English translation

18 September 2014

Progress of the Plan for Removal of Capital Controls
A report as provided for in Act No. 16/2013 of the Icelandic parliament Althingi
This report is published by the Minister of Finance and Economic Affairs as provided for in Act No.
16/2013 of the Althingi:[The Minister shall make public a report on the progress of plans to remove restrictions on
cross-border capital movements and foreign currency trading at six-month intervals until
such restrictions are finally removed. The report referred to in the first sentence shall be
published for the first time within six months of the entry into force of this Act.]The first of the reports provided for in the Act was published on the website of the Ministry ofFinance and Economic Affairs on 17 September 2013 1. A second report was published on 17 March
2014.2 Reference is made to the previous reports for a general discussion of the background of thecapital controls, their purpose and the main aspects of the plan for their removal.

New advisors and organisation of the programme
At the beginning of July 2014 the Ministry of Finance and Economic Affairs, after consulting with theMinisterial Committee on Economic Affairs and the Steering Group on Removal of Capital Controls,
concluded an agreement with the legal office Cleary Gottlieb Steen & Hamilton LLP, the consultants
White Oak Advisory LLP, and economics professor and former IMF deputy managing director Anne
Krueger of Johns Hopkins University, to work with the Icelandic authorities on removing capitalcontrols. Attorney Lee Buchheit of Cleary Gottlieb Steen & Hamilton will direct the legal office's workon this project. The engagement of these foreign advisors is part of the government's work to relieve
the economy of capital controls.
At the beginning of July the Minister of Finance and Economic Affairs furthermore engaged four
experts to work with the above-mentioned advisors on behalf of the Steering Group. They are
Benedikt Gíslason, advisor to the Minister of Finance and Economic Affairs on capital controls,
Supreme Court attorney Eiríkur Svavarsson, Freyr Hermannsson, head of the Central Bank's treasury
section, and Glenn V. Kim, who will lead the team. This four-man executive committee has worked
closely with the foreign consultants for the past two months towards an overall solution whichwould include all aspects of the capital controls and will deliver specific proposals on options fortheir removal to the Steering Group. The work involves both legal and economic issues, and inparticular the macroeconomic conditions for removal of controls and granting of exemptions.

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http://eng.fjarmalaraduneyti.is/media/frettir/Progress-of-the-Plan-for-Removal-of-Capital-Controls.pdf
http://www.fjarmalaraduneyti.is/frettir/nr/17803

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English translation
The consultation committee on removal of capital controls, comprised of representatives ofparliamentary groups, has been kept informed of the progress of events. Its members are Árni PállÁrnason, of the Social Democratic Alliance; Bjarkey Gunnarsdóttir, of the Left-Green Movement;
Frosti Sigurjónsson, of the Progressive Party; Guðmundur Steingrímsson, of Bright Future; Jóhann
Haukur Gunnarsson, of the Pirate Party; and Vilhjálmur Bjarnason, of the Independence Party.
Tómas Brynjólfsson, director general in the Ministry of Finance and Economic Affairs, chairs thecommittee while Steindór Grétar Jónsson, specialist in the same Ministry, is its secretary.

FX auctions of the Central Bank of Iceland
The Central Bank of Iceland has continued its FX auctions in accordance with its programme forremoval of capital controls published in March 2011. The auctions are intended to reduce the stockof ISK assets held by non-residents, so-called offshore ISK. Auctions of Treasury securities for foreign
currency began in the summer of 2011, and the first auction of the Investment Programme was heldin February 2012. A total of 22 auctions of Treasury securities have been held and 20 auctions havebeen held under the Investment Programme. In both cases investors oblige themselves to hold theinvestment for at least five years. When auction participants are divided into residents and nonresidents it turns out that 36% of the total amount was from domestic and 64% from foreign
investors. In this analysis, foreign companies owned by Icelandic residents were classified as
domestic investors. During this same period an additional 21 auctions have been held inviting bids
from non-residents wishing to sell their ISK assets in exchange for FX which is exempt from
repatriation obligations. The most recent auction was held on 2 September 2014 and no further
auctions have been announced.
Through these auctions and extraordinary transactions concluded by the Central Bank of Iceland it
has been possible to reduce the amount of offshore ISK since the autumn of 2008 from over 40% ofGDP in 2008 to 16% of GDP at mid-2014.

