Cyprus: mired in uncertainty

The Cypriot bailout could have a devastating effect on the whole of the country’s economy, including its legal services market.

yiota kythretou theodorou pamboridis

In the early hours of 16 March 2013, the Cyprus government and the Eurogroup reached political agreement with respect to the Cyprus “bailout” plan.

The Cyprus government provisionally agreed to a one-off levy on bank deposits in Cyprus at a rate of 6.75 per cent for deposits up to €100,000 rising to 9.99 per cent for amounts in excess of €100,000. The aim was to raise €5.8bn required to recapitalise Cyprus banks. The European Central Bank (ECB) and the International Monetary Fund (IMF) would advance the remaining €10bn to cover the estimated funding requirements of Cyprus. The levy would be imposed on funds deposited as at 15 March 2013.

The agreed measures also included an increase in corporation tax from 10 per cent to 12.5 per cent as well as an increase in the Special Defence Contributions on interest and dividends from 15 per cent to 25 per cent and from 20 per cent to 30 per cent respectively.

There is a strong feeling among the government and the general public that the Troika, and especially the Eurogroup, have been extremely heavy handed with Cyprus – more than with any other troubled EU member state that turned to them for help. There is a strong feeling that we were, in effect, blackmailed into this agreement with the threat that, if we did not agree, Emergency Liquidity Assistance (ELA) would cut off liquidity to Cyprus banks leading to a collapse, firstly, of Laiki Bank, followed by the Bank of Cyprus and possibly more.

On Monday night, at a telephone conference, the Eurogroup decided that Cyprus can differentiate the originally agreed rates provided that the total amount raised remains at €5.8bn. The draft bill that was eventually put before Parliament exempted from the levy deposits of less than €20,000.

This agreement was to be put before the Cyprus Parliament for approval on Sunday, 17 March. This was postponed to Monday 18 March and then again postponed to Tuesday 19 March.

It was clear before the bill was put to the vote that it was doomed to fail. In fact not a single MP voted in favour of the bill. I think it was the right decision to make. A “yes” vote would have been the tombstone on the entire Cyprus services industry. It would have been catastrophic for the Cyprus economy. It is impossible to comprehend how the Troika and our EU partners consider that this “haircut” in savings would in any way contribute to improving Cyprus’ economy. I don’t doubt that corrections need to be made to the Cyprus banking sector but an adjustment this violent would only have made the problem worse.

It is not clear if there is a “Plan B”. A few alternatives are being discussed. One is assistance from Russia (a traditional ally of Cyprus) but this does not seem to be readily forthcoming. The Cyprus finance minister is in Moscow for talks at the moment and there are rumours that the president of Cyprus, Nicos Anastassiades, will be joining him soon.

Another is the creation of one or more “bad banks” where the two biggest Cyprus banks will transfer their toxic assets (this would result in unsecured creditors making an even bigger loss than the proposed 9.99 per cent). Some are discussing the nationalisation of pension and provident funds as a way for the government to access funds, in conjunction with a different kind of levy on deposits and the raising of funds through a government bond. There is widespread fear in Cyprus though is that all this is simply too little, too late.

Following last night’s developments, the reaction from Europe, as expected, has not been a happy one. Angela Merkel has “encouraged” Anastassiades not to look to Russia for support but only talk with the Troika. German finance minister Wolfgang Schaeuble warned that Cyprus banks that are insolvent cannot expect continued support from ELA, a view that has been echoed by ECB board member Joerg Asmussen.

In the meantime, a banking holiday was declared for Tuesday 19 and Wednesday 20 March (Monday was a public holiday anyway) and is expected to be extended until this coming Friday. This would mean that the banks will be shut until Tuesday 26 March (as Monday 25 is a scheduled bank holiday). The Cyprus Stock Exchange is also expected to be closed till then.

Eurogroup’s decision of last Saturday has hit Cyprus hard. Despite the fact that the bill did not make it through Parliament the repercussions of the events of the last few days are immense. The financial, fiduciary and legal sectors are counting their losses. The services industry, which remained one of the few relatively healthy industries of the Cyprus economy during the last few years has received a big blow.

Despite the proposed levy, the tax exemption on dividends, capital gains on shares and other financial instruments, permanent establishment profits, IP profits and interest earned by non- residents are not affected. It is also not obligatory for Cyprus companies to maintain bank accounts in Cyprus (indeed most Cyprus companies used in holding structures do not). For what it’s worth, Cyprus continues to be an advantageous holding company jurisdiction.

But we have to be realistic. The loss to Cyprus’ credibility as a financial centre is devastating. It will be extremely hard, if at all possible, to recover from a hit of this magnitude.

For the private sector, lawyers, accountants and other service providers (following the initial shock) the focus has now shifted toward damage limitation, for their clients, for the country, the industry and for themselves. Things are simply too fluid at the moment and it is impossible to predict how events will unfold. The prevalent feeling amongst colleagues is that this whole mess has been handled clumsily by the Troika, our EU partners and ourselves (past and present government included). There were other ways and options, less damaging, less threatening and less risky. We now have to wait and see how events will unfold.

Yiota Kythreotou-Theodorou is managing partner of Pamboridis