Testing the water

Feature | 27 April 2016
Page 23 TFR March 2016__WEB

Patrick Murphy considers the
'new normal' of doing business with Iran in
a post-Implementation Day geopolitical climate

For many years, the ordinary businessman looking at the vast potential of the untapped Iranian market would have viewed it as an enticingly juicy apple that was just out of reach.

The reasons for this view were varied. Some businesses were expressly prohibited from doing anything at all with Iran, such as US companies or their subsidiaries or EU companies stifled by the less sweeping but no less damaging 'sectoral sanctions' that stopped EU companies dealing in certain key areas of the Iranian economy, such as finance, insurance, oil, gas, petrochemicals and shipping. Even companies with no connection to the US or EU were hampered by US secondary sanctions which targeted activities in those same key areas of Iran's economy. Potentially the most significant brake on trade with Iran, however, had been the almost wholesale refusal of the banking sector across the globe to handle Iran-related business at all. All told, combined with Iran's inability to generate foreign currency through sales of crude oil, the prospects of carrying out profitable business in Iran were slim.

The deal encapsulated in the Joint Comprehensive Plan of Action (JCPOA) to lift sanctions had been a long time coming. When Implementation Day finally occurred on 16 January 2016, it had been more than two years since the first steps towards rapprochement between the P5+1 and Iran on the nuclear issue had been taken in late 2013.1

Understanding the new normal

Sanctions have added 15% to the cost of trading with Iran and lifting them will save the country some US$15bn yearly in cheaper trade, says Iran's first Vice-President Eshaq Jahangiri.

With sanctions gone, Iran could boost its GDP growth to around 5% in 2016-17, from almost zero currently, says the International Monetary Fund.

But after so much time in gestation, what does the 'new normal' look like? The apple is now within the reach of many businesses, but there are still pitfalls awaiting them.

The good news

First, the good news: the EU's 'nuclear' sanctions and US secondary sanctions against the Middle East and North Africa (MENA) region's second biggest economy have been lifted. Legal restrictions on doing business in Iran's oil, gas, petrochemical and shipping sectors have been lifted. Iran can sell its oil on the open markets again and repatriate its foreign currency earnings. Most of its banks are no longer cut off from the world's banking sector and the SWIFT financial messaging system is connected to Iran again. Foreign investors can make capital investments in Iran's estimated US$250bn projects market. Its 80 million consumers, half of whom are under the age of 30 and who are increasingly brand conscious, are targets for the western fast moving consumer goods market. Intellectual property rights can be registered to protect brands.

In a world economy where growth is a scarce resource, the opening up of an untapped diversified economy, with attractive demographics and a natural resource sector requiring significant investment, is an enticing opportunity.

According to the World Bank, "real GDP should rise to 5.8% and 6.7% in 2016 and 2017, respectively, as oil production reaches 3.6 and 4.2 million barrels per day. Reforms to the business environment to promote competition, rationalize licensing and authorization requirements, reduce the imprint of State-Owned Enterprises in the economy, and improve the health of the financial and banking sector are needed to accelerate growth and private-sector led job creation."2

Reality check

But now the reality check: the new normal for businesses is not an unfettered ability to trade with Iran. While the restrictions are much fewer than previously, there are still many in force.

While the EU nuclear sanctions targeting sectors of the Iranian economy were lifted, there are still residual restrictions connected with ballistic missile and human rights violations that mean that a number of Iranian entities remain 'designated' for asset freezes. Similarly, the US maintains a number of designations on Iranian entities (Specially Designated Nationals - SDNs) that will restrict businesses generally from dealing with them. For example, both the EU and the US have maintained, after Implementation Day, the designation of the Islamic Revolutionary Guard Corps (IRGC) which has interests in many areas of the Iranian economy.

Counterparty risks and KYC remain significant issues

The first key step for any international investor in Iran will therefore be to identify not only whether its counterpart is designated in any way, but also whether that counterpart is owned or controlled by persons who are designated. That is likely to be a difficult conversation for a foreign investor (particularly a western investor) to have with an Iranian counterpart. Without a culture or history of 'client due diligence' in Iran, requests for information about shareholders and directors of Iranian companies, not to mention passport copies, are likely to be met by strong resistance.

Yet such know your client (KYC) information will be essential for foreign companies doing business in Iran. On any view, Iran is a high risk jurisdiction. As well as the involvement of the IRGC in many aspects of the Iranian economy, Iran remains designated by the US as a 'state sponsor of terrorism'. The Financial Action Task Force reiterated its concerns in February 2016 about Iran's failure to address anti-money laundering and combatting financing of terrorism deficiencies, and highlighted the threat this poses to the integrity of the international financial system. Iran consistently ranks low down in Transparency International's Corruption Perceptions Index. Against this background, detailed KYC on Iranian counterparts will be a fact of life for international investors for some time.

