of those employees, working for the ResCom, should be sacked; it could not be deemed safe that they had access to the failed bank’s documents. The ResCom followed the advice but by then these employees had already had complete access to all material for almost three months.

Criminal cases against Kaupthing managers have exposed examples of back-dated documents, done after the bank failed. According to one such document, Hreiðar Már Sigurðsson was supposed to have signed a document in Reykjavík when he was indeed abroad (from the embezzlement case against HMS). There is also an example of September 2008 minutes of a Kaupthing board meeting being changed after the collapse of Kaupthing. No one has been charged specifically with falsifying documents, but these two examples are not the only examples of evident falsification.

The central role of Kaupthing Luxembourg in Kaupthing hf’s dirty deals

The fully documented stories behind the many dirty deals in Kaupthing first surfaced in April 2010 in the report by the Special Investigative Commission, SIC. Intriguingly, these deals were, almost without exception, executed in Luxembourg.

By the time the SIC published its report, the Icelandic regulator, FME, already had a fairly clear picture of what had been going on in the banks. The fraudulent activities in Kaupthing made that bank unique – and most of these activities involved fraudulent loans to the favoured clients. In January 2010, the Icelandic regulator, FME, sent a letter to the CSSF with the header “Dealings involving Kaupthing banki hf, Kaupthing Bank Luxembourg S.A., Marple Holding S.A., and Lindsor Holdings Corporation.”

Through the dealings of these two companies, Skúli Þorvaldsson profited over the last months before the bank’s collapse by around ISK8bn, at the time over €50m. These trades mainly related to Kaupthing bond trades: bonds were bought at a discount but then sold, even on the same day, at a higher price or a par. Þorvaldsson profited handsomely through these trades, which effectively tunnelled funds from Kaupthing Iceland to Þorvaldsson, via Kaupthing Luxembourg.

Þorvaldsson was already living in Luxembourg when Kaupthing set up its Luxembourg operations in the late 1990s. He quickly bonded with Magnús Guðmundsson; Icelog sources have compared their relationship to that of father and son. When the bank collapse, Þorvaldsson was Kaupthing Luxembourg’s largest individual borrower and, in September 2008, the bank’s eight largest shareholder, owning 3% of Kaupthing hf through one of his companies, Holt Investment Group. At the end of September 2008, Kaupthing’s exposure to Þorvaldsson amounted to €790m. The CSSF would have been fully familiar with the fact that Þorvaldsson’s entire shareholding was funded by Kaupthing loans.

In addition, the FME pointed out that four key Kaupthing Luxembourg employees, inter alia working on those trades, had traded in bonds, financed by Kaupthing loans, profiting personally by hundreds of thousands of euros. Intriguingly, these employees had not previously traded in Kaupthing bonds for their own account. Some of these trades took place days before Kaupthing defaulted, with the FME pointing out that in some cases the deals were back-dated.

The central role of Kaupthing Luxembourg in Kaupthing’s Icelandic criminal cases

Following the first investigations in Iceland, the Office of the Special Prosecutor, OSP, in Iceland, now the County Prosecutor, has in total brought charges in five cases against Kaupthing managers, who have been found guilty in multiple cases: the so-called al Thani case, and the Marple Holding case, connected to Skúli Þorvaldsson, who was charged in that case but found not guilty.

The third is the CLN case, the fourth case is the largest market manipulation ever brought in Iceland. The charges in the fifth case concern pure and simple embezzlement where Hreiðar Már Sigurðsson, at the time the CEO of Kaupthing Group, is charged with orchestrating Kaupthing loans to himself in summer of 2008 in order to sell Kaupthing shares so as to create fraudulent profit for himself. Three of the cases are still ongoing. The two cases, which have ended, the al Thani case and the market manipulation case resulted in heavy sentencing of Sigurðsson, Magnús Guðmundsson and Sigurður Einarsson, as well as other employees.

The first case brought was the al Thani case where Sigurðsson, Guðmundsson, Einarsson and Ólafsson were charged were misleading the market – they had all proclaimed that Sheikh Mohammed Bin Khalifa al Thani had bought shares in the bank without mentioning that the shares were bought with a loan from Kaupthing. The lending issued by the Kaupthing managers was ruled to be breach of fiduciary duty. The hidden deals in this saga were done in Kaupthing Luxembourg. Equally in the Marple case and the CLN case: the dirty deals, at the core of these cases, were done in Kaupthing Luxembourg.

