EMTA SPECIAL SEMINAR: ICELAND'S SELECTIVE DEFAULT?
Wednesday, June 29, 2016
EMTA
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York City
In recently passed legislation, Iceland has
codified specific restrictions on particular króna-denominated assets, an
unconventional decision that has alarmed members of the international financial
community. The country has presented the holders of “offshore króna assets” –
certain króna-denominated assets, such as deposits held by foreign retail and
institutional investors – with a Catch-22 scenario: participate in a Central
Bank of Iceland auction with unfavorable terms, or have their assets placed into
locked, non-interest-bearing accounts.
This maneuver is drawing comparisons to “selective defaults”, like that of Argentina. Broadly framed within Iceland’s economic turnaround, the decision to segregate particular assets – and consequently, impact only certain asset holders – fits into a broader discussion around the challenges of both lifting capital controls and navigating relationships with international investors.
11:45 a.m. Registration
12:00 noon – 2:00 p.m. Panel Discussion
James Glassman (American
Enterprise Institute) –
Moderator
Arturo Porzecanski
(American University)
Lee Buchheit (Cleary
Gottlieb Steen & Hamilton)
Magnus Arni Skulason (Reykjavik Economics)
Lunch will be provided
Registration fee for EMTA Members: US$95 / US$695 for non-members / Credential Media Complimentary
Iceland in the News
EMTA hosted a Special Seminar, “Iceland’s Selective Default?”, on June 29, 2016 at its NYC offices. James Glassman (American Enterprise Institute) moderated the panel, with the following panelists: Arturo Porzecanski (American University), Lee Buchheit (Cleary Gottlieb Steen & Hamilton) and Magnus Arni Skulason (Reykjavik Economics).
In recently passed legislation, Iceland has codified specific restrictions on particular króna-denominated assets, an unconventional decision that has alarmed members of the international financial community. The country has presented the holders of “offshore króna assets” – certain króna-denominated assets, such as deposits held by foreign retail and institutional investors – with a Catch-22 scenario: participate in a Central Bank of Iceland auction with unfavorable terms, or have their assets placed into locked, non-interest-bearing accounts.
This maneuver is drawing comparisons to “selective defaults”, like that of Argentina. Broadly framed within Iceland’s economic turnaround, the decision to segregate particular assets – and consequently, impact only certain asset holders – fits into a broader discussion around the challenges of both lifting capital controls and navigating relationships with international investors.
A summary of the panel discussion will be contained in the 3rd Quarter Bulletin.
Experts Gather to Discuss Iceland’s Next Move
EMTA hosted a Special Seminar, “Iceland’s Selective Default?”, on June 29, 2016 at its NYC offices. James Glassman (American Enterprise Institute) moderated the panel, with the following panelists: Arturo Porzecanski (American University), Lee Buchheit (Cleary Gottlieb Steen & Hamilton) and Magnus Arni Skulason (Reykjavik Economics).
In recently passed legislation, Iceland has codified specific restrictions on particular króna-denominated assets, an unconventional decision that has alarmed some members of the international financial community. The country has presented the holders of “offshore króna assets” – certain króna-denominated assets, such as deposits held by foreign retail and institutional investors – with two options: participate in a Central Bank of Iceland auction (some claim at unfavorable terms), or have their assets placed into locked, noninterest-bearing accounts. This choice is drawing comparisons for some investors in the market to “selective defaults”, like that of Argentina. Broadly framed within Iceland’s economic turnaround, the decision to segregate particular assets – and consequently, impact only certain asset holders – fits into a broader discussion surrounding the challenges of both lifting capital controls and navigating relationships with international investors.
Recent articles by Glassman and Porzecanski relating to Iceland can be accessed by Clicking Here.
Glassman provided a brief summary of Iceland statistics (including its over 330,000 population and fact that it beat England in soccer that week), as well as noting its impressive recovery from the 2008 disaster that led to the bankruptcy of many banks and businesses, decrease in the stock market and downgrading of sovereign bonds. Iceland repaid a $2 billion loan from the IMF and its sovereign rating has increased from BBB- to BBB+. Given all this progress, Glassman asked panelists why they thought the country has offered this “Hobbesian roach motel” option of being locked at 0.5% for an indeterminate amount of time.
