The European Commission

Commissioner for enlargement tefan Fle

Commissioner for consumer policy Tonio Borg
The European Parliament
President Martin Schulz
EU delegation to Iceland
Ambassador Timo Summa
European Integration manager Amela Trhulj
EFTA Surveillance Authority
President Oda Helen Sletnes
Frakkastg 27, hsni Tknisklans, 101 Reykjavk, ICELAND
January 9th, 2013
Re: Complex financial indexation imposed on Icelandic consumer credit
The Homes Association of Iceland, Hagsmunasamtk heimilanna (HH), was established in 2009. HH is
a public interest group in the consumer field, lobbying and fighting for the rights, protection and
prosperity of Icelandic households. Currently HH has over 8.500 registered members, ca. 5 % of
homes in Iceland.
The main short term objective of HH is to urgently address the impact made by the financial crisis on
households, and prevent households frombecoming victims of unfair and possibly illegal confiscation
of property as well as unsustainable debt and social disintegration. Among our key objectives are
corrections of mortgage capital indexed to inflation or foreign currencies, a reasonable interest rate
environment, and sharing of risk and responsibility between borrowers and lenders. A particular
issue of concern is a specific form of indexation called vertrygging.
Iceland has a relatively long history of widespread financial indexation and as it turns out, most
household mortgages are not really what most other countries would recognize as such. The most
common type of mortgage loan in Iceland is actually more like the complex derivative type of
financial instrument, a loan for a term of 40 years at a fixed rate of interest combined with an
inflation derivative (vertrygging) and secured by residential real estate collateral. This kind of
financial contract which Icelandic law requires to be linked to the official consumer price index (hence
the termCPI-indexation) is commonly known as an index-linked loan, and has also been referred to in
a recent bank report as slandsln or Iceland-loan.
While rampant inflation would ordinarily cause inflation linked mortgage payments to rise sharply,
these loans have additionally been engineered with graduating payments and negative amortization
schedules, leading to compounding interest accrual and in the long run exponential growth of
monthly payments. The ever increasing costs inevitably lead to a variety of economic calamities and
human tragedy. Since originally introduced, such contracts have become so widespread as to
currently represent 85% of the Icelandic mortgage market or around 75% of GDP, one third being
accumulated cost of inflation or around 25% of GDP. Through the years this risk transfer mechanism
has imposed enormous liabilities on the homes which for many has turned out to be an impossible
burden to bear, resulting in thousands of families defaulting on their payments with many of them
having to suffer, or are now facing foreclosure.
Among key objectives of HH are corrections of FX and CPI-indexed mortgages and abolishment of
indexation on consumer loans. In the past years we have tried to achieve these goals by various
measures; by rallying, lobbying on different forums and in 2010 by sending a complaint to ESA
against Icelandic authorities, because of their failure in the area of consumer protection regarding
consumer loan indexation, including FX and CPI-indexation. HH is currently involved in court trials
claiming that indexation on consumer loans is incompatible with consumer rights protection as
defined by the directives which have supposedly been implemented in Icelandic law.
Our actions have revealed unquestionable opposition by the Icelandic public against consumer loan
indexation. According to a Capacent Gallup poll conducted in November 2011, abolishment was
supported by 80% of the public, and in the same year a petition for mortgage debt relief and
abolishment of indexation was signed by over 37.000 voters during the course of six months.
Unfortunately such demands by the public have to this date been largely ignored by the authorities
and government of Iceland. Minor adjustments have been made, mostly to write off bad debt, but
none so far that sufficiently address this root cause of bad debt in the first place, the specific and
widespread form of financial indexation in consumer loans called vertrygging.
In the meanwhile some leading political forces actively promote EU-membership as a panacea for
mortgage debt problems in Iceland, although any specifics yet remain unclarified to the public. This
question becomes even more pressing in light of the fact that substantial parts of the acquis on
consumer protection and financial services, should already be implemented or adopted in Iceland via
legislative coordination with North-European countries and Icelands membership to the European
Economic Area since ratification of the EEA agreement in 1993. These include:
Directive 85/577/EEC to protect the consumer in respect of contracts negotiated away from
business premises
Directive 87/102/EEC for the approximation of the laws, regulations and administrative
provisions of the Member States concerning consumer credit as amended by directive 98/7 *
Directive 93/13/EEC on unfair terms in consumer contracts
Directive 97/7/EC on the protection of consumers in respect of distance contracts
Directive 98/27/EC on injunctions for the protection of consumers' interests **
Directive 2002/65/EC concerning the distance marketing of consumer financial services
Directive 2004/39/EC on markets in financial instruments
Regulation No 2006/2004 on Consumer Protection Cooperation
Directive 2005/29/EC concerning unfair business-to-consumer commercial practices in the
internal market
* It should be noted that since the year 2000, mortgage loans have been defined as consumer credit
under the scope of current implementation by act. no. 121/1994 on consumer credit.