Hreiðar Már Sigurðsson has been charged in all five cases; Magnús Guðmundsson in four cases and chairman of the board at the time Sigurður Einarsson in two cases. In addition, the bank’s second largest shareholder and one of Kaupthing’s largest borrowers Ólafur Ólafsson was charged and sentenced in the al Thani case.

What the CSSF has been investigating: Lindsor and the untold story of 6 October 2008

One of the few untold stories of the Icelandic banking collapse relates to Kaupthing. On 6 October 2008, the Icelandic Central Bank, CBI, issued a €500m loan to Kaupthing after the CBI governor Davíð Oddsson called the then PM Geir Haarde to get his blessing. This loan was not documented in the normal way: it is unclear where this figure of €500m came from, what its purpose was or how it was then used. As Oddsson nonchalantly confirmed on television the following day, the loan was announced by accident on the day it was issued. The loan was issued on the day the government passed the Emergency Act, in order to take over the banks and manage their default.

On the day that Kaupthing received the CBI loan, Kaupthing issued a loan of €171m to a BVI company, Lindsor Holdings Corporation, incorporated in July 2008 by Kaupthing, owned by Otris, a company owned by some of Kaupthing’s key managers. The largest transfer from Kaupthing October 6 was €225m in relation to Kaupthing Edge deposit holders, who were rapidly withdrawing funds. The second largest transfer was the Lindsor loan.

Having obtained the loan of €171m, Lindsor purchased bonds from Kaupthing entities and from Skúli Þorvaldsson, again via Marple, which seems to have profited by €67.5m from this loan alone. In its January 2010 letter to the CSSF, FME stated it “believes that the purpose of Lindsor was to create a “rubbish bin” that was used to dispose of all of the Kaupthing bonds still on the books of Kaupthing Luxembourg as the mother company, Kaupthing Iceland, was going bankrupt… Lindsor appears to FME to be a way to both reimburse favoured Kaupthing bondholders (Marple and Kaupthing Luxembourg employees) as well as remove losses from the balance sheet of Kaupthing Luxembourg. These losses were transferred to Lindsor, and entity wholly owned by Kaupthing Iceland,” at the time just about to go into default.

In addition, FME pointed out that most of the documents related to these Lindsor transactions had not been signed until December 2008 “but forged to appear as though they had been signed in September 2008. Employees in both Kaupthing Luxembourg and Kaupthing Iceland appear to have been complicit in this forgery.” – Yet another forgery story.

Intriguingly, when the OSP in Iceland decided to investigate Marple Holding, it already had a long-standing relationship with authorities in Luxembourg, having inter alia conducted multiple house searches in Luxembourg, first in 2010, with assistance from the Luxembourg authorities.

The purpose of the FME letter in January 2010 was not only to inform but to encourage the CSSF to open investigations into these trades. It took the CSSF allegedly some years until it started to investigate Lindsor. According to the Icelandic daily Morgunblaðið, the Prosecutor Office in Luxembourg now has the fully investigated case on his desk – the only thing missing is a decision if the case will be prosecuted or not.

Judging from evidence available on Lindsor in Iceland, there certainly seems a strong case to prosecute but the question remains if the investigation wins over the extreme lethargy in the Duchy of Luxembourg in investigating financial institutions.

AND SO, BANQUE HAVILLAND ROSE FROM KAUPTHING LUXEMBOURG’S COMPROMISED BOOKS

Enter the administrators

It is clear, that already in the summer of 2008, before Kaupthing Luxembourg collapsed together with the Icelandic mother company, Luxembourg authorities were fully aware that not everything in the Kaupthing Luxembourg operations had been in accordance with legal requirements and best practice.

On 9 October 2008, Kaupthing hf was put into administration in Iceland. On that same day, Kaupthing Luxembourg was granted suspension of payment for six months with the CSSF appointing administrators: Emmanuelle Caruel-Henniaux from PricewaterhouseCoopers, PWC, and the lawyer Franz Fayot. After Banque Havilland later came into being, PWC became the bank’s auditor. Its auditing fees in 2010 amounted to €422,000. In 2017, the fees had jumped to €1.3m.