Skulason opened his remarks with the question “Is the emerging financial restructuring prodigy child Iceland transforming into Icarus [who flew too close to the sun and the sea]?” While Iceland is accustomed to winning (even in battles with its creditors), he stated that it is potentially making a grave mistake by “interpreting sovereign debt as private debt”. His PowerPoint presentation (the full text of which can be accessed by Clicking Here) shows how its improved access to foreign credit markets has enabled resident borrowers to pay off foreign debt, and it has a positive underlying current account, which led, in 2015, to a repayment to the IMF and other bilateral loan creditors. However, both the Central Bank and the IMF acknowledge that Iceland might have potential challenges when the capital controls are lifted. He wondered whether Iceland will lose the opportunity to be a textbook example of a successful sovereign financial restructuring. He claimed that Iceland has fared well out of the international financial crisis and has surfaced from the October 2008 abyss, mainly because it did not socialize private debt, but did prioritize depositors. He explained that offshore kronas were a specially defined asset class defined recently by law, broadly divided into three categories: sovereign bonds denominated in ISK mainly held by four U.S. mutual funds, equity denominated in ISK and deposits denominated in ISK. He posited that the Central Bank’s “Auction” was a failure at a 27% discount (with only 40% of the offered bids accepted and only 20% of the total offshore krona amount), stating that Iceland had a chance to negotiate at a discount and owners of offshore ISK had no other option than to participate, and asking “is it an auction where the intermediary is the auctioneer and the buyer at the same time? Would anyone sell a Picasso painting where the auctioneer was the only buyer and would set the price? The Central Bank can do better than this without creating legal, economic and political challenges”. He clarified that he didn’t think the country was in a selective default situation yet (not having implemented a strategy for its reserve account), but it could be heading there unless a solution was found. If Iceland forces the offshore ISK sovereign bondholders into locked accounts with negative real interest rates, it might be interpreted as a selective default (which could happen as early as September or November of this year). Potential solutions for preventing selective default and avoiding prolonged litigation with an uncertain outcome include allowing the offshore ISK sovereign bondholders to reinvest in Iceland for the long-term in the securities market, like all other domestic investors, or a EUR/ISK offer that would reflect better the current economic position of Iceland.
Porzecanski provided some background (the full text of his remarks can be accessed by Clicking Here) on how stringent capital controls were first imposed in late 2008 in order to prevent large-scale capital flight and a complete collapse of the exchange rate. They were intended as a short-term measure to be removed as soon as possible, and in any event by November 2010 (expiration of the IMF program). He remarked with dismay that almost eight years later the stringent capital controls were still in place, “despite the fact that the banking crisis has been resolved to the government’s satisfaction and Iceland has exhibited a more vigorous economic recovery than most Nordic countries…most of [its] vital indicators are looking healthier today than they did before the crisis”. With many of the preconditions for dismantling the capital controls being met, the country was now “put[ing] in [its] crosshairs the foreign financial investors who years ago were courted by the government and the private sector, to buy government and corporate bonds and acquire other financial assets, such as stocks and bank deposits…, [the] the so-called offshore krona investments [officially estimated 319bn krona], which have been trapped inside Iceland by the rationing of access to foreign exchange”. While these foreign investors reportedly offered to exchange their krona for a government bond denominated in dollars, rather than insisting on cash up front, he viewed the government’s response as “vindictive…, [wanting] to inflict heavy damage on these creditors too, as if they had been responsible for the country’s banking crisis…Offshore krona investors were recently given a one-time chance to exit their positions and access foreign exchange by agreeing to a departure tax of between 37 and 58% on their holdings. To encourage foreign investors to swallow such a bitter pill after eight years of waiting, the authorities have announced their intent to imprison any remaining funds and to bleed them slowly over time. As per legislation passed in late May, all residual offshore krona funds are to be segregated into accounts subject to a 100% compulsory requirement to purchase krona-denominated deposit certificates, issued by the CBI, paying a miserly interest rate of 0.5% per annum – a fraction of the 5.75 interest rate that the CBI has been paying on seven-day bank deposits. Foreign investors spurning the auction were warned by the authorities to expect to languish in these creditor prisons for ‘many years’… This smells to me like the kind of coercive, punishing debt exchanges that we saw orchestrated by Argentina in 2005 and 2010, and in Greece in 2012”. He viewed this as a “confiscatory and discriminatory scheme with no economic justification and concocted to avoid the appearance of a distressed debt exchange” that should be classified as a sovereign selective default.
He closed with the following: “The irony is that the government has recently admitted that there are foreign investors wanting to come into Iceland. These potential investors could generate the foreign exchange inflows to compensate for whatever outflows, on account of liberated offshore-krona balances, the authorities would countenance. And yet, rather than welcoming them to Iceland, earlier this month the government requested, and the Icelandic parliament readily agreed, to pass a law authorizing the CBI to impose a reserve requirement of up to 75%, for a period as long as five years, to discourage such capital inflows into domestic bonds and bank deposits. In other words, instead of making progress on capital liberalization, the authorities in Reykjavík are about to couple capital controls on outflows with new controls on inflows”. The lifting of capital controls was a “no-brainer”, there are lots of sources of financing available, the country is “ideally positioned”.