** Since january 2012 HH has been appointed as a consumer protection organization under the
injunctions directive. The first such case was brought forward in early 2012, leading to a ruling by the
Supreme Court of Iceland on october 15 where the requested injunction was not granted. We
believe the court may have misinterpreted the injunctions directive, enabling lenders to continue
overcharging on certain loan agreements that have been ruled illegitimate by the same court.
Directive 2008/48/EC on credit agreements for consumers has yet to be implemented in Iceland. To
such ends in march 2012, a bill of amendments to the act on consumer credit was proposed to the
140th session of Alingi and a revised version was proposed to the current 141th session in october.
Despite these efforts however, on november 28 the EFTA Surveillance Authority decided to bring a
case against Iceland before the EFTA court for failure to timely implement the directive.
On the basis of extensive research into the problem of indexation (vertrygging) in consumer
credit, HH and others have made formal comments on the proposed bill which are available on the
Althingi website. In our comments we have tried to straighten out the confusion that seems to
surround these issues in Iceland, allowing lenders to get away with questionable business practices,
seemingly in violation of the act on consumer credit and EEA consumer protection.
In order to press for this issue to be resolved, a case has recently been brought to trial before the
Reykjavk district court, in which the attorney general himself defends the claimon behalf of lenders
that the act on consumer credit allows exclusion of the cost of indexation fromthe total cost of credit
and its expression by the annual percentage rate of charge (APRC) as defined by the act and
directives regarding consumer credit. This is obviously in contrast with any common understanding of
the meaning of the words total and cost which is only reasonable to assume must include any
and all costs, including the cost of inflation imposed by indexation.
Such clear willingness to disregard the objectives set by the EEA consumer protection directives is
disconcerting, in particular when taken into account that in commentary notes attached to the new
bill on consumer credit is what seem to be nothing less than carefully crafted explanations
attempting to retroactively provide a sense of legitimacy to this otherwise illegitimate practice of
excluding a substantial cost factor from information provided about the total cost of credit. It is the
perception of HH on behalf of our members and supporters that such misrepresentation can only
serve to hide the true cost of consumer credit contracts in support of marketing practices that would
best be described as deceptive, misleading, and therefore probably illegitimate.
Attached to this letter are examples showing graphical representations of mortgage repayment
schedules as calculated for Icelandic CPI-indexed loans, and comparison including and excluding the
cost of inflation due to CPI-indexation of outstanding credit. More extensive information can be
found on the HH website and the english section in particular regarding indexation. Finally we would
welcome any requests for more information or further insights concerning these issues.

Respectfully,
on behalf of the Homes Association, Iceland
_______________________________________
lafur Gararsson, chairman

Attachment: side-by-side comparison showing total cost of credit and indexation
Hagsmunasamtk Heimilanna
The Homes Association - Iceland
THE EXPLOSIVE LOAN MACHINE
A Model of Icelandic CPI-indexed Mortgage Loan Repayment Structure
LOAN CRITERIA
Loan principal ISK 20.000.000
Stamp duty 1,5% 300.000
Borrowing fee 1,0% 200.000
Paperwork cost ISK 5.900
Cash disbursment ISK 19.494.100
Borrowing date 30 1/1/2013
First payment 2/1/2013 1/2/2013
Loan term years 40
Instalments # 480
Invoice fee ISK 195
Annual interest rate 4,50%
Inflation forecast 30 4,50%
Base CPI points 402,0
Historical inflation average 5,79%
Total repayment 118.369.979
Repayment percentage 592%
Annual percentage rate 10,65%
Note: faded lines represent repayment plans excluding indexation, while bold represent the actual total cost including indexation
EUROPEAN COMMISSION
Directorate-General Enlargement
- CROATIA, MONTENEGRO, THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA,
TURKEY, ICELAND
B.4 - ICELAND
Brussels,
Dear Mr. lafur Gararsson,
Mr Fle has asked me to reply to your letter of 10 J anuary 2013 concerning Iceland's
financial indexation on consumer credit.
We thank you for sharing this information with us and take note of your assessment of
Iceland's implementation of the acquis on consumer protection and financial services.
Iceland has already achieved a high level of alignment and applies a substantial part of
the acquis on consumer and health protection. As mentioned in last Iceland Progress
Report of October 2012, additional efforts to align with the acquis are necessary,
especially in the area of consumer protection and, in particular, as regards Directive
93/13/EC on unfair terms in consumer contracts and Directive 2008/48/EC on credit
agreements for consumers.
You can be reassured that we will continue monitoring progress in the alignment with
and implementation of the acquis throughout the negotiations, devoting particular
attention to those specific issues on consumer protection where certain transposition gaps
remain.
