Europe-Iran Trade Mechanism Completes Landmark Iran Sale

The Germany foreign ministry announced on Tuesday that INSTEX, the Iran trade mechanism backed by nine European states, has completed its first transaction.

"France, Germany and the United Kingdom confirm that INSTEX has successfully concluded its first transaction, facilitating the export of medical goods from Europe to Iran. These goods are now in Iran," the ministry said in a statement.

An individual with knowledge of the transaction, speaking on background, said that a German exporter had used the INSTEX mechanism to receive payment for the sale of medication to an Iranian private sector importer. The transactions was later reported to be worth EUR 500,000.

The sale is consistent with INSTEX’s initial mission to facilitate humanitarian trade, currently impinged by the impact of U.S. secondary sanctions on banking ties between Europe and Iran.

Officially launched in January 2019, INSTEX was slow to operationalize as French, German, and British officials grappled with the political and technical challenges of establishing a novel state-owned trade mechanism.

But in the summer of last year, INSTEX hired its first managing director and expanded its team, leading to a step-change in the company’s operations.

The new management resisted pressure to conclude an initial transaction as soon as possible—European officials had explored providing a factoring service as a stopgap—and instead sought facilitate a sale that would utilize the cross-border clearing mechanism. Through this mechanism, INSTEX makes payments to European exporters on behalf of Iranian importers, reducing the transaction costs associated with Europe-Iran trade. These sales are netted against exports made by Iranian companies, who are paid in turn by INSTEX’s Iranian counterpart, STFI.

INSTEX management has been working on several transactions in parallel, on the back of strong interest from European exporters to engage the mechanism. The German foreign ministry statement concludes, “INSTEX and its Iranian counterpart STFI will work on more transactions and enhancing the mechanism.”

Photo: IRNA

INSTEX Develops New Service in Bid to Fast-Track Iran Transactions

The state-owned company at the center of European efforts to save the Iran nuclear deal is entering its next phase of development. In a push to process transactions more quickly, INSTEX is rolling out a new factoring service for European exporters. The company is also making new hires that will enable it to expand operations in the coming year. 

Having reached the end of his six-month contract, Per Fischer is stepping down as the president of INSTEX, the state-owned company established by France, Germany, and the United Kingdom to support trade with Iran. Fischer’s replacement is former German ambassador to Iran Bernd Erbel. A career diplomat, Erbel has been posted in Lebanon, Saudi Arabia, and Egypt, and served as ambassador to Iraq prior to his stint as ambassador to Iran. 

The change in leadership comes as INSTEX finalizes several other management hires. By filling these roles, INSTEX will enter a new phase of operation as a standalone company based in Paris. Until now, both INSTEX’s outreach to European companies and its coordination with its Iranian counterpart, STFI, has been led by civil servants at the foreign and economy ministries of the company’s three founding shareholders. 

Fischer, a former Commerzbank executive, had been selected as the company’s first president due to his banking background. But Erbel, who lacks commercial experience, will have a different mission as he assumes his leadership role. Erbel will leave key commercial responsibilities to the new managers, focusing instead on ensuring a constructive working relationship between INSTEX and STFI. In recent weeks, cooperation between the two entities has slowed. Iranian authorities have called for INSTEX to be funded by Iran’s oil revenues—a move that would leave INSTEX vulnerable to sanctions from the United States. 

Erbel’s deep knowledge of Iran may help him navigate the tensions surrounding the INSTEX project in Tehran and reassure Iranian stakeholders of the seriousness of European efforts to develop the mechanism further. 

The goal for INSTEX remains to ease Europe-Iran trade by developing a netting mechanism that eliminates the need for a cross-border financial transactions. In this model, INSTEX will coordinate payment instructions between companies engaged in bilateral trade between Europe and Iran, enabling European exporters to receive payment for sales to Iran from funds that are already within Europe. The counterpart entity, STFI, will then mirror those transactions, allowing Iranian exporters to get paid with funds already in Iran. 

