Funds Asked to Take a Hit in Iceland $2.4 Billion Auction

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  • Euro discount may be as much as 50% to official rate
  • Currency auction to pave way for dismantling capital controls

Investors were asked to take a hit as Iceland embarks on the last crucial step in dismantling its more than seven-year-old capital control regime.

The central bank on Thursday offered part of its foreign currency reserves in an auction to exchange $2.4 billion of mostly kronur-denominated Glacier bonds held by Loomis Sayles, Eaton Vance Management and hedge funds including Autonomy Capital. They were asked accept euros at a rate of as much as 50 percent below the official rate. The auction ran from 10 a.m. to 2 p.m. local time.

The offers will now be reviewed “over the days to come,” the central bank said in a statement Thursday. Results will be published no later than June 22.

Iceland late last year reached a deal with creditors in its failed banks, whose collapse plunged the nation into financial and economic chaos in 2008. Successive government have since resurrected the economy, winning praise for policies that have included refusing to bail out banks and mortgage writeoffs for struggling homeowners.

"Hopefully the auction will be a success, as this is the final move for Iceland to complete all matters related to the economic collapse of 2008,” said Asgeir Jonsson, an economist at the University of Iceland, in a telephone interview.

The bonds, which were sold outside Iceland until 2008, played a key role in bringing about the kind of imbalances that led to the demise of Kaupthing Bank, Glitnir Bank and Landsbanki Islands.

The size of the discount Iceland will impose in the auction depends on how many investors take part.

If it covers at least 175 billion kronur ($1.4 billion), a rate of 190 kronur per euro will be paid, representing a discount of 36 percent to the current rate of 139 per euro. If only 50 billion kronur are tendered, the bank will pay a lower rate of 210 per euro. The auction is structured with a single-price format and all accepted offers will paid at one price.

Investors who do not take part will see their assets locked into special accounts with an interest rate of 0.5 percent until further notice.

As far as Iceland is concerned, the investors can take or leave the offer.

"We’re going to neutralize the rest of the economy from the offshore kronur and then start to liberalize capital flows for residents, irrespective of whether the turnout is high or low," central bank Governor Mar Gudmundsson said in an interview in Reykjavik.

Iceland also this month erected new defenses to block fast money from chasing western Europe’s highest interest rates. The island set requirements for new offshore investors forcing them to keep 40 percent in reserve accounts in Iceland for at least one year, according to rules issued by the central bank.

Economists are clear that even as the last restrictions are now being unveiled, the krona will never really be free again.

“But the government will likely change the appearance of the restrictions or at least attempt to do it through its economic policies,” said Jonsson.

(An earlier version of this story was corrected to remove reference to hedge fund ahead of Loomis Sayles.)