Mr. lafur Gararsson
Homes Association Iceland
E-mail: heimilin@gmail.com
Commission europenne/Euro pese Commissie, 1049 Bruxelles/B russel, BELGIQUE/BELGI - Tel +32 22991111
Office: 5/199 - Tel. direct line+32 229-91999
Ref. Ares(2013)149795 - 06/02/2013
EUROPEAN COMMISSION
HEALTH AND CONSUMERS DIRECTORATE-GENERAL
Financial services and Redress
Headof Unit
Brussels,
DG SANCO.B4/ML/at D(2013)
Mr. O. Gararrson,
Chai man
Homes Association, Iceland
mailto: heimilin@gmail.com
Dear Mr Gararrson,
Subject: Financial indexation imposed on Icelandic consumer credit
Thank you for your letter of 9 January 2013, to which I reply on behalf of Commissioner
Borg. I have taken note of your concerns on offers of credit to Icelandic consumers.
First of all I would like to clarify that the views expressed in this letter constitute only an
opinion of the European Commission services, since a binding interpretation of
Community law can only be given by the European Court of Justice.
As concerning your comment indicating that the Supreme Court of Iceland may have
misinterpreted the Injunctions Directive, unfortunately, with the limited information you
provided in your letter the Commission cannot give any opinion on this issue.
On Directive 2008/48/EC on consumer credit (CCD), I would like also to clarify that it
does not cover mortgage credits. Mortgage credits are currently covered by the proposal
of the Directive on Credit Agreements Relating to Residential Property.
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This proposal is
still in the legislative process.
In general, the CCD does not regulate the contractual relationships between creditors and
borrowers. However, it fully harmonises the provision of information at the advertising,
pre-contractual and contractual stages. Its objective is to facilitate the functioning of the
internal market (recital 7) and to offer a sufficient degree of protection to ensure
consumer confidence, in particular enabling free movement of credit offers (recital 8).
In 2012, the European Commission published a guidance document on the application of
the CCD in relation to costs and the annual percentage rate of charge (APR). The
guidance document is available on the Commission website at:
http://ec.europa.eu/consumers/rights/docs/uidelines consumer credit directive swd2Ql
2 128 cn.pdf
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COM(2011) 142
Commission europenne/EuropeseCommissie, 1049Bruxelles/Brussel, BELGIQUE/BELGI - Tel. +3222991111
Office: F101- Tel. direct line+32229-80905 - Fax +32229-65608 Maria.Iissowska@ec.europa.eu
Ref. Ares(2013)199625 - 15/02/2013
As to your specific questions on theinclusion or exclusion of thecost of indexation in the
total cost of credit, and, consequently, in theAPR, I underlinethat thetotal cost of credit
accordingto definition 3(g) means all thecosts, includinginterest, commissions, taxes
and any type of fees theconsumer is required to pay in connection with thecredit
agreement and which are known to the creditor. Also, Article 3(1) defines the total
amount of credit as aceilingor total sums madeavailableunder thecredit contract. The
sumof thetotal cost of credit and theamount of credit gives thetotal amount payableby
theconsumer, as defined in 3(h).
As far as weunderstood fromyour letter, theindexation of theprincipal does not mean
that thesums availableto theborrower increase. Thus theindexed principal cannot be
treated as atotal amount of credit. Thetotal cost of credit is thedifferencebetween the
total amount payableby theconsumer (given by thesums of all thepayments madeby
theconsumer, includingtheeffect of theindexation of theprincipal) and thetotal amount
of credit (thevaluemadeavailableto theconsumer). Thus theeffect of indexation should
beincluded in thetotal cost of credit, and as aconsequence, also in theAPR.
Specific rules apply for thecalculation of APR withrespect to changes in theborrowing
rateand charges unquantifiableat themoment of thecalculation. In particular, according
to Article 19(4), for credit agreements containingclauses allowing variations in the
borrowingrateand charges, whichareunquantifiableat thetimeof calculation, theAPR
shall becalculated on theassumption that theborrowingrateand charges remain fixed at
theinitial level until theend of thecontract. Thus, in thecaseyoudescribe, theAPR shall
becalculated accordingto theinitial level of interest rates, initial level of charges and the
initial level of inflation, whererelevant, for examplefor theindexation of theprincipal of
thecredit.
TheCCD establishes strict information disclosurerequirements duringthecredit process.
In particular, in thepre-contractual information (Article5.1(f)) thecreditor shall specify
theconditions governingtheapplication of theborrowingrateand, whereavailable, any
index or referencerateapplicableto theinitial borrowingrate, as well as the periods,
conditions and procedurefor changingthe borrowingrate. Thesame obligation with
regard to theborrowingrateapplies to thecontract (Article10.2(f)).
An identical disclosure requirement applies to charges other than theborrowingrate.
That indexation is part of theborrowingrateor applied to theprincipal should beclearly
stated and its effect on thetotal cost of credit and theAPR should bequantified.
As stated, it is foreseen that creditors may apply variableinterest rates and charges,
unquantifiableat thetimeof calculation of theAPR. However, creditors should inform
borrowers, at the pre-contractual and contractual stages, about the conditions under
whichtherates and thecharges may bechanged.
Should yourequireclarification, pleasedo not hesitateto contact Ms MariaLissowska,
email: Maria.Lissowska@ec.europa.eu, tel: +3222980905.
Yours sincerely
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