Sweden: The Swedish authorities takes a stand

Author: | Published: 1 Oct 2009
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In the early 1990s, Sweden had a domestic financial crisis that was mainly caused by imprudent lending into the real estate sector. That financial crisis and the government's management of it have served as a model, or at least an inspiration, for other countries since. The lessons learned then could only partially be used by Sweden and its various agencies during the 2008 and 2009 financial crisis. This 2008 and 2009 crisis had its roots outside of Sweden and manifested itself differently. It may be interesting to see how Sweden has reacted this time around, in light of the fact that, since July 1 2009, Sweden holds the Presidency of the EU and has a central role in the management of the financial and economic crisis in Europe.

The consensus is that the root of the financial crisis was the US mortgage sector and the collapse of the US subprime loan market in particular. This was aggravated by the spread of securitisation of such assets. However, Swedish banks have traditionally stayed away from structured securities based on subprime loans. Moreover, the Swedish financial system is not particularly exposed to the US mortgage market. The financial crisis in Sweden was therefore caused by the US crisis itself rather than the same factors that caused the US crisis. The crisis did not even begin to affect the Swedish financial market in a more appreciable way until the collapse of Lehman Brothers in September 2008, almost one and a half years after effects had started to show in the US.

The direct losses suffered by Swedish banks on account of positions against Lehman Brothers were relatively small and manageable. However, Sweden is a small country and heavily dependent on exports. Its financial system is integrated with the global financial market. Sweden is therefore sensitive to changes in foreign financial and general economic markets. The Lehman Brothers collapse triggered public concern and distrust primarily in the financial industry, which followed in the footsteps of the collapse of the financial industry in the US and a number of euro zone countries.

An early signal was the sudden exceptional demand for secure short-term investments, notably Swedish treasury bills, in October 2008. The liquidity problems in the US and in the euro zone started to affect the Swedish financial market. It was, inter alia, manifested in increased liquidity risks on Swedish securities. This caused Swedish financial institutions to hoard liquid assets and to be more reluctant to lend money over the interbank market. Some banks had difficulties funding themselves on reasonable terms.

The liquidity of Swedish banks deteriorated a lot during the last months of 2008. The more cautious attitude between the banks led to reduced interbank lending, rising interbank interest rates and increased funding costs for the banks.

Starting in October 2008, the Swedish Central Bank began to actively provide liquidity to the financial sector. Initially, loans were provided with three and six months maturities against collateral in certain listed debt securities and certain foreign currencies. In May 2009 the Central Bank also started providing loans at 12 months maturity. In cooperation with the US Federal Reserve, the Central Bank also offered loans in US dollars. Concerns over Swedish companies' ability to finance themselves by corporate certificates led the Central Bank to launch facilities under which banks could lend from the Central Bank using corporate certificates as collateral.

The Swedish Central Bank also cut the repo interest rate, successively decreasing it from 4.75 % in September 2008 to the current level, 0.25 % (as of August 31 2009).

True to its strategy of offering bank deposits at an interest rate generally 0.5 % lower than the repo rate, the Central Bank became the world's first central bank to introduce negative interest rates on bank deposits (at -0.25 %) in July 2009.

Between the end of December 2008 and the middle of March 2009 all four major banks, tapped into the capital market to strengthen its capital base. In October 2008 Swedbank announced a rights issue to and raised SEK 12.4 billion (before transaction costs). In December 2008, SHB raised SEK 2.1 billion through an issue of hybrid debt. Then, in the beginning of 2009, both Nordea and SEB announced rights issues raising €2.5 billion and SEK 15.6 billion respectively. Swedbank announced a second issue of some SEK 15 billion in August 2009.

On October 20 2008, the Swedish government proposed a stabilisation plan to secure the stability of the financial system. The purpose of the stabilisation plan was to strengthen the stability of the Swedish financial system and deal with the negative effects of the global financial crisis, including the lack of liquidity in the financial system and the increasing cost of funding. Some days later, the Swedish Parliament approved a government bill designed to enhance the stability of the Swedish financial system. New legislation, the Act on Government Support to Credit Institutions (Support Act) was implemented.

The Support Act provides for a stabilisation fund for financing the stabilisation plan. The stabilisation plan also includes powers to provide targeted support to ensure the stability of the Swedish financial system, a guarantee programme and a recapitalisation scheme. The stabilisation plan is administered by the Swedish National Debt Office on behalf of the government.

The objective of the stabilisation fund (together with the deposit guarantee fund) shall equal an average of 2.5% of Sweden's GDP within 15 years. Initially, the government provided SEK 15 billion by special appropriation. It is contemplated that payments to the stabilisation fund will comprise guarantee fees, stability fees, deposit guarantee fees and recoveries from support measures provided under the stabilisation plan.

The Swedish National Debt Office has been vested with certain extraordinary powers under the Support Act, if a financial institution encounters severe financial difficulties, creating a risk of serious disruption to the Swedish financial system. It may then intervene with support to continue the business of the institution if its business is considered sustainable or to organise reconstruction or winding-up of an institution that is not profitable in the long term.