Fayot was to play a visible role in the second coming of Kaupthing Luxembourg and has, as PWC, continued to do legal work for Banque Havilland. From 1997 to 2015 Fayot worked for the law firm Elvinger Hoss Prussen, EHP, another name to note; in 2015 Fayot joined the Luxembourg lawyer, Laurent Fisch, setting up FischFayot.

Contrary to the measures taken in Kaupthing Iceland, there was allegedly no visible attempt by the Kaupthing Luxembourg administrators to comparable scrutiny: Magnús Guðmundsson stayed with the bank and worked alongside the administrators with other Kaupthing employees. Their aim seems to have been to make sure that the bank, bursting with skeletons, would be sold on to someone with a certain understanding of Kaupthing’s business model.

The Kaupthing sale could only have happened with the understanding and goodwill of Luxembourg authorities: in spite of knowing of the severe issues and faulty management, the regulator seems to have left the administrators and Kaupthing staff to its own devices. Crucially, the state of Luxembourg was instrumental in giving the bank a second life, as Banque Havilland, by guaranteeing it a state aid of €320m.

JC Flowers, the Libyans and Blackfish Capital

Consequently, right from the beginning, everything was in place to enhance Kaupthing Luxembourg’s appeal for restructuring; the only thing missing was a new owner. The Luxembourg government had already outlined a rescue plan, drawing in the Belgian government, as Kaupthing Luxembourg had operated a subsidiary in Belgium where it marketed its high-interest accounts, Kaupthing Edge.

In a flurry of sales activity, the administrators contacted 40 likely buyers but the call for tender was open for everyone. The investment fund JC Flowers, which earlier had been involved with Kaupthing hf, had briefly shown interest in buying the Luxembourg subsidiary. But already by late 2008, Kaupthing Luxembourg seemed to be firmly on the path of being sold to the Libyan Investment Authority, LIA, the Libyan sovereign wealth fund, at the time firmly under the rule of the country’s leader Muammar Gaddafi.

The LIA certainly had the means to purchase the Luxembourg bank. In the end, however, two things proved an unsurmountable obstacle. The creditors rejected the Libyan plan 16 March 2009, possibly taking the reputational risk into account. And perhaps most importantly, given that the Luxembourg state wanted to enable the purchase with considerable funds, the Luxembourg authorities did in the end balk at the deal with the Libyans but only after months of negotiations.

Blackfish Capital and Jonathan Rowland’s “lieutenant”

In 2008, Michael Wright, a solicitor turned businessman, was working for Jonathan Rowland, son of David Rowland. In an ensuing court case, Wright described his role as being Jonathan’s “lieutenant” in spotting investment opportunities.

By 2013, Wright had fallen out with the Rowlands, later suing father and son in London where he lost his case in 2017. According to the judgement, Wright maintained that he had played a leading role in securing the purchase of Kaupthing Luxembourg for the Rowlands: after being introduced to Sigurður Einarsson or “Siggi” as he called him, already in late 2008, Wright brought the opportunity to purchase Kaupthing Luxembourg to the Rowlands.

The Rowlands admitted that Wright had been involved in “some discussions” with Einarsson and Kaupthing Bank representatives in early 2009 relating to “a proposed transaction concerning bonds,” which did not materialise but that the contact leading to the Rowlands acquiring Kaupthing Luxembourg came “subsequently.” The judge on the case noted that all three men were unreliable witnesses.

As late as March 2009, a deal with the LIA to purchase Kaupthing Luxembourg still seemed on track. According to Kaupthing hf Creditors’ report, updated in March 2009, the government of Luxembourg and a consortium led by the LIA had signed a memorandum of understanding with the aim of enabling Kaupthing Luxembourg to continue its operations. In order to facilitate the restoration, the governments of Luxembourg and Belgium had agreed to lend the bank €600m, enabling the bank to repay its 22,000 retail depositors.

From other sources, Icelog understands that the Rowlands were only contacted after it was clear that neither JC Flowers nor LIA would be buying Kaupthing Luxembourg. The person who contacted the Rowlands, according to Icelog sources, was indeed Magnús Guðmundsson, who had heard that father and son might be looking for a private bank to buy. By early June 2009, the Rowlands’ agreement with the administrators was in place.

