Iceland Faces Legal Battle as U.S. Funds Balk at Krona Discount

  • Iceland met tepid demand in auction forcing 38% haircut
  • U.S. funds file complaint to EFTA Surveillance Authority

U.S. funds holding billions in offshore kronur filed a complaint against Iceland for forcing them to accept a currency discount of almost 40 percent as a condition to let the investors exit the nation’s capital controls.

The case was filed to the EFTA Surveillance Authority, according to Asdis Olafsdottir, a communications officer at the agency that monitors Iceland’s compliance with the European Union’s single market. She declined to provide details of the complaint or to comment further.

U.S. fund manager Eaton Vance Management confirmed it was one of the investors to file the complaint, while Icelandic broadcaster RUV reported that hedge fund Autonomy Capital was also a party. Autonomy didn’t immediately respond for a comment. Iceland’s central bank will look into the complaint but had no immediate response, according to spokesman Stefan Stefansson.

“We’re hoping we can continue to work with the government to find a solution that meets the interests of all parties,” said Eric Stein, co-director of global income at Boston-based Eaton Vance, which has about $319 billion assets under management. “We’re not asking for special treatment.”

The krone slid 0.4 percent to 138.74 per euro as of 1:56 p.m. in Reykjavik, after falling almost 3 percent on Monday.

The brewing legal battle follows a tepid response from investors in a currency auction earlier this month designed to mop up about 320 billion kronur ($2.6 billion) in offshore holdings. Iceland struck a deal last year with creditors in the three banks that collapsed in 2008, with creditor settlements marking a crucial step before capital controls can be lifted for consumers and corporations.

The central bank only accepted 72 billion kronur in offers at the June 16 auction, paying a rate of 190 per euro, while rejecting 106 billion kronur in offers. The official exchange rate was 138 kronur per euro at the time though the krona trades lower in offshore markets. The bank said it will pay the 190 per-euro rate on all kronur that aren’t sold before June 27.

Finance Minister Bjarni Benediktsson in a June 16 opinion piece in the Wall Street Journal lashed out at critics claiming the auction terms were tantamount to a sovereign default.

“Although the investments were knowingly made into an economy with capital controls, the hedge funds now apparently believe that they are entitled to be taken out of these positions at a significant profit before Iceland even begins to lift the burden of capital controls on its residents,” he said.

EMTA, a trade group for investors in emerging markets, is holding a seminar in New York on June 29 to discuss whether Iceland is in a “selective default.”

Investors who didn’t participate in the auction will have their assets locked into special accounts with an interest rate of 0.5 percent until further notice, the central bank has said. The final results will be published after settlement on June 29.

Iceland has won praise from Nobel laureates and the International Monetary Fund for policies that have included refusing to bail out its banks and providing large-scale debt relief for struggling homeowners, helping fuel an economic recovery.

“We continue to be positive on the long-term story in Iceland,” said Stein at Eaton Vance. “The progress since 2008 has been remarkable.”

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