It is suggested that support shall primarily be provided by the National Debt Office subscribing for preference shares with high voting power. The support must be provided at arm's length and must not unduly distort competition.

Further, the National Debt Office is given the right to compulsorily redeem shares issued by a financial institution if such redemption is considered of exceptional importance from a public policy perspective. Further requirements are that (i) the institution or the relevant shareholder has not accepted a support agreement proposed by the Swedish National Debt Office which has been considered reasonable by a special appeal board; (ii) the institution or a shareholder has not fulfilled a material obligation under a support agreement; or (iii) the capital base of the institution is less than 25% of the required level.

The government has also launched a guarantee programme to facilitate borrowing for financial institutions. Under the guarantee programme, an eligible financial institution can draw down a guarantee issued by the Swedish government, represented by the Swedish National Debt Office, for part of its borrowings, provided the institution enters into a specific contract with the government, a guarantee agreement. The guarantee agreement contains, inter alia, caps for increases in the wages of executives and restrictions on bonus payments, severance packages and increases in board remuneration during the term of the guarantee.

The guarantee programme is open to banks and major mortgage institutions based in Sweden, as well as credit market companies incorporated in Sweden serving municipalities. In order to obtain a state guarantee, the applicant must meet certain requirements regarding the composition and size of its capital base.

The purpose of the guarantee programme is to facilitate borrowings of banks and certain credit market companies and to reduce their borrowing costs during the prevailing global financial crisis. The total financial limit of the guarantee programme is SEK 1.5 trillion. Guarantees under the guarantee programme can be issued up to November 1 2009 unless prolonged by the government. By June 2009 only a handful institutions had signed up for the guarantee programme, most notably SEB, Swedbank, state owned mortgage institute SBAB, car leasing institute Volvo Finance Bank and Swedish investment bank Carnegie Investment Bank.

Under the recapitalisation scheme, the Swedish National Debt Office may, after obtaining government approval, provide capital to banks, mortgage institutions and credit market companies serving Swedish municipalities. The total limit for the recapitalisation scheme is SEK 50 billion. The capital provided to a particular institution may amount to no more than the equivalent of an increase of 2% in the institution's capital ratio. The injection of capital must be provided as share capital or as subordinated debt capable of being included in the institution's core capital.

The recapitalisation transaction itself can take different forms. The National Debt Office can participate in a market transaction, whereby it acquires up to 70% of the shares or debt instruments issued at the same terms as other investors. Additionally, it may subscribe for securities in a directed issue, whereby the state acquires shares or convertible debt instruments on terms decided by the National Debt Office. In the case of a directed issue where the state acquires more than 70%, the Swedish National Debt Office will set the price based on a model reflecting the risk of the issuing institution and the returns on similar financial instruments under normal market conditions. The returns must always at least equal the level calculated according to the ECB model. The recapitalisation scheme is funded through the stabilisation fund.

The Swedish financial crisis started as a liquidity crisis. Over time, the lack of liquidity by banks and the resulting difficulty for businesses to borrow money has affected the economy. In 2008, the number of bankruptcies rose 7% compared with 2007. In 2009, the bankruptcies have risen even further. The aftermath of the crisis has been significant adverse effects on employment and economic growth. According to the Central Bank, recession will be deep in 2009 and interest rates are expected to remain at low levels until autumn 2010.

So far, the Swedish economic crisis has had its fair share of corporate victims. For instance, Swedish private equity house Nordic Capital found it impossible to save car component manufacturer Plastal, which consequently went bankrupt in March 2009.

Swedish car manufacturer SAAB applied for company reorganisation in February 2009. It was recently announced that GM and Swedish sports car manufacturer Koenigsegg had signed an agreement for the sale of SAAB. Although the deal is yet to close, recent information suggests that the required financing may soon be in place. Several smaller businesses, especially in wholesale, have suffered bankruptcies.

In the financial sector, however, the only true Swedish victim of some size is the Carnegie group. D Carnegie & Co (D Carnegie), with its investment banking subsidiary, Carnegie Investment Bank, was for some time one of Sweden's most esteemed and profitable investment banking groups. In 2001, the shares of the parent company, D Carnegie, were listed on the Stockholm Stock Exchange.

Unlike many other banks, Carnegie Investment Bank did not have access to funding through the Central Bank's repo programme and therefore relied heavily on the interbank market. When the finance crisis began to affect the Swedish financial market in the autumn of 2008, Carnegie Investment Bank found it increasingly difficult to borrow at the interbank market. Moreover, Carnegie Investment Bank's principal bilateral lender informed that it would reduce its credit line by the end of October 2008. Facing a liquidity deficit, Carnegie Investment Bank applied for and received a SEK 2.4 billion loan from the Central Bank on October 28 2008 as liquidity support. (This was done under the old regime which was subsequently replaced by the stabilisation plan.) The parent company, D Carnegie, supported the credit, inter alia, by a pledge over its shares in Carnegie Investment Bank in favour of the Central Bank.