Delayed by political disagreements, INSTEX and STFI remain in the process of establishing the netting mechanism. But in a bid to fast-track transactions, INSTEX has opted to roll out a new service that does not require the direct participation of its Iranian counterpart. INSTEX is now in advanced negotiations to a provide factoring service to an initial cohort of European companies.

In factoring transactions, INSTEX will purchase the expired invoices of European exporters who have failed to receive payment for sanctions-exempt goods sold to Iran. The focus on expired invoices allows INSTEX to avoid lengthy French regulatory approvals for a full factoring service. Importantly, INSTEX will not require the goods in question to have been delivered to the Iranian buyer in order for the European exporter to factor its receivables. In this sense, the service approximates a kind of trade finance. 

According to a draft contract between INSTEX and a European company seen by Bourse & Bazaar, the purchase price paid to the European exporter by INSTEX would amount to 95 percent of the “assigned receivable.” In other words, INSTEX will charge a 5 percent fee as part of its factoring service. This fee will vary based on the transaction.

Such costs are not negligible for European exporters, especially when considering that INSTEX will require each transaction to undergo third-party due diligence at the exporter’s expense. Yet they are commensurate with the transaction fees typically charged by banks in those cases in which the bank is willing to accept funds originating in Iran. Moreover, for European companies burdened with unpaid invoices, the certainty of payment from INSTEX, a state-owned European company, is inherently attractive.

In some respects, the factoring service is a more appealing solution for companies than the netting mechanism service which INSTEX still intends to operationalize. However, factoring is inherently less scalable as it requires significant capital to be made available to INSTEX in order purchase invoices. INSTEX will also assume the burden of seeking payment from the Iranian debtor.

However, should the factoring solution prove popular, it may be the case that INSTEX could subsequently transfer its newly assigned receivables to STFI, making it possible for Iranian importers to pay STFI for goods purchased from European exporters. Alternatively, INSTEX could open an account either in Iran or at the Iranian bank branch based in Europe in order to receive payment for the outstanding invoices. While conceived as a stopgap solution, the experience with factoring could help INSTEX develop a more robust netting mechanism.

As it welcomes new leadership and pivots to a new service, INSTEX resembles any ordinary startup at a key stage of its development. Like all startups, INSTEX continues to face many hurdles—its success is far from assured, particularly in the darkening political climate. But the individuals responsible for its development are responding to pressure from demanding shareholders and skeptical customers with creative solutions—an encouraging sign.

Photo: Anna McMaster

Trading With Iran Via the Special Purpose Vehicle: How It Can Work

This article has been republished with permission from the European Council on Foreign Relations. 

Following weeks of speculation, France, the United Kingdom, and Germany (the E3) have formally registered a special purpose vehicle (SPV) to help facilitate trade with Iran – trade that the return of US sanctions has significantly hampered. This comes after months of technical coordination between member states led by the European External Action Service. While reactions in Tehran have been mixed, this is a significant demonstration of Europe’s commitment to preserving the Iran nuclear deal after President Donald Trump withdrew the United States from it.

The E3’s foreign ministers issued a joint statement with a brief overview of this new mechanism, called the Instrument in Support of Trade Exchanges (INSTEX), but have provided little clarity on the details of how it works. This is understandable given that they must finalise several technical aspects of INSTEX before it becomes operational. INSTEX will initially focus “on the sectors most essential to the Iranian population – such as pharmaceutical, medical devices and agri-food goods”. This means that, for now, INSTEX will avoid a direct clash with the White House, since US sanctions permit these categories of trade due to their humanitarian nature.

But the exact method INSTEX uses will be the first instance in which Europe tries to mitigate the effects of US secondary sanctions on what it sees as legitimate trade. Companies in Europe and Iran are eager to know if the system can be of practical use. The assessment below lays out INSTEX’s likely structure.

Sovereign Shield

An important element of the mechanism is its sovereign backing from the E3. The supervisory board of INSTEX will include senior European diplomats such as UK Permanent Under-Secretary of State for Foreign Affairs Simon McDonald; Miguel Berger, head of the economic department at the German Foreign Office; and Maurice Gourdault-Montagne, secretary-general of the French Ministry of Europe and Foreign Affairs. The E3 governments are also shareholders of INSTEX.

