Photographer: Paul Taggart/Bloomberg

U.S. Funds to Argue Iceland Defaulted on Its Sovereign Claims

  • Allegations to follow existing EFTA case against Iceland
  • S&P warns ‘legal risks’ may weigh on ratings considerations

Lawyers representing U.S. funds that bought Icelandic treasury bonds after the island’s 2008 banking collapse say the terms of a debt settlement may represent a partial sovereign default.

An auction arranged by Iceland’s central bank forced investors to accept “a huge haircut” on their claims and “violates their constitutional rights,” Petur Orn Sverrisson, one of a team of lawyers representing Eaton Vance Corp. and Autonomy Capital LP, told Bloomberg. 

The funds asked the Reykjavik District Court in June to appoint specialists to investigate whether Iceland has any economic grounds for refusing to exchange their kronur at market prices. Once the specialists respond, Sverrisson says the funds plan to file a formal case alleging a potential default has occurred. Iceland’s government rejects any suggestion it failed to honor its obligations, said Gudmundur Arnason, permanent secretary at the Finance Ministry.

The decision “may constitute a sovereign default, or at least something that’s akin to composition, whereby creditors are forced to accept a payment that’s lower than they are due," Sverrisson said.

Last month, the central bank invited offshore investors to offload 319 billion kronur -- the equivalent of $2.6 billion at current rates -- in securities that had been trapped behind capital controls since late 2008. The June 16 auction drew offers worth 178 billion kronur, of which the central bank accepted just 72 billion kronur. The claims were settled at an exchange rate of 190 kronur per euro, compared with the 138-krona market rate at the time. Those refusing to participate were told their assets would be locked up in a low-interest account until further notice.

The allegations from Eaton Vance and Autonomy Capital come on top of a case that has been referred to the EFTA Surveillance Authority, a Brussels-based body that monitors the compliance of European Economic Area members like Iceland with the rules that govern the European Union’s internal market. In the existing EFTA filing, the two funds say Iceland discriminated against investors who chose not to accept the terms of the auction by locking them into low-rate accounts.

Ratings Concern

The dispute is already a source of concern for S&P Global Ratings.

“We see legal risks from the government’s approach to remaining offshore ISK holders, which are likely to try to reach a better settlement either through continued negotiation or litigation," S&P said on Friday as it affirmed its BBB+ rating for Iceland.

Iceland’s government rejects any suggestion it has acted unconstitutionally. Arnason at the Finance Ministry says “there’s no reason to fear that our actions are in violation of the laws," and dismissed allegations that Iceland’s handling of creditors constituted a failure to honor sovereign obligations. He also said he sees it as unlikely that the development will hamper the country’s efforts to achieve a higher credit rating.

"We’re getting very positive feedback from the rating companies," Arnason said in an interview. "The rating is little by little moving up and what’s positive is that we’re getting closer to again being rated A."

While Iceland’s biggest banks defaulted in 2008, the government managed to get through the darkest hours of the financial crisis without reneging on any of its obligations to creditors, though it did draw on the International Monetary Fund and other international lenders for support.

The country is now taking its final steps toward rejoining the global financial community, with remaining restrictions on consumers and corporations due to be lifted by the end of the year. The Nordic economy, which is not part of the European Union, will grow 4.5 percent this year and 4 percent in 2017, according to the central bank. That compares with average growth of less than 2 percent in the EU this year and next, according to the European Commission.

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