Along with those counterparty risk and KYC concerns, there are still substantive sanctions in place in the US that will concern companies looking to do business in Iran. Although the US secondary sanctions targeting non-US persons were lifted, the US primary sanctions directed at US persons are still in force, preventing any US business from carrying out any activities with Iran and from facilitating others carrying out business in Iran.

US dollar trades still prohibited and insurance remains problematic

The corollary of that is that the US dollar is still off-limits for any trade with Iran. A hypothetical seller in China and buyer in Iran cannot denominate their sale contract in US dollars.

Then there are the consequential effects of the remaining sanctions that continue to present concerns following Implementation Day. The insurance of Iranian risks or business presents a good example. By its nature, insurance is reinsured a number of times over into various markets. It is likely that significant risks which require well-capitalised reinsurers behind them will be exposed to US reinsurers at some point. Those US reinsurers will not be able to pay out on such claims because of the links to Iran. Insurers underwriting Iranian risks may find themselves facing claims for losses which are uninsured if they have any exposure to reinsurance from US reinsurers.

Workarounds exist

But it is not all doom for US businesses. Before Implementation Day, the US had not only prohibited US companies from engaging in business with Iran, but also prohibited their overseas subsidiaries from doing so. Following Implementation Day, General Licence H now permits foreign subsidiaries of US companies to engage in business with Iran, provided that it does not conflict with the purposes of the JCPOA and that it is not with the Government of Iran. The US parent company will need to be wary of unwittingly 'facilitating' trade with Iran by giving any approvals (by way of shareholder or board resolutions, for example) for its subsidiary to carry out such business. However, General Licence H permits US parent companies to pass the necessary approvals to divest themselves of the decision-making authority for the entry of that business, allowing the foreign subsidiaries to take the ultimate decision to engage in that business themselves.

Using General Licence H is therefore a means by which conglomerates with links to, or even headquarters in, the US could carry on business with Iran, via their subsidiaries. Care would have to be taken to ensure that US nationals were not involved in any aspect of that business (either in the delivery of the business or in determining to enter into it) but it is nonetheless a viable strategy. The principal concerns for US linked conglomerates are the obligation, which continues after Implementation Day, for Securities and Exchange Commission (SEC) filings to identify any business with Iran that has been carried out by group members, and the potential for negative publicity from this exposure.

Further relief for US companies is specifically provided through a new licensing policy by which US and non-US persons are able to obtain a licence to sell commercial passenger aircraft and parts to Iran. The new policy will be a boon to Iran's aging civil aviation fleet and to European and potentially US aircraft manufacturers. Within days of the announcement of the new policy, Airbus confirmed it had received an order from Iran Air for 118 new aircraft in a US$25bn (€22bn) deal. It remains to be seen whether orders for Boeing aircraft will follow.3

Banking issue remains a key concern

The overriding concern that lingers is likely to be the banking issue. There was no relief for US clearing banks on Implementation Day or for foreign financial institutions which deal in US dollars. The potential for settlements, such as those agreed by BNP Paribas and Commerzbank for allegedly engaging in US dollar transactions with Iran, has not diminished following Implementation Day. Indeed, it has arguably increased as more business is anticipated to be carried out with Iran.

While Iranian banks are connected to the SWIFT financial messaging system once again, few if any tier one financial institutions are listening at the other end. There is reluctance among them to support business with Iran in any currency because of the risks associated with accidentally handling US dollars. Whether that reluctance translates into a substantial handbrake on the potential for trade with Iran is the great unknown in the immediate aftermath of Implementation Day. If so, the windfall from Implementation Day will be substantially smaller than hoped for.

On the plus side, however, it is inevitable that some enterprising banks will be first movers in supporting business with Iran, potentially at the expense of their relationships with US respondent banks in New York.

Iran's central bank says lifting banking sanctions will allow US$30bn of foreign reserves currently frozen in accounts around the world to be brought back; the US Treasury says the figure is US$50bn. According to press reports, US$100bn of overseas frozen funds have been released and are starting to be transferred from China, Japan, South Korea and Turkey to Iranian accounts in Germany and the UAE. Nine banks, including the central bank, have been reconnected to the SWIFT international transaction system.

The new normal: both exciting and challenging

The outlook for business with Iran is undoubtedly brighter than it was prior to Implementation Day. But it will be a dynamic and evolving situation characterised by first movers making tentative steps into an exciting but still challenging market.



Patrick Murphy is dispute resolution partner at Clyde & Co in Dubai

"The most significant brake on trade with Iran, however, had been the almost wholesale refusal of the banking sector across the globe to handle Iran-related business"

"The US dollar is still off-limits for any trade with Iran"

  1. The UN Security Council's five permanent members - China, France, Russia, the UK and the US - plus Germany.

  2. bit.ly/21WcFEb

  3. See Simon Littlewood's blog on the Airbus deal at www.tfreview.com/node/13380

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