26.06.2017

Amendments to the Rules on Foreign Exchange - Restrictions on carry trade-related risk and foreign issuance of króna-denominated bonds

Central Bank of Iceland

New Rules Amending Rules no. 200/2017 on Foreign Exchange were published on the Central Bank of Iceland website today. The amending Rules were also published today in the Law and Ministerial Gazette [Icel: Stjórnartíðindi] and will take effect tomorrow, 27 June 2017.

With Rules no. 200/2017, which took effect on 14 March 2017, most restrictions on foreign exchange transactions and cross-border movement of domestic and foreign currency were lifted. Since then, households and businesses have generally been unaffected by the restrictions provided for in the Foreign Exchange Act, including those on foreign exchange transactions, investment abroad, hedging, and lending. The requirement that foreign currency be repatriated was lifted as well. Restrictions on specified transactions are still in place, however, with the aim of reducing the likelihood of carry trade in connection with investments not subject to the special reserve requirement provided for in the Rules on Special Reserve Requirements for New Foreign Currency Inflows, no. 490/2016.

When Rules no. 200/2017 took effect, foreign issuance of bonds denominated in Icelandic krónur – sometimes referred to as Glacier bonds – became permissible again without restrictions. Earlier in the year, a general framework was created for the granting of exemptions relating to derivatives trading with domestic financial undertakings for hedging purposes. This framework was later incorporated into the Rules. This makes it possible to conduct carry trade by issuing bonds in Icelandic krónur and entering into derivatives contracts with domestic banks. Credit rating upgrades and foreign investors’ bolstered interest in carry trade following the liberalisation of capital controls in March, and the Central Bank’s purchase of offshore króna assets have made such transactions both more appealing and more probable. The Central Bank therefore considers it appropriate to take action before non-residents’ short-term króna positions accumulate again, with the associated macroeconomic and financial risk. Experience has shown that capital inflows in connection with foreign issuance of króna-denominated bonds (Glacier bonds) could weaken monetary policy by complicating its transmission along the interest rate channel and shifting it to the unpredictable exchange rate channel, which could contribute to exchange rate volatility and trigger unsustainable credit growth and asset price increases. In order to ensure the effectiveness of the special reserve requirement in the wake of liberalisation, the Rules on Foreign Exchange have been amended so as to exclude hedging-related derivatives trading in connection with the issuance of krónur denominated bonds from the exemption for hedging-related derivatives trading with financial undertakings in Iceland.

In addition, several amendments are made to the Rules so as to narrow the scope of exemptions granted under Rules no. 200/2017. The objective is to prevent investment in Iceland from becoming a vehicle for carry trade. The chief amendments are as follows:

- First, cross-border movement of Icelandic krónur will not be exempt from the restrictions provided for in the Foreign Exchange Act when they are related to: i) exports of specified securities issued in Icelandic krónur; and ii) specified measures involving payment remitted, directly or indirectly, by withdrawal from an account owned by a foreign financial undertaking (Vostro account). In both instances, reference is made to securities and measures that are comparable to the investment options falling under Article 2 of the Rules on Special Reserve Requirements for New Foreign Currency Inflows, no. 490/2016. If the parties involved have met the special reserve requirement for their investment, related movement of capital will remain exempt from the restrictions provided for in the Act.

- Second, settlement of transactions with further specified financial instruments comparable to those falling under Article 2 of the Rules on Special Reserve Requirements for New Foreign Currency Inflows, no. 490/2016, will not be exempt from the restrictions on settlement of trades with such financial instruments pursuant to the Foreign Exchange Act.

- Third, króna-denominated lending by non-residents to residents will not be exempt from the restrictions laid down in the Foreign Exchange Act when the proceeds of the loan are used, directly or indirectly, for investment options comparable to those falling under Article 2 of the Rules on Special Reserve Requirements for New Foreign Currency Inflows, no. 490/2016.

In addition to the above, the amending Rules require that financial undertakings and others conducting capital transactions notify the Central Bank of Iceland of specified transfers of domestic and foreign currency. Even though the aforementioned amendments somewhat narrow the scope of general exemptions provided for in Rules no. 200/2017, the restrictions under the Foreign Exchange Act that are reinstated with the amendments will have a negligible impact on Icelandic households and businesses. Furthermore, they will not affect owners of offshore króna assets subject to special restrictions pursuant to Act no. 37/2016.

The Guidelines for implementation of the Rules will be updated concurrent with the entry into effect of the amendments.

The Foreign Exchange Act, the Rules on Foreign Exchange, and the Guidelines can be found here.

Further information can be obtained from Governor Már Guðmundsson at tel: +354 569 9600.

No. 21/2017
26 June 2017

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