Umbrellas don't work in Iceland. When rain sweeps the small, volcanic island, which lies just beneath the Arctic Circle, the water assaults you from all directions. Icelanders equip themselves with hoods and waterproof clothing, shunning the accessories that keep people dry in tamer climates.

But when it comes to the media, the concept of an umbrella is becoming increasingly Icelandic. After some terrible blows to Iceland's image – its most famous recent exports being financial turmoil and volcanic ash – the country has turned its creative energy towards creating a catch-all freedom of expression law, which would protect journalists from all manner of legal threats.

Over the past couple of years a group of journalists, freedom of information campaigners and political activists living in Iceland have been working on turning this idea into reality. A resolution proposing the Icelandic Modern Media Initiative (IMMI), has already been unanimously passed by the country's parliament.

The concept crystallised when John Barlow, an American cyberlibertarian, met members of the group at an Icelandic Digital Freedoms Society conference in 2008.

Barlow suggested that Iceland become the equivalent of an offshore tax haven – instead of assisting tax avoidance, it would offer the positive endeavour of protecting investigative journalism against litigation. Or as Barlow put it, Iceland could become "the Switzerland of bits".

Media freedom

"John said we could take the concept of a banking haven and flip it on its head," says Smári McCarthy, one of IMMI's organisers. "We could cherry-pick the best laws for media freedom and free speech from around the world and make Iceland the world leader."

The IMMI does exactly that: combining the laws most friendly to journalists, so that Iceland-based media would be immune from the least friendly laws elsewhere.

"For example, Sweden has a really progressive law on the protection of sources," says McCarthy. "Journalists are actually not allowed to reveal sources there. IMMI's proposal for source protection is based on that."

The inspiration for IMMI is global. In addition to Sweden's laws on source protection, Norway and Estonia's freedom of information laws are selected for their presumption of public access to all government documents. And a recent law introduced in the US state of New York, which could be implemented at federal level and attempts to protect Americans from judgments of the English high court in so-called "libel tourism" cases, is also replicated in the initiative.

"IMMI is embracing the reality that the media has no borders," says Birgitta Jónsdóttir, an Icelandic poet and activist who recently became an MP. "There is already an incredible amount of dialogue between journalists in different countries.

"I have already heard from journalists who can't wait to move here or to have a second base here, including some very prominent producers," she adds. "I think it's important to have one place in the world that is a haven for transparency."

Róbert Marshall, a former editor, now an MP and the leader of the Social Democrat party, says: "Libel tourism just shows that the media does not respect any boundaries. Companies are willing to use all legal and financial means to influence the media and to stop stories that are damaging from being published."

Concern about the state of the UK's media laws has been one of the driving forces behind IMMI, although its creators hope to attract journalists from all over the world.

"The media in the UK is highly respected but it is really shocking how bad the situation is there," says Marshall. "I can foresee a situation where the Guardian would put its servers here. If there was an attempt to remove something from the Guardian's archive, you would want to put the servers in a country where the legal framework was friendly."

Jónsdóttir says: "I was not aware how bad the situation was in the UK until I started looking into it in working on IMMI. The problems with libel and libel tourism, and superinjunctions, and the fact that stories are being taken out of the historical record – it is so disturbing."

The country's potential for evading the sanctions that usually flow from releasing secret information gained widespread recognition last year, when the founder of Wikileaks, Julian Assange, released a 38-minute film exposing the shooting of 18 people, including two Reuters journalists, by US soldiers in Iraq. Assange worked on and released the film from Iceland, drawing on the support of its free-speech activists and the relative safety of its legal climate.

Defiance

Assange describes his site as "an uncensorable system for untraceable mass document leaking and public analysis" – its extensive catalogue uses more than 20 servers in numerous countries and hundreds of domain names. Assange is frequently threatened with litigation, to which his response is defiance. There are about 100 cases pending against Wik- ileaks, from threats to national security to data protection and privacy, but none have yet come to court. But despite the hostility shown by many governments to such mass leaking – the Pentagon called it a threat to national security – Iceland's attempt to become a base for the world's Assanges has encountered remarkably little political opposition.

"There has been no serious opposition to the proposals," says Marshall. "We had to make some changes, to reassure those who were concerned that Iceland would become a haven for online gambling and porn. And there are concerns about security – this is something we will have to take into account when we write the amendments.

"But the idea here is to get the best ideas from around the world and put them into one package. If we stick to that, we really can't go wrong."

One reason IMMI has been so difficult for Iceland's politicians to oppose is the popularity there of anything that increases transparency, after the failure of all its institutions to prevent a banking crash of such epic proportions.

"Transparency is a very popular concept in Iceland right now," says Ólafur Hardarson, the dean of social sciences at the University of Iceland.