Interestingly, there had apparently been some tentative interest from large Kaupthing shareholders – who nota bene had all bought Kaupthing shares with Kaupthing loans. The Guðmundsson brothers, Lýður and Ágúst, who owned Exista, Kaupthing’s largest shareholder, had allegedly been interested in joining David Rowland as minority shareholders but that did not happen. In an open letter to Hreiðar Már Sigurðsson and Magnús Guðmundsson, published in January 2019, Kevin Stanford, once close to the Kaupthing managers, claimed the two bankers did explore the possibility of buying Kaupthing together with the Guðmundsson brothers but the plan was abandoned.

Whatever the reality of these tentative plans, they show that the Kaupthing managers and the largest shareholders focused on keeping Kaupthing Luxembourg alive, caring less for other parts of the bank. That is intriguing, given the role of the Luxembourg subsidiary in Kaupthing’s dirty deals.

The €320m Luxembourg state aid for restructuring

From contemplating a loan of €600m, as the Kaupthing hf creditors had been led to believe, the final figure was a still generous €320m. Led by Luxembourg, with half of the funds provided by the Belgian government through an inter-state loan, the deal was finalised 10 June 2009. The sum of €320m was decided since €310m was deemed to cover the liquidity shortfall with €10m extra as a margin.

In December 2008, the Kaupthing Luxembourg shares had been moved to a new company, Luton Investments (now BH Holdings), set up by a BVI nominee company, Quebec Nominees Limited that Kaupthing Luxembourg had often used (and most likely owned).

Rowland took Luton Investments over in May 2009. On 10 July, Rowland increased its capital by the agreed amount of €50m, raising its capital to the agreed figure, according to the restructuring plan. Rowland also pledged to add further €25 to 75m in liquidity. The private banking activities and the deposits, at 13 March 2009 €275 to 325m, were taken over by Rowland’s Blackfish Capital, and registered as a new bank, Banque Havilland. Its starting balance was €1.3bn, €750 to 800m of which were existing commitments to the Luxembourg Central Bank, BCL.

Part of Rowland’s lot was also Kaupthing Luxembourg’s entire infrastructure, including headquarters and IT system. With Kaupthing’s staff of 100 employees, Banque Havilland had from the beginning funding, infrastructure and staff to ensure a smooth transition from the old Kaupthing Luxembourg to the new Banque Havilland.

On July 9 2009, the European Commission gave its approval of the state aid. It indicates that the Banque Havilland’s main source of income during its early years, was indeed the money coming from the Luxembourg state.

Pillar Securitisation

Banque Havilland’s €1.3bn starting balance was only around half of old Kaupthing Luxembourg’s balance sheet. The rest, €1.2bn, more or less the old bank’s lending operations, for which no buyer was found, was placed in a new company, Pillar Securitisation, in order to be sold over the coming years, to pay off the main creditors: the Luxembourg state, the Luxembourg deposit guarantee fund, AGDL, Luxembourg Deposit Guarantee Association (funded by retail banks), and Kaupthing Luxembourg’s inter-bank creditors.

Having received a banking licence, Banque Havilland came into being on July 10 2009: Luton Investments, the sole owner of Kaupthing Luxembourg, was split in two, Banque Havilland, the “living” bank and Pillar Securitisation, the “dead” bank. Crucially, Pillar was de facto not a separate unit: it had no staff but was run in-house by Banque Havilland, residing at the Banque Havilland address at 35A avenue J.F. Kennedy, formerly the premises of Kaupthing Luxembourg.

The proceeds of Pillar were vital for the recovery of creditors since asset sales of that company determine their recovery. The main creditors were the two governments that lent into the restructuring. The loan was divided into a super-senior tranche of €210m and a senior tranche of €110m, split in two to repay the two states, Luxembourg and Belgium. The same was for the AGDL, and the around €300m it covered as deposits were transferred: AGDL received bonds in return.

Having scrutinised the state loans to Kaupthing Luxembourg, the European Commission ruled that the loans amounted to state aid: after all, no commercial bank would have agreed to a non-interest loan to a bank during suspension of payment. These advantages were conferred to Blackfish Capital via the state-aided restructuring plan. However, the Commission was equally clear that this state aid was compatible with the Treaty, which does allow for a remedy caused by “serious disturbance in the economy of a Member State.”