While Glassman bristled at Porzecanski’s use of “vindictive” to describe Iceland’s behavior, rather favoring more of a “business as usual” approach to governing by just “saving some cash”, Buchheit said that the description of this Seminar in the advertisement for the event and the composition of the panel reminded him somewhat of the assurance that Judge Roy Bean used to give defendants who appeared before him: “Son, in this court I can promise you a fair trial before we hang you”. His seminal point was “to own a currency of a country doesn’t make me a creditor”; there are no obligations, no default, selective or not; the description of events is untrue and the argument for default is “fallacious”. He recounted how in ’08 90% of the banking system collapsed literally overnight, and that there was no pressure to bail-out the banks since Iceland was not under the Euro rubric. He viewed the capital controls as not being too problematic, given the small economy, but he admitted that they’re self-fulfilling – the more they’re in place, the more they erode investor confidence, the more they have to continue to be in place – they are “always adhesive and undesirable and rarely temporary”. On the three categories of krona holders during the crisis, he posited the following: (1) the three largest Icelandic banks (which owed billions to European financial institutions that sold claims for pennies on the dollar) were allowed to fail, thus causing big damage to the fx market and otherwise, (2) offshore holders who were paid rich interest rates and (3) residual individuals and local pension funds (with a youthful population contributing lots to those funds) were prohibited from buying more foreign-denominated currencies because capital controls were imposed, which contributed to the huge pent-up demand to access the fx market.
While “the sooner it can end the better”, to be “judicious and fair”, capital controls couldn’t just be lifted without jeopardizing the economy, the decision was made to do so in stages (with the (3) holders dealt with last). The (2) holders received the best deal, being allowed to participate in 22 auctions, where they could buy offshore krona at a discount and take their foreign currency out of the country. Eight years of progress has resulted in 60% of offshore krona being resolved, the estates of failed banks have been satisfactorily resolved without an adverse effect on the exchange rate, and the government received a windfall (gaining krona that was unexpected and unbudgeted). Far from being vindictive, the government has chosen to be cautious, prudent and deliberate (rather than acting recklessly in such a small economy) and has eased capital controls, accepted 98% of tenders at auctions (and there may be a 23rd or future auction as well, although Porzecanski points out that the government has proclaimed this will be the final one) and has dealt with a “scarce resource” and an “intractable problem” in the most admirable and efficient way. The fate of those who declined to bid or whose bids were not met are in the same position as they were all throughout these last eight years, and some may even have bought krona under this exchange control regime scenario. He posits that 0.5% is not at all miserly, but rather positively “lavish” in a global era of negative interest rates (while Porzecanski posited that the correct comparison was not to negative interest rates, but rather to relevant opportunities available internally). Now the (3) category of holders (25% of GDP representing pension funds and probably 10% representing the other residuals) must be dealt with. He concluded by stating that there was no question that Iceland’s bonds will be paid on time, it has never defaulted on its debt and its record is “stainless”.
In response to Glassman’s request for other country precedents which may be defined as “defaults”, Porzecanski reiterated that money here was locked into an account, with holders unsure of when it can come out, which was similar to the conundrum of being able to sell one’s home with a 70% tax on it, attributable just to that home seller (the “freedom to sell” was clearly lacking). He predicted this situation was “headed for the courts” (with the European Economic Agreement detailing rights), given Iceland’s discriminatory stance of confiscation and expropriation without due compensation intended just for foreign investors. “By Iceland’s standards, it’s a precedent”. Buchheit responded that not much has changed in the last eight years, and especially not adversely for offshore krona holders, and that if you buy a home and know there’s a 70% tax on it, you have no right to object if the tax is levied. All that has been done thus far by the country has been to protect the economy, not for some sinister motive or conspiracy.
Concluding remarks were: this discriminatory action prohibited by Iceland’s own Constitution may discourage inflows in the future, and rating agencies may continue to downgrade (Glassman); there are more options in its toolbox than in the last crisis (Skulason); this could be solved cheaply with market solutions without antagonizing creditors; this is a government that made money out of its banking crisis, which means it screwed its creditors with haircuts; a number of countries in crisis have not imposed capital controls, which may be easy to put on and very difficult to take off (although Argentina seemed to have removed them from one day to the next); I don’t mind a haircut, but don’t want a scalping (Porzecanski); and investors are more likely to applaud than criticize Iceland; markets forgive and forget – see Argentina’s recent bond issuance (Buchheit).
Lastly, in response to an audience question of whether it was fair to discriminate based on residency even if krona was held pre’08 crisis, Buchheit replied that there was no discrimination based on residency of the investor, and, if there was, then residents are more discriminated against than foreigners.