Debt heat

Next month (18 September) the Icelandic government’s battle with the European Free Trade Association Surveillance Authority (EFTASA) will come to a head in Luxembourg, with the first hearing in the dispute over failed Icesave deposit schemes.

From the outset legal rows over the collapse of Landsbanki back in October 2008 have been tinged with political rhetoric. When more than 200,000 UK-based depositors with online accounts at Icesave, the brand owned by Landsbanki, found themselves without access to their savings it was the UK Treasury that stepped in to bail them out. While it may have scored the UK Government a few political points at home, some suggest the view from Iceland could not have been frostier.

Icy blast

In November that year chairman of the governors of the Iceland central bank Davíð Oddsson spoke for a nation when he stated flatly: “When the bulk of our banking system collapsed in the space of a few days in October and the British placed a fellow NATO member on a list together with the most notorious terrorists on the planet – a list that included not only Landsbanki but also the Republic of Iceland – it was no wonder that foreign exchange activity between Iceland and other nations should be utterly paralysed.”

The UK Treasury’s subsequent attempt to recoup those lost funds from the Icelandic government was never going to be easy and when it came to the nation voting on a proposed deal to pay back the UK Government, 92 per cent rejected it.

While the political punches are being thrown behind the scenes a legal war is being waged in which the Icelandic government is looking to pull off a major coup against EFTASA and its supporters. In May 2010, ahead of the Iceland referendum on the deal, the EFTASA issued a letter of formal notice to the Iceland government outlining its position on the legal obligations the government was under.

The emphatic rejection of the proposed deal between Iceland, the UK and the Netherlands pushed EFTASA into starting proceedings against the Icelandic government.
Under the EU Deposit Guarantee Directive, it said, Iceland was obliged to provide minimum compensation of €20,000 (£16,000) per depositor. Responding, the Icelandic government argued that it considered setting up a guarantee scheme to be enough to fulfil its obligations under the directive. It has also argued that the directive may not be applicable if deposits are unavailable because of a major and general banking crisis.

Can’t pay, won’t pay

According to Monckton Chambers’ Tim Ward QC, who is instructed to defend the case for the Icelandic government, “the Icelandic compensation pot is empty - you can’t pay if you don’t have the money”.

He continues: “If you have a bank crash on the scale Iceland did, no deposit guarantee scheme would be able to cope. The government shouldn’t have to step in.”
That clearly was not the view of the European Commission (EC), which in April sought permission to intervene in the case in support of EFTASA. It was the first time the commission had sought permission to have direct involvement a matter before the EFTA court.

In June the Icelandic government set out its response to the EC intervention - the final battle of words before the oral court hearing in September. EFTASA, it claimed, had moved away from its position that the state should step in following the failure of a deposit guarantee scheme as had the EC. There is only an obligation to ensure the guarantee scheme is capable of ensuring minimum compensation for depositors.

Iceland argues that this shows a lack of understanding of the limits of a deposit guarantee scheme. If the state is obliged to ensure that a guarantee scheme will be able to pay compensation, it will ultimately be required to use its own resources.

The assertion by the EC that such schemes should be notified under EU state aid rules would not be permitted without the approval of the EC or EFTASA with regard to the EFTA states. Such a position, counters Iceland, is inconsistent with an obligation to ensure compensation is paid in all cases, as such assistance would fall outside the scope of state aid rules if there was an obligation to finance the guarantee scheme under the Deposit Guarantee Directive.

Complaints that the new Icelandic banks could have borne the cost of the compensation scheme were unrealistic, Iceland argues. The liabilities of the Icelandic deposit guarantee scheme represented around 30 per cent of the new banks’ total assets at the end of 2008. Had they been required to finance the guarantee scheme’s obligations they would not have been able to secure a license from the Financial Supervisory Authority so any compensation would have been further delayed.

It is Iceland’s case that the EC should be dismissed from the dispute.

This is a case that will be closely followed by other EU member states, with the Deposit Guarantee Directive in the spotlight. In the meantime, Landsbanki administrators are working hard to reduce its international debt obligations.

For the Icelandic government the political stakes are high, but the financial implications could be bleak.