Transparency International's consistent ranking of Iceland as one of the least corrupt countries in the world has been much derided – and Iceland's journalists have shared some of the blame for failing to expose the reckless financial dealing.

A nine-volume report into the events that led to the financial crash has a volume dedicated to the role played by the media, which journalists accept points to unacceptable failings. "The media had some responsibility as far as the crash was concerned," argues Marshall. "The upshot of the report is that the press were not very critical. They seemed to share in the belief that our businessmen were the founders of absolute truth.

"The whole nation went along with the idea that somehow because of the Icelandic work ethic – we are accustomed to long hours and working very hard – that this was the reason for our success. Nobody asked where the money was actually coming from. Journalists failed to follow the basic rule: follow the money."

Kristinn Hrafnsson, an investigative journalist and news presenter at RÚV, the national broadcaster, who collaborated with Assange on the Iraq video, says: "Most people agree that the press were not doing a good job of holding business tycoons to account. We were leaving it up to the business specialists, and instead of being critical of the business tycoons, they were in bed with them."

IMMI's creators hope that complacency will be prevented in future, which would renew confidence in the press. But enacting a law of this nature is not without its legal obstacles, and the IMMI project became so complicated they did not actually draft the proposed legislation themselves. "We are asking the parliament to change about 13 different laws," says Jónsdóttir. "We were advised by lawyers that it was best to task the government with doing it."

Jón Vilberg Guðjónsson, the ministry of culture lawyer who is doing so, is quick to point out the legal complexity of implementing these proposals. "There are obstacles in the national law which can be overcome," he says. "But there is also the question of our international obligations."

Although Iceland is not yet a member of the European Union – it was formally granted candidate status to open membership talks last month – it is already a member of the European Economic Area, with resulting obligations on data protection.

Libel tourism

The situation is particularly thorny when it comes to blocking the effect of English court decisions on libel tourism cases. Although US legislators have created a precedent, the EU law already imposes obligations on European states regarding the recognition and enforcement of foreign judgments. Passing new laws contrary to the EU's legal regime is unlikely to help Iceland's bid to join.

There is also the question of regulation. "One of the things that would have to be looked into is whether the responsibility for published material can be adjusted," says Guðjónsson. "For example, if it were published on a web server hosted in Iceland, the legal entity responsible would have to be brought within the ambit of the Icelandic Media Authority.

"There are also issues about data protection. The EU data protection directive provides for the protection of databases. If disclosure from Iceland involves revealing the contents of databases, there might be intellectual property interference."

Perhaps the most controversial aspects are those concerning national security. "The secret service of a foreign country whose material is on its way to being published on a public server hosted in Iceland might be tempted to block the servers giving access to the material," says Guðjónsson. "And persons connected to the disclosure of the information might be exposed to personal risk. These issues will have to be looked into further by national security experts."

There is an element of irony about Iceland attempting to turn itself into a journalistic haven. In addition to the legacy of the banking crash in exposing the flaws in Iceland's supposedly open and transparent regime, the country's media is in a far from perfect state.

IMMI would remedy serious flaws in Iceland's media law, where criminal libel is still on the statute books. There have been instances of whistleblowers being fired, and there was much legal drama surrounding the protection of sources in the country until 2000, when its supreme court ruled journalists had a right to keep them secret.

Aside from the legal issues, the press is struggling to find revenues from online publishing, as in all other countries. And the extent of Iceland's unique financial crisis has hit broadcasters head-on. RÚV has already endured 10% budget cuts, and is facing a further 10% next year. Hrafnsson says two of the investigative programmes he was working on at two different channels have been shut over the past year.

"People say they value investigative journalism, but when cuts are made, it's the first thing to go," he says.

There are the concerns about the ownership of the media, with powerful business interests still in control of the press and broadcasting. Although journalists in Iceland deny being put under overt pressure, most describe the self-censorship of not wanting to run stories inimical to their paymasters.

IMMI's supporters, however, are confident that the obstacles can be overcome, and that the project could help improve things for Iceland's long-suffering journalists. The prospect of journalists and media organisations relocating there could bring a much-needed boost to the country's economy and, importantly to Icelanders, to its reputation.

Hrafnsson says: "Iceland is very concerned about what is written about it abroad. People here were more concerned about the loss of reputation than they were about the loss of money."

There are other major battles being waged in Iceland. Just weeks after the EU approved the country's candidacy status, a poll revealed 80% of Icelanders were opposed to joining. The conservative Independence party recently passed a resolution among its party members calling for the application to be withdrawn, prompting vicious political rows.

Even if the legal obstacles to IMMI are overcome and the measures become law, it remains to be seen whether the world's major newspapers will rush to install their servers and investigative journalists in the country. But with broad political support for the measures in Iceland and an atmosphere of having nothing left to lose, IMMI's creators have adopted a typically Icelandic attitude to the project – try it anyway and see what happens.