Interestingly, the original plan was to wind Pillar down in just a few years; ten years later, that goal has still not been reached.

ROWLAND, THE BANK OWNER

What Rowland bought: CSSF’s concerns and Kaupthinking in practice

By buying a failed bank, Rowland showed he was not too bothered about reputational risk. By keeping the ex-manager of Kaupthing Luxembourg, Magnús Guðmundsson and his staff, he also showed that he was not worried about Kaupthing’s activities. True, much of that story was not public at the time. Rowland would however have heard of CSSF’s serious concern in summer of 2008, before the bank failed. Concern, related to risky loans to large shareholders and related parties, that would have leapt out of the books on due diligence.

Although the CSSF had been chasing Kaupthing for credit risk and over-exposure to large clients and shareholders, the regulator was apparently as unbothered as the administrators that the Kaupthing managers were in charge of the bank during its suspension of payment.

Not only did CSSF apparently not follow up on earlier worries but the Luxembourg state decided to facilitate the bank’s second life with loans, notably without making it a condition that the management should be changed.

In Banque Havilland’s 2010 annual accounts, COO Venetia Lean (Rowland’s daughter) and CFO Jean-Francois Willems stated in their introduction that the bank would focus on retaining clients who met “strategic requirements… Towards the end of the year the family started to introduce members of its network to the Bank and we are working on the development of co-investment products whereby clients have the opportunity to invest alongside the family.” This focus, on co-investing with the family, is no longer mentioned.

Rowland’s first foreign investments after Luxembourg: Belarus and Iceland

In November 2010, Banque Havilland embarked on its first foreign venture, in Belarus: ‘the first Belarusian foreign direct investment fund,’ apparently a short-lived joint-venture with the Russian Sberbank Group. The press release seems to have disappeared from the Havilland website.

From 2011 to 2015 Banque Havilland expanded both in Luxembourg and abroad, i.e. in Monaco, London, Moscow, Liechtenstein, Switzerland and Nassau, either by buying banks or opening offices. The expansion in Monaco, Liechtenstein and Switzerland were done inter alia by buying Banque Pasche in these three locations. In the London office it set up a partnership with 1858Ltd in order to add art consultancy to its services.

Rowland’s interest for Icelandic investments did not end with Kaupthing Luxembourg. Contrary to most other foreign investors at the time, Rowland did not seem unduly worried by capital controls in Iceland, in place since autumn 2008. In the spring of 2011, it transpired that he had bought just under 10% of shares in the Icelandic MP Bank, which he held through a family-owned company, Linley Limited, represented on the MP board by Michael Wright.

MP Bank was named after its founder Margeir Pétursson, a Grand Master in chess, who set it up in 1999. In 2005, Pétursson was interested in expanding abroad but rather than following Icelandic bankers to the neighbouring countries, he made use of his knowledge of Russian and bought Lviv Bank in Ukraine. MP Bank survived the banking collapse in 2008 but was struggling. By 2010, the bank was no longer under Pétursson’s control and he left the board. In early 2011 the bank was split in two, with Pétursson still running that part owning the bank’s foreign assets.

At the time Rowland bought shares in MP Bank the bank was being revived with new capital and new shareholders. Another new foreign shareholder, who bought a stake in MP, equal to Rowland’s, was the ex-Kaupthing client, Joe Lewis, who, with Kaupthing loan to buy shares in Kaupthing and scantily covered loans, fitted the characteristics of a favoured client.

Enic was a holding company Lewis co-owned with Daniel Levy through which they held their trophy asset, Tottenham Hotspur. Kaupthing Singer & Friedlander, KSF, Kaupthing’s UK subsidiary, had issued a loan of €121.9 million to Enic, with shares in the football club as collateral. Kaupthing deemed the club was worth €89m, which meant the loan was only party covered in addition to the collateral being highly illiquid. Yet, the rating of the collateral on Kaupthing books was ‘good’ as Kaupthing had “confidence in the informal support of the principals.” According to the loan book “Joe Lewis is reputedly extremely wealthy and a target for doing further business with.”