2

English translation

Non-residents' short-term ISK assets
Octóber 2008 - July 2014
700

ISKbn% of GDP 2014
35600

30500

25400

20300

15apr..14

okt..13

apr..13okt..12

apr..12okt..11

apr..110okt..100apr..105okt..09

100
apr..0910okt..08200

Íbúðabréf
Ríkisbréf og ríkisvíxlarInnlán
Sources: Statistics Iceland, Central Bank of Iceland

3Investment Programme
In the Investment Programme auctions investors can purchase ISK at the auction exchange rate forthe equivalent of 50% of the amount to be invested, while the other 50% is converted on thedomestic FX market. To date investors have brought EUR 982 million, or ISK 186 billion, into thecountry through the Investment Programme, with over 2/5 of this amount passing through thedomestic FX market. Total foreign investment under the Investment Programme amounts to over
10% of Iceland's 2013 GDP. Around 46% of this capital inflow through the Investment Programme
has been invested in bonds, around 41.1% in equities, 12.2% in real estate and around 0.7% inUCITS.

Treasury securities option
One of the objectives of the Treasury securities option was to ensure refinancing of Treasury debt
and extend its repayment profile. When the Treasury securities option was established, it was3Íbúðabréf = HFF bonds, Ríkisbréf og –víxlar = Treasury notes and bills, Innlán = Deposits
3English translationconsidered important to ensure the sale of Treasury paper to new investors to replace those nonresidents wishing to transfer their capital out of the country. The Treasury securities option wasdirected primarily at pension funds, encouraging them to exchange foreign assets in return for long
inflation-indexed Treasury bonds. In more recent auctions the pension funds have not been asinterested in the Treasury securities option as they were in the beginning and have been replaced byother buyers. Investors have invested a total of EUR 261 million in Iceland through the Treasury
securities option, or ISK 56.4 billion, based on the auction price in each instance. Of this amount, ISK
32.7 billion, equivalent to 58% of the total amount sold, was sold in two of the three first auctions.

Sales of ISK for EUR
Auctions of EUR in exchange for ISK are intended to provide a route for non-residents wishing to exit
the country. In 21 auctions a total of ISK 401.7 billion have been offered for sale, of which theCentral Bank has purchased ISK 145.9 billion or just over 36% of the total amount offered. The
amount of ISK acquired by the Central Bank for FX in each instance is determined by the quantity of
the foreign currency offered for sale through the Treasury securities option and Investment
Programme. In this manner the impact of the auctions on the currency reserves is kept to aminimum. The auction price is determined following the three auctions on the auction date. In 2011
two such auctions were held, with the exchange rate ISK 210 per euro. The price remained fairly
steady in 2012, at ISK 240 per euro, but has decreased since then. In 2013 the price fluctuatedbetween ISK 210 and 230 per euro, while this year it has fallen still further. In the most recentauction, on 2 September this year, the auction price was ISK 181 per EUR.

Amendments to the Foreign Currency Act
In May, the Icelandic parliament Althingi passed amendments to Act No. 87/1992, on ForeignCurrency. The objective of the amendment was to remove all doubt that legal entities could bepenalised for violations of the Act or Rules adopted by virtue of it. The definition of the concept ofdividend, in the understanding of the Foreign Currency Act, was also amended.
The authorities are examining possible further amendments to the Act on Foreign Currency with aview to relaxing and simplifying its implementation for the benefit of individuals.

