Yesterday – 8 October – witnessed a new turn of events in the global financial crisis, as the need for Governments to underwrite their financial sectors led to growing diplomatic strains between the United Kingdom and Iceland.
As is well known, ING, the Dutch banking and insurance group, agreed to take on deposits from the online service provided by a UK subsidiary of Kaupthing, and also took over savings in Heritable Bank, a UK subsidiary of Landsbanki. These transfers have been executed under the Banking (Special Provisions) Act 2008, the legislation introduced following the Northern Rock crisis.
But it is the position of Landsbanki itself which forms the subject matter of this Briefing. Landsbanki was placed into receivership in Iceland on 7 October. The diplomatic difficulties caused by this collapse spring largely from Icesave, an internet deposit taking product operated by Landsbanki and which accepted funds from consumers in the UK.
Iceland is a member of the European Economic Area and, as such, has implemented the EU’s Directive on Deposit Guarantee Schemes. Consistently with the overarching principle of “home State supervision”, that Directive requires each country to introduce guarantee schemes which cover deposits accepted by their banks throughout all EEA member countries. As a result, the first €20,000 of each deposit accepted by Landsbanki is guaranteed by the Icelandic deposit guarantee scheme, and the UK Government would have no obligation in respect of that amount. Since the UK offers a more favourable guarantee (up to £50,000), “top up” arrangements are in place such that the UK’s Financial Services Compensation Scheme would cover the excess amount, but amounts over £50,000 would be uninsured.
The problem was summarised by the Chancellor of the Exchequer, who told the BBC “…The Icelandic Government, believe it or not, told me yesterday that they have no intention of honouring their obligations here…Because this is a branch of a foreign bank, the first call would be on the Icelandic compensation scheme which, as far as I can see, hasn’t got any money in it…”
However that may be, the exigencies of the situation compelled the Treasury to guarantee all Icesave deposits, regardless of amount. In the absence of a change of mind on Iceland’s part, or some other political settlement, the UK has declared its intention to take legal proceedings to compel Iceland to meet its obligations under the Directive. But such proceedings may take years, and more immediate action was felt to be necessary.
The Freezing Order
That immediate action took the form of The Landsbanki Freezing Order 2008, which came into effect at 10.10 a.m. on 8 October. The Treasury announcement states that the freeze is intended to remain in place “…until the position with respect to the future of the firm and UK creditors becomes clearer…” This, presumably, means that the freeze will be effective at least until Iceland undertakes to cover UK deposits in compliance with the Directive.
Measures which are expressed to be “temporary” have an unhappy habit of remaining in force for extended periods. But however long the Order remains in force, the background to it suggests that any breach of the Order is likely to be taken seriously by the authorities. Compliance will therefore be a critical issue for financial institutions, professionals and others.
Somewhat improbably, the Order has been made under the Anti-Terrorism, Crime and Security Act 2001, with the result that any breach of the Order will be a serious criminal offence.
When does the Order apply?
In essence, the Order applies where two conditions are satisfied, namely:
a. Any payment or transfer or property is to be made by (i) any person in the UK, (ii) a body corporate (including a company or limited liability partnership) established in the UK, or (iii) a British citizen, even if outside the UK; and
b. The payment or transfer has the effect of making assets available (i) to Landsbanki or (ii) insofar as the relevant funds or assets are referable to Landsbanki, to the Government of Iceland, to its Central Bank or Financial Services Authority, or to the Landsbanki receivership committee.
Article 4 of the Order creates wide-ranging offences which can be committed by anyone. Specifically, a person cannot make frozen funds available to any of the prohibited recipients, nor may he accept instructions to transfer or otherwise deal with frozen assets. A bank or professional who assists another person in making a prohibited transfer (e.g., by preparing documentation or moving client funds) will likewise be guilty of an offence.
The broad scope of the Order has in many respects been cut back by a General Activities Licence issued by the Treasury on 9 October. The General Licence is designed to allow the London branch of Landsbanki to continue to service its business customers. In particular it allows for the following:
a. Landsbanki can continue to operate its Commercial Finance and Asset Based Lending divisions, and third parties are allowed to continue dealing with them;
b. Borrowers and other debtors may make payments to or for the account of Landsbanki’s London branch, but payments to the head office or other branches remain unlawful;
c. Landsbanki may carry out foreign exchange transactions for customers;
d. Banks which hold accounts for Landsbanki are permitted to operate those accounts on the instructions of the London branch (although the London branch is specifically prohibited from transferring funds to other parts of the bank or to other group companies); and
e. Third parties may exercise any set-off, close out or netting rights which they may have as against Landsbanki.