Around about the same time, Carnegie Investment Bank reported large provisions related to credit engagements with a long-term customer and Swedish securities and real estate tycoon. Carnegie sought to reduce its exposure against the customer gradually, but the Lehman Brothers collapse and the sharp decline in share prices on the stock market triggered margin calls which could not be met by the customer. The whole situation caused the Swedish Financial Supervisory Authority (FSA) to initiate an investigation regarding, inter alia, breach of the large exposure regulations.

On November 10 2008, the National Debt Office and the FSA took some extraordinary actions against Carnegie. Initially, the loan from the Central Bank was repaid by a SEK 2.4 billion loan granted by the Swedish National Debt Office to Carnegie Investment Bank pursuant to the newly implemented stabilisation plan. Half an hour later the FSA decided to revoke Carnegie Investment Bank's licence to conduct banking and securities business. Just two minutes after that decision was announced, the Swedish National Debt Office declared that it realised its security in, inter alia, the shares in Carnegie Investment Bank by taking over ownership. Then, eight minutes later, the FSA announced that it changed its decision to withdraw the licence and issued a warning to Carnegie Investment Bank instead. The motive was that the state, in the guise of the National Debt Office, during the last couple of minutes had taken over the ownership of Carnegie Investment Bank.

The legality of the realisation of the pledge is subject to pending litigation in the Swedish courts between the parent company, D Carnegie, and the National Debt Office. The matter of the valuation of the collateral taken over by the National Debt Office is pending before the Stabilisation Plan Appeal Board. In the spring of 2009, the National Debt Office sold Carnegie Investment Bank to private equity company Altor and investment company Bure.

Looking specifically at the Swedish banking sector, focus has now shifted considerably from liquidity to a feared surge in credit losses in Eastern Europe.

Over the last couple of years, certain Swedish banks have expanded quite aggressively into the Baltic states and Ukraine. Swedish banks are said to account for around 50% of the banking market in Latvia and Lithuania and around 75% of the Estonian banking market (based on the volume of lending). They are responsible for around SEK 500 billion in lending to borrowers in the Baltic region. As the Baltic states' economies have become increasingly strained there is a growing concern that credit losses in the Baltic states will pile up, especially in the event the Baltic states would decide to devaluate its currencies.

Indeed, for Swedbank and SEB credit losses in the Baltic states rose considerably in 2009 and are expected to increase even further. According to the Central Bank's stability report, the major Swedish banks are expected to suffer credit losses of SEK 170 billion in 2009 and 2010. Out of this, 40% are estimated to be caused by the banks' Baltic and eastern European activities. According to the Central Bank, the major Swedish banks can sustain this level of loss without the need for additional capital to meet capital adequacy requirements. In a stress test in August 2009, the Central Bank stated that the Swedish banks could sustain credit losses of some SEK 350 billion and a serious recession in both Sweden and the Baltic States, yet still meet capital adequacy requirements.

One of the main issues during Sweden's ongoing Presidency of the EU is obviously the global financial crisis. The president and member states will jointly continue to work to reduce the negative impact of the crisis on growth and jobs. Sweden therefore wants joint actions in the financial and economic sectors as well as on the labour market. The government's ambition is to restore confidence in the financial markets, realising economic recovery as soon as possible and creating long-term solutions for sustainable growth, employment and open markets.

Sweden has, inter alia, declared that it will work for a new supervisory framework and strengthened supervisory bodies. The objective of the president is to reach consensus and support for a European body to supervise stability in the financial system as a whole. This proposed body also contains a European system for financial supervision at micro level. The work at the micro level will ensure reinforced cooperation among national supervisory authorities and more efficient supervision of cross-border banks.

Although Swedish authorities may be seen as having been reasonably successful in managing the 2008 and 2009 crisis, the lesson seems to be that only a sound and restrained global financial market supervised by an effective cross-border regulatory framework may mitigate future financial crises, in Sweden as elsewhere. It will be fascinating to see whether the Swedish Presidency can facilitate that development. Sweden's own management of the 2008 and 2009 financial crisis and its aims for its Presidency of the EU seem to suggest that Sweden will indeed advocate a strong and proactive cross-border supervision of the European financial market.

About the author

Main areas of practice include financing, restructuring, insolvency law and dispute resolution.

Professional memberships
Swedish Bar Association

Career
LLM, Uppsala University, 1996; LLM, London School of Economics and Political Science, 1997; Law clerk, Tierp District Court 1996;  Gernandt & Danielsson Advokatbyrå, 1997- (Partner since 2005);  Visiting lawyer at Clifford Chance and Latham & Watkins, 2000.

Publications
Author of articles in i.a. Svensk Juristtidning, Juridisk Tidskrift and International Corporate Rescue. Author of legal commentaries on Swedish commercial law in Karnov.
Contact information

Marcus Johansson
Gernandt & Danielsson Advokatbyrå KB

PO Box 5747
Hamngatan 2
114 87 Stockholm,
Sweden
Dir +46 8 670 66 78
Mob +46 734 15 26 78
marcus.johansson@gda.se