Pension funds' investments abroad
Pension funds' investment authorisations are currently being examined in the Ministry. Before thecontrols are fully removed the question of setting “speed limits” on the increase in pension funds'
foreign assets will be examined, as the Central Bank has requested. In this respect, however,concerns to limit the outflow from Iceland conflict with the rationality of allowing the funds to once
more build up an international asset portfolio with diversified risk, as these funds hold the lion's
share of the savings of the Icelandic public.
4English translation
According to information from The Icelandic Pension Funds Association, at year-end 2013 the foreign
assets of Icelandic pension funds as a ratio of their net funds for payment of pensions was around22.4%. During the past four years (2010-2013) net contributions to the funds, i.e. contributions netof pension payments, have totalled over ISK 40 billion. If it is assumed that the funds fully avail
themselves of their authorisations to re-invest abroad, that the ISK exchange rate remains steady,and that returns on domestic and foreign assets will be the same, the funds would have to invest
22.4% of their net contributions, or around ISK 9 billion, annually in foreign assets to maintain theircurrent proportion of foreign assets.
In the Association's estimation, it is unacceptable for the long term for the pension funds' proportionof foreign assets to be less than 40% and it would be desirable to have it higher, or close to 50%. For
it to be possible to increase the share of pension funds' foreign assets substantially in coming years,
therefore, it is important to create as soon as possible the conditions for an active FX market and theremoval of capital controls is a key step towards this end. Under current circumstances, purchasesby pension funds or other parties of FX for additional tens of billions of ISK each year would beadded to instalments by domestic parties on foreign loans (see the figure below) and would
therefore put significant pressure on the ISK exchange rate, thereby eroding possible gains on
foreign investment.

5English translation

Estimated instalments on foreign loans and debt inforeign currencies owed to the failed banks, otherthan those of the Treasury and Central Bank1
140ISKbn

120
100
8060
40
20
048

59

5959

14621

51918

29

16
71

23

7
1016202014

2015

2016

2017

Landsbankinn

414

31431

81325
52018

1222
12019

Skuldir innlendra aðila, án Landsbankans, við föllnu bankana í erlendum
gjaldmiðlumAðrir aðilarFyrirtæki sveitarfélaga
Fyrirtæki með ríkisábyrgð
Viðskiptabankar og ýmsar lánastofnanir
Sveitarfélög

1. Based on the situation and exchange rates as of 26/02/2014
Source: Central Bank of Iceland4More robust financial stability framework
A more robust financial stability framework is one of the premises for removing capital controls
successfully. In this connection it is worth mentioning that the first meeting of the newly establishedFinancial Stability Council was held in the Ministry of Finance and Economic Affairs on Wednesday,
10 September 2014. The Financial Stability Council is a formal co-operation forum of publicauthorities for financial stability. The Council serves as venue for consultation, exchange ofinformation and policy formulation on financial stability and co-ordinates the preparedness of public
4

Landsbankinn – Debts of other domestic parties owed to the failed banks in FX – Other parties –Municipal corporations – Enterprises with state guarantees – Commercial banks and various credit
institutions – Municipalities
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English translation
authorities for financial crises. The Financial Stability Council is comprised of the Minister of Financeand Economic Affairs, who acts as chairman, the Central Bank Governor and the Director General of
the Financial Supervisory Authority.
The principal tasks of the Financial Stability Council are the following:
1. to formulate public policy on financial stability;
2. to assess economic imbalances, financial system risks, undesirable incentives and othercircumstances liable to jeopardise financial stability;
3. to define those actions, other than implementing the Central Bank's monetary policy
management tools, which are considered necessary at any given time to influence thefinancial system with the objective of reinforcing and safeguarding financial stability;
4. to confirm definitions of systemically important regulated entities, infrastructure andmarkets of such nature that their activities can impact financial stability.
Apart from its regular meetings, the Council convenes to provide a formal governmental
consultation body when a financial crisis is seen to be imminent or has struck, or when there is a riskof events which could result in major contagion effects.

Outlook for removal of controls
Conditions have become more favourable for taking the next steps towards removal of capital
controls since the last report in March 2014. The Treasury currently has ready access to foreign
credit markets, as the issue of euro-denominated Treasury notes in July this year has confirmed.
Credit terms have continued to improve as the year progressed. The Central Bank's regular FX
purchases have been successful and were stepped up further in the summer months. Since thebeginning of this year the Central Bank's net FX purchases are equivalent to ISK 73.9 billion. A budget
surplus in 2014, no further increase in debt and a continuing reduction of Treasury debt relative toGDP in coming years, for instance, in accordance with the 2015 budget bill and the state's Mediumterm Fiscal Programme, are important steps towards removal of capital controls.

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