The broad intention thus seems to be that, whilst assets relating to its consumer business remain frozen, the London branch is allowed to continue its commercial financing activities. This is done on the footing that all London branch assets will effectively remain “ring fenced” from the remainder of the bank.
The General Licence thus significantly restricts the scope of the Order itself. It nevertheless remains important to examine the reporting requirements imposed by the Order which are unaffected by the?General Licence, and to consider some practical implications.
What are the reporting requirements?
Clearly, compliance with the “frozen funds” provisions is crucial, and the Treasury can demand information for the purpose of investigating any possible breach.
Article 15 of the Order also requires banks carrying on business in the United Kingdom to report to the Treasury any information about (i) any customer relationship with Landsbanki, the Government of Iceland or any of its relevant financial authorities and (ii) any transaction in which it has been involved with any of those entities. This requirement does not depend on any request from the Treasury and must be complied with “as soon as practicable”. However, the requirement applies only to continuing relationships or transactions; it is thus not necessary to report contacts of a purely historic nature.
What are the practical consequences?
The practical consequences of the Order will vary according to the nature of the business at issue. However, it may be helpful to highlight a few selected issues:
a. Borrowers. It is lawful for UK borrowers to continue to make payments to the London branch of Landsbanki when due. However, borrowers who have arrangements with the head office or other branches must defer payment so long as the freeze remains in place. The English Courts will not hold such borrowers to be in default merely because they withhold payment during the period of the freeze;
b. British banks. A bank incorporated in the United Kingdom is required to ensure that the freeze is applied on a worldwide basis to the assets of Landsbanki and the relevant Icelandic government authorities. Such banks must therefore ensure that any relevant funds or payments held at branches both within the UK and overseas are frozen in accordance with the Order, and must take “global” action to that end. Notwithstanding the terms of the General Licence it should be appreciated that the freeze continues to apply in its fullest rigour to assets or funds held for the account of branches of Landsbanki outside the United Kingdom. Furthermore, and although the point is not entirely clear, it may also be safest for such banks to assume that all continuing relationships with Landsbanki should be reported, even if they are held by an overseas branch. In principle, the freezing and the reporting requirements apply to foreign branches of British banks but not to their foreign-incorporated subsidiaries. Even here, however, some care may be necessary; if an overseas subsidiary is managed by a British national, he may personally commit an offence if he is involved in a payment or transfer which breaches the Order.
c. Foreign banks. The UK branches of foreign banks are subject to the same freezing and reporting requirements, with the difference that they apply only to the extent of the business which they conduct within the United Kingdom.
d. Insolvency practitioners. Any person who has previously been appointed as an administrator of a Landsbanki borrower may continue to act in that capacity, in part because the process is intended for the benefit of the creditors as a whole and in part because the assets principally belong to the company in administration. Since the Commercial Finance and Asset Based Lending divisions are permitted to remain in business, it would also appear to be acceptable for the administrator to account to the London branch for any realisations,
e. Other professionals. Other professionals engaged in transactions involving Landsbanki may also be caught by the freeze. For example, lawyers who have recently completed transactions and hold shares or other securities must retain them even though they are otherwise subject to a security interest in favour of Landsbanki. Such assets should only be released if it is clear that they have been taken for the benefit of business divisions which are allowed to continue their activities.
f. Set-off rights. Where an institution has mutual debits and credits with Landsbanki, the exercise of rights of set-off rights would have infringed the Order because they would reduce Landsbanki’s obligation to pay future interest - thus constituting a prohibited “dealing” with Landsbanki’s assets. This, in turn, would have prohibited the closing out of swap, repo and similar contracts, because the amount and character of Landsbanki’s obligations are thereby altered. In most cases, however, the exercise of such rights will now be permitted under the terms of the General Licence.
g. Scope of the freeze. It has already been noted that the freeze also extends to the Government of Iceland and certain of its financial authorities, insofar as the relevant funds relate to Landsbanki itself. The precise scope of the freeze may thus cause difficulty for those having dealings with the Government of Iceland and associated entities – how can an outside party know whether any relevant assets have a nexus with Landsbanki? It will be necessary to exercise care in such dealings for so long as the Order remains in force.
h. Subsididaries. The Order applies only to Landsbanki itself and does not affect the assets of its subsidiaries.
In cases of doubt or difficulty, the safest course may be to apply to the Treasury for a licence to make particular payments or to enter into transactions.
The new Order is an unusual step, taken in remarkable times. As is always the case with blocking and sanctions orders, a significant burden of compliance is placed on the financial services industry. Banks will need to put in place the procedures necessary both to ensure that any relevant funds are blocked and to secure compliance with the reporting obligations described in this Briefing.