Kaupthing, Banque Havilland and Kvika

In 2009, the former KSF director Ármann Þorvaldsson published a book, Frozen Assets, about his Kaupthing life. In it, he tells, almost with palpable nostalgia, of sitting on Lewis’ yacht in June 2007, discussing further projects; Þorvaldsson was keen to build a stronger relationship with the man estimated to be one of the 20 richest people in the UK. What ties were being forged on the yacht is anyone’s guess.

Rowland was clearly as unworried about MP Bank’s reputation – at the time, involved in some court cases – as he had been about Kaupthing Luxembourg’s reputational risk. In 2014, MP Bank and Virðing, an Icelandic asset management company with numerous ex-Kaupthing employees, attempted to merge with MP Bank, giving rise to rumours in Iceland that a new Kaupthing was in the making. The merger floundered. In the summer of 2015, both Rowland and Lewis apparently sold their stakes to Straumur, another resurrected Icelandic investment bank. Yet, according to Linley Limited 2015 annual accounts, the MP Bank shares were written down that year and Rowland is no longer a shareholder in the bank.

After the Straumur purchase in 2015, MP Bank changed its name to Kvika. As Virðing and Kvika did indeed merge in 2017, the former director of KSF, Ármann Þorvaldsson became CEO of Kvika until he recently demoted himself by swapping places with Kvika’s deputy CEO Marínó Örn Tryggvason, another ex-Kaupthing employee, and moved to London in order to focus on Kvika London. The question is if Kaupthing’s former clients in London will be tempted to bank with Kvika. One of them has already stated to Icelog that he will not be switching to Kvika.

Out of the three largest Icelandic banks, that collapsed in October 2008, Kaupthing, or rather Kaupthing-related people, both managers and shareholders, seem to be the only ones who keep giving the idea that Kaupthing-connections are still alive and meaningful. These musings reverberate in the Icelandic media from time to time.

THE KAUPTHING SKELETONS IN BANQUE HAVILLAND

The Kaupthing – Banque Havilland link: Immo-Croissance

One link that connects old Kaupthing with Banque Havilland is the real estate company, Immo-Croissance, founded in 1988. By the time, Immo-Croissance attracted Icelandic attention, it owned two prime assets in Luxembourg, Villa Churchill and a building, set for demolition, on Boulevard Royal, where the land was the valuable asset. In 2008, Jón Ásgeir Jóhannesson, the Icelandic businessman of Baugur-fame and a long-time large borrower of Kaupthing and all other Icelandic banks, had set his eyes on Immo-Croissance.

Jóhannesson had hoovered up real estate companies here and there, most notably in Denmark, where he had been on a wild shopping spree, all merrily funded by the three Icelandic banks. Interestingly, he used Kaupthing Luxembourg for this transaction – Kaupthing put up a loan of €122m – although a consortium under Jóhannesson’s control had been the largest shareholder in Glitnir since spring 2007.

In November 2007, Immo-Croissance’s board reflected the Baugur ownership as Baugur-related directors took seat on the board, together with Kaupthing employee Jean-François Willems. Under Baugur-ownership, Immo-Croissance apparently went on a bit of a cruise through several Baugur-owned companies. In  June 2008, a Baugur Group company, BG Real Estate Europe, merged with Immo-Croissance, whereby magically the €122m loan to buy Immo-Croissance landed on Immo-Croissance own books.

But as with so many purchases by the Kaupthing’s favoured clients, Baugur’s purchase depended entirely on Kaupthing’s funding. By the end of September 2008, Baugur was in dire straits and Immo-Croissance was sold, or somehow passed on to SK Lux, a company belonging to the Kaupthing Luxembourg’s largest borrower, Skúli Þorvaldsson.

According to Icelog sources in Luxembourg, familiar with the Immo-Croissance deals in 2008, the SK Lux purchase of Immo-Croissance left all the risk with Kaupthing Luxembourg, a consistent pattern in deals financed by Kaupthing for the bank’s favoured clients.

The second and third life of Immo-Croissance

A key person in the Immo-Croissance saga, as in the origin of Banque Havilland, is the lawyer Franz Fayot, Kaupthing Luxembourg’s administrator until the bank was sold in summer of 2009. It was during his time as administrator of Kaupthing Luxembourg that Immo-Croissance was put up for sale, as SK Lux defaulted when the Kaupthing loan came to maturity at the end of October 2008.