The E3 have gone to great lengths to create a diplomatic shield around INSTEX and to share risk among the biggest economies in Europe. With the E3 having stuck their necks out, several other European countries are also considering joining the SPV as shareholders. While this does not eliminate the risk of US pressure on the mechanism, it does substantially raise the stakes for Washington should it seek to directly sanction or otherwise coerce a sovereign European entity or its senior management board – as it has with the European private sector.

It is important that the Iranian government now establishes another SPV to mirror INSTEX inside Iran. To persuade European companies to use the SPV, the Iranian entity will need to meet high standards of transparency in anti-money laundering and counter-terrorism financing regulations. Thus, the E3 would prefer that the Iranian SPV was either a new company or operated under an Iranian bank that has not been subject to US secondary sanctions. This is likely to reduce the risk that the US administration will apply pressure to INSTEX’s operations.

In theory, Iran should establish its SPV more quickly than the E3 did their mechanism, given that Tehran will not need to balance the interests of several countries. However, it is inevitable that this issue will be caught up in extensive political debate in Iran. To speed up this process, Tehran should carefully consider offers from the European Union and the E3 on technical assistance in launching an Iranian SPV.

The Mechanism Behind INSTEX

INSTEX is best understood as an international trade intermediary that provides services to ease trade between Europe and Iran. Although the new company is not a bank, it will have a role in coordinating payments relating to trade with Iran. This coordination is necessary. Iranian importers have struggled to purchase and receive euros from the Central Bank of Iran on time – as is necessary to make payments to European suppliers. Even when they do acquire euros, Iranian importers struggle to make payments to suppliers, as European banks remain hesitant to accept funds originating in Iran. This holds true even for humanitarian trade that is formally exempt from sanctions: several exporters of food and medicine to Iran have reportedly experienced disruptions in recent months, contributing to troubling shortages and sharp price increases.

INSTEX will seek to facilitate Europe-Iran trade while reducing the need for transactions between the European and Iranian financial systems. It will do this by allowing European exporters to receive payments for sales to Iran from funds that are already within Europe, and vice versa. For example:

• A European exporter with an order for medicine from an Iranian importer provides INSTEX with the relevant documentation on the transaction. This will include evidence that the importer has practised reasonable due diligence in relation to the Iranian buyer and the end user. Crucially for European companies, INSTEX will not provide the requisite due diligence service.

• Once it has approved the sale, INSTEX will register it on a ledger of trade.

• INSTEX will examine its ledger to identify an instance in which a European importer has registered a purchase of pistachios from an Iranian exporter.

• INSTEX will then approve a payment from the European importer of pistachios to the European exporter of medicine, meaning that the payment can be made from one European bank to another without using funds that originated in Iran.

• To complete the process of trade intermediation, the Iranian counterpart to INSTEX will coordinate a similar payment from the Iranian importer of medicine to the Iranian exporter of pistachios. These funds will remain within Iran.

While it is novel for European governments to establish a state-owned company that performs this function, the basic mechanism at work here will not be new to international companies active in Iran. The innovative aspects of the new mechanism are its scale and the backing it receives from European countries rather than companies.

These transactions will not always match up perfectly, individually or in aggregate. This is particularly so given the European companies have stopped purchasing Iranian oil. Even companies in Greece and Italy that received US waivers to continue importing Iranian oil have reportedly not used them. Overall, European trade in food with Iran is roughly balanced: according to data from Eurostat, in the first eleven months of 2017, the EU’s food exports to Iran totalled €298m and its imports of similar goods from the country totalled €292m. The bloc’s trade in medicine and medical devices is far more imbalanced, with exports totalling €851m and imports just €27m in the period. As such, there will likely be greater demand for the new mechanism in facilitating sales to Iran than purchases from the country.

INSTEX will need to find a way to balance payments within both overall trade flow and at an operational level, so that payments can be settled in timely fashion – ideally, within 60 days. In balancing overall trade, European policymakers should attempt to maximise Iranian food exports to Europe through the mechanism.

