Following Iceland recently unveiling legislation to unwind capital controls, creditors including hedge funds could be facing a one-time stability tax of 39%.

Several funds flocked to Iceland after its 2008 collapse, snapping up distressed banking assets following the $85 billion default of the island’s three largest lenders.

Creditors Face $5 Billion Tax As Iceland Unveils Stability Tax

Iceland’s legislation to unwind capital controls

As reported by ValueWalk, Iceland’s prime minister Sigmundur Davio Gunnlaugsson and finance minister Bjarni Benediktsson announced a plan to ease capital controls on Monday, which marks a huge step in the financial rehabilitation of the country. The announcement came almost 7 years after the capital controls were introduced in November 2008.

Hedge funds that specialize in distressed debt snapped up Icelandic bank claims as early as 2010 when the country’s banking system collapsed. While other casualties of the financial crisis were eventually liquidated or bailed out, and creditors were repaid, Iceland’s insolvent banks remained in the limbo created by the island nation’s capital controls. Creditors have since been trapped behind currency restrictions estimated to be blocking about $6 billion from leaving the economy.

The winding-up committees of the three failed banks, Glitnir Bank hf, LBI hf and Kaupthing Bank hf, said Monday they would seek composition agreements while providing “stability contributions” to the Icelandic authorities.

The vast majority of claims against the banks are held by U.S. hedge funds, including Davidson Kempner Capital Management, Silver Point Capital LP and Taconic Capital Advisors LP. The banks’ winding-up committees had urged the government to let them sidestep the capital controls, which they said would help settle claims faster.

One-time 39% levy

Iceland’s latest legislation will let it tax the bank creditors trying to exit the $15 billion economy. The plan envisages a one-time levy of 39% on the estates of failed banks unless they reach composition agreements by the end of 2015. The accords will have to fulfill financial stability requirements from both the central bank and the Finance Ministry, roughly equal to $5.1 billion.

Iceland has tried to ensure its treatment of creditors caught in an $85 billion banking default won’t drag the island through an Argentine-like period of litigation. The 2008 financial meltdown wiped out its three biggest banks after the government said the $15 billion economy didn’t have the means to save them.

In a bid to exit from Iceland’s financial conundrum, the government said it intended to set a Dec. 31 deadline by which creditors must compromise with committees in charge of winding up the banks’ estates, or face a steep tax before receiving clearance to take their assets back home. The prime minister said if creditors opt for compromise, they will be exempted from the 39% tax, but would still have to make a sizable contribution to the government-run stability fund.