At the time, Dexia was interested in buying Immo-Croissance. Its offer was a set-off against Kaupthing debt to Dexia, in addition to a cash payment. Kaupthing Luxembourg however preferred to sell to an Italian businessman Umberto Ronsisvalle and his company, R Capital. Guðmundsson arranged the deal for Ronsisvalle through Consolium, a Luxembourg company set up by an Icelandic company, later taken over by Guðmundsson and a few other ex-Kaupthing bankers. Consolioum went through name changes, with some of the bankers’ wives later taking over the ownership as the bankers got indicted or were at risk from being indicted in Iceland.

Ronsisvalle offered €5.5m. In addition, Immo-Croissance would get a loan from Kaupthing Luxembourg of €123m to refinance the earlier loan. This time however the loan was against proper guarantees, not like the earlier loan to the Icelandic Immo-Croissance owners, where no guarantees to speak of were in place.

By the end of January 2009, Umberto Ronsisvalle was in charge of Immo-Croissance but only for some months. By early summer 2009, the Kaupthing-related directors were again in charge, amongst them Jean-François Willems.

The unexpected turn of events took place in early 2009. Ronsisvalle paid the €5.5m but asked for some payment extension since he had problems in moving funds. He had understood that Kaupthing had agreed but hours after he provided the funds, Kaupthing changed its mind: it announced the loan was in default and moved to take a legal action to seize not only Immo-Croissance but also the collaterals, getting hold of €35m. The thrust of Kaupthing’s legal action was that Ronsisvalle had tried to take over Immo-Croissance without paying for it.

Early on, a judge refuted this Kaupthing allegation, pointing out that there was both the down-payment of €5.5m and the guarantees, contrary to earlier arrangements. Ronsisvalle’s side of event is that Kaupthing manipulated a default in order to get hold of the cash and the collaterals, in addition to keeping the assets in Immo-Croissance, a saga followed by the Luxembourg Land.

Havilland, Immo-Croissance and EHP

The lawyer for Kaupthing in the Immo-Croissance case was Pierre Elvinger from the legal firm Elvinger Hoss Prussen, EHP, where Franz Fayot worked prior to taking on the administration of Kaupthing. As the case has stretched over a decade now, Pillar Securitisation replaced the old Kaupthing Luxembourg in the Immo-Croissance chain of legal cases. Franz Fayot has been a lawyer for Havilland in these cases.

In 2013, the case had reached a point where a judge had ordered Pillar to hand back Immo-Croissance to Ronsisvalle, its legal owner according to the judge. The problem was that in the meantime, Pillar had sold the company’s two most valuable assets, Villa Churchill and the building on Boulevard Royal.

In an article in Land, in July 2013, it was pointed out that Villa Churchill was sold to a company owned by three partners at EHP. The Boulevard Royal asset was sold to Banque de Luxembourg, a private bank where one EHP partner was a member of the board. In both cases, questions were raised regarding the price and a friendly deal.

EHP complained about the reporting and its comment was published in Land: EHP pointed out that Fayot ceased to be administrator as Banque Havilland and Pillar Securitisation came in to being in July 2009, whereas the two assets were sold in 2010. Also, that the price had to be agreed on by Immo-Croissance owner, Pillar Securitisation, i.e. the Pillar creditors’ committee.

What the law firm does not mention is that Fayot has stayed in business relationship with Banque Havilland, inter alia as a lawyer for Banque Havilland, for example in the Immo-Croissance cases and in a case against a Kaupthing employee whom Havilland has kept in a legal battle for over a decade.

Court cases related to this action are still ongoing but Ronsisvalle has so far won at every stage and has regained control of the company after fighting in court for years. He is now involved in a legal battle with Banque Havilland and Pillar regarding the assets sold. Since Immo-Croissance was placed in Pillar Securitisation, the outcome could in the end spell losses for the creditors of Pillar, mainly the two governments that provided the state-aid, which made Kaupthing Luxembourg an attractive and largely risk-free purchase.

The ex-Kaupthing employee hounded by Banque Havilland

On 9 October 2008, the day of Kaupthing Luxembourg’s default, the bank’s risk manager resigned. In his opinion, the bank had paid far too little attention to his warnings on exposures to the large favoured clients, with equally little notice being taken to the CSSF’s warnings on the same issues. The attitude of the bank’s management seemed to be that it could not care less.