Additionally, as has been suggested by European and Iranian officials, it may be possible to invite non-European countries to join the new mechanism. The SPV is more likely to succeed if it links with revenues related to Iran’s oil exports to countries such as China, India, and Japan.

INSTEX will expand gradually, accepting clients in a way that maintains a general balance in the ledger. At times, INSTEX may need to step in to top up the funds available to pay European exporters. To do so, the mechanism will need working capital. It could raise this capital either through contributions from European countries that are, or are becoming, shareholders in it. INSTEX could also charge a commission fee for the use of its services, thereby creating reserves that it can use to balance trade within a given payment period. Currently, banks that facilitate payments to and from Iran typically charge 2-3 percent of the transaction’s value, a high fee. INSTEX could reasonably charge a similar fee, thereby generating cash flow.

Speedy Implementation Required

It is hard to tell how much trade will flow through the mechanism. Ideally, normal correspondent banking channels should continue to facilitate a large portion of Europe-Iran humanitarian trade. INSTEX will step in to facilitate trade that might otherwise not occur given the currency and banking restrictions outlined above. On this basis, the initial version of the mechanism will have been a success if it eventually facilitates trade in the order of tens of millions of euros each year, perhaps intermediating around 5 percent of the total value of European exports to Iran. In this scenario, Europe could then consider expanding the mechanism to a wider range of trade.

Both Iran and the E3 should expect a teething period while the mechanism adjusts to best serve commercial actors. For European treasury managers and compliance officers tasked with finding workable financial channels with Iran, complexity has long been the norm. If the INSTEX channel proves reliable, companies are likely to use its services.

The E3 should undertake the necessary technical arrangements to operationalise INSTEX as quickly as possible. The new managing director of INSTEX will need to tour Europe to meet business executives and policymakers. They will need to engage in extensive outreach with European operators to persuade them to use the SPV – and, more importantly, with European banks that are instrumental to it – by settling accounts between European companies. The European External Action Service should be closely involved in this coordination effort across Europe.

By acting swiftly, Europe will boost its credibility with Iran, where the government is scrambling to manage the economic fallout of the US withdrawal from the nuclear deal and is increasingly under pressure to reduce compliance with the agreement. This will also increase the E3’s leverage with the US administration by demonstrating that they have substantive resilience against US sanctions.

Photo Credit: AFP

How Europe’s Forthcoming SPV Can Help Iran Fight Inflation

Europe has yet to launch its special purpose vehicle (SPV) to support trade with Iran and while Iranian stakeholders grow increasingly impatient, some have begun to question the likely impact of the new mechanism. The chief complaint is that the initial SPV, if limited to humanitarian trade, will not have a meaningful economic impact for Iran, which had sought to maintain oil exports to Europe in the face of US sanctions.

As recently argued in a joint report from Bourse & Bazaar and the European Leadership Network, the creation of a humanitarian SPV (H-SPV) has important advantages from the standpoint of protecting the new trade mechanism from interference by the United States. A focus on non-sanctionable trade will enable Europe and Iran to develop a more robust mechanism that delivers practical value for businesses. When a truly useful mechanism has been devised, subsequent SPVs can be established to facilitate what the United States considers sanctionable trade. 

Nonetheless, in order to be welcomed by a broad spectrum of Iran’s political and business establishment, the initial SPV, especially if limited to non-sanctionable trade, must demonstrate a positive impact on Iran’s economy in the near term. An examination of the nature of Europe-Iran trade and the impact of this trade on Iran’s currency markets, suggests that the SPV could have a significant and stabilizing impact on Iran’s economy by helping to fight runaway inflation, the foremost economic challenge facing Iran’s leadership.

Trade Deficits and Inflation

Since early 2018, Iran has been struggling to contain rising inflation exacerbated by rapid currency devaluation. Rising costs of imports have impacted the costs of goods in the consumer basket. The year-on-year increase in the consumer price index in Aban (October 23 - November 22), the most recent period for which data is available, was 39.9 percent. This increase was driven by year-on-year rises in categories including food and beverages (59.9 percent), tobacco (150.8 percent), clothing and footwear (48.5 percent), and furnishings and household goods (83.1 percent). The increase in the health category, which includes medicine, was a significant 19.6 percent.