In his resignation letter, the risk manager referred to the CSSF August letter to the Kaupthing management. In spite of the warnings, Kaupthing had, according to the risk manager, not taken any measures to diminish the risk, thus probably aggravating the bank’s situation. And by doing nothing, the bank had cast shadow over the reputation of both the bank itself and its risk professionals.

In addition, the bank had not dedicated enough resources to its risk management, leaving it both lacking in personnel and IT solutions. This had also led to the standards of risk management, as expressed in the bank’s Handbook, being wholly unachievable. All of this had become much more pressing since the bank’s liquidity position had turned dramatically for the worse after 3 October 2008.

As he had resigned by putting forth a harsh criticism of the bank, effectively making himself an internal whistle-blower, he expected to be contacted by the CSSF. When that did not happen, he did contact the regulator. It turned out that the letter had not been passed on to the CSSF and no one there was particularly interested in meeting him. After pressing his point, the risk manager did get a meeting with the CSSF, which showed remarkable little enthusiasm for his message.

The CSSF, in August 2008 so critical of the Kaupthing Luxembourg management, now seemed wholly uninterested in the bank. That is rather remarkable, given that the state of Luxembourg had risked millions of euros to revive the bank, now run by the bankers that the CSSF had earlier criticised.

Baseless accusations of hacking and theft of documents

The risk manager heard nothing further from the CSSF nor from the administrators but strangely enough he got a letter from Magnús Guðmundsson, with the Kaupthing logo as if nothing had happened. He finally brought his case to Labour Court in Luxembourg both to assert that he had had the right to resign and to get a final salary settlement with Kaupthing Luxembourg.

Although the risk manager quit Kaupthing around nine months before Banque Havilland came into being, that bank counter-sued the risk manager for hacking, theft of documents and breach of banking secrecy. Interestingly these allegations were raised in 2010, after the risk manager had been called in as a witness by the UK Serious Fraud Office and the Icelandic OSP.

The hacking and theft allegations ended with a judgment in 2015, where the risk manager won the case. The judge found that the risk manager had obtained these documents as part of his duties and could legitimately hold them as evidence in the Labour Court case. This case had delayed the Labour Court case, which then could only be brought to court by the end of 2017, a still ongoing case.

Technically, the labour case was part of the liabilities that Banque Havilland took over and litigations take time. The remarkable thing is that Banque Havilland has pursued the case without any regard for the evidence of illegalities taking place in Kaupthing as well as not paying consideration to the fact that the CSSF had severely criticised Kaupthing’s management.

After all the risk manager had quit Kauthing as he felt he could no longer work with the management the CSSF had found to be failing. Using the courts to harass people is a common tactic, used to the fullest in this case. Havilland has pursued the case forcefully, which is why the case is still doing the rounds in the various courts of Luxembourg thus undermining the risk manager both financially and in terms of his professional reputation.

If a Banque Havilland employee has ever contemplated criticising the bank or in any way bringing up anything about the bank, this case shows how the Havilland owners might react. It is not certain that the attitude of Luxembourg authorities regarding whistle-blowers rhyme with European legislation.

Luxembourg, the rotten heart of financial Europe             

The ongoing legal wrangling with the risk manager and the Immo-Croissance are two stories that embody the strong and long-lived ties between Kaupthing Luxembourg and Banque Havilland. Both Franz Fayot and Pierre Elvinger from EHP, the company that still resides in Villa Churchill bought out of Immo-Croissance, have represented Banque Havilland in court.

Quite remarkably, the CSSF lost all interest in Kaupthing Luxembourg, after the bank failed. Instead, it chose to lend funds to its new owners, who had less than a stellar reputation. Owners, who kept the Kaupthing management, that had given rise to the CSSF’s earlier concerns.

In addition, after knowing full well what had gone on in Kaupthing Luxembourg and being fully informed about the criminal cases in Iceland, the Luxembourg Prosecutor, now seems to be dithering as to bringing a case related to Lindsor Holding, not to mention other cases that were never investigated.

This is the state of affairs in Luxembourg, still the rotten heart of financial Europe.

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