These categories represent the daily needs of Iran’s households. They are also, broadly speaking, goods which do not fall under the restrictions of US secondary sanctions. Not only are the goods themselves not sanctioned, but the larger role of the private sector within the food, pharmaceutical, and FMCG sectors in Iran means that the Iranian corporate entities active in these sectors are typically not subject to secondary sanctions. On this basis, a humanitarian SPV which would focus on non-sanctionable trade, would be well-suited to support Europe-Iran trade related to these elements of the consumer basket.

While Iran does manufacture many of these goods domestically, overall consumption still relies on a significant volume of imports of food and medicine, with the European Union (EU) the most important trading partner. Even the domestically produced products rely on imports of raw materials which mainly originate in the EU. In 2017, the most recent full year of trade without sanctions, Iran faced a trade deficit with Europe of just under EUR 1 billion in the food and beverage, medicine, clothing and footwear, and furniture categories, based on imports of EUR 1.3 billion and exports of approximately EUR 300 million. Importantly, this figure does not include Iranian imports from Switzerland, a major source of pharmaceutical products with about as much export volume as Germany. But given that the SPV is an EU undertaking, and given that the Swiss are working on a separate banking channel to support their humanitarian trade with Iran, it can be kept separate for the purposes of this analysis.

Beyond humanitarian goods, Iran has typically run a trade deficit of about EUR 1 billion with Europe, even in those years that Iran has been able to export significant volumes of oil to European buyers. The trade imbalance with the EU has a direct impact on inflationary pressures in three areas. First, the euro is a strong currency and the rapid devaluation of the rial has made imports considerably more expensive over the last year. Second, purchasing European goods generally involves higher transaction costs for Iranian importers related to the restrictions on banking channels between Europe and Iran. Finally, Europe is the only source for a number of imports, particularly medicines, meaning that a fall in exports will have a direct and often unmitigable impact on available supply in Iran, pushing prices higher and creating black markets for some specialized medicine. All three phenomena can be seen in the Iranian market today.

There are other indirect drivers as well. As is common for countries at the same level of development, Iran’s process of industrialization is import-intensive. New technologies are acquired to produce a wider range of foods, medicines, and consumer goods domestically, often in accordance with licenses for European formulations or technology. Iran imported EUR 5.5 billion in industrial machinery and equipment in 2017 in order to support domestic industrial capacity. When this equipment or the relevant services, spare parts and training are unavailable, it has a knock-on effect on manufacturing output, available supply, and the market price for consumers.

On one hand, the fall of Iranian imports of European machinery from their 20-year high of over EUR 8 billion in 2004, suggests that Iran is increasingly sourcing such machinery from other markets, especially China. But, Europe retains a technological advantage over China for the manufacturing of food and medicine and the most popular brands in Iran in these categories are often European brands or formulations. This means that substitutions cannot be easily made for the equipment necessary in the domestic production of these goods. Moreover, Iran also relies on European technology for the storage and distribution of food and medicine across the supply chain.

The SPV Intervention

Given these challenges, the appeal of Europe’s SPV, if properly operationalized, is clear. The SPV can help alleviate inflationary pressures by empowering European and Iranian policymakers to better manage foreign exchange risks, reduce transaction costs, and address the trade deficit, particularly around key items within the consumer basket.

First, in the area of foreign exchange, the SPV could reduce pressure on the Central Bank of Iran to source and allocate euros for importers of so-called “essential goods.” Presently, delays in the allocation of foreign exchange are leading to payment issues on the part of Iranian importers of both food commodities and pharmaceuticals. In one manifestation of these delays, cargo ships are remaining anchored off of Iran’s coast for as many as sixty days, incurring demurrage costs.

If the SPV oversees a ledger of trade between Europe and Iran, a role which some have compared with that of a “clearing house,” it would be able to coordinate a version of book transfers, which would enable Iranian importers to pay European exporters indirectly with the SPV coordinating a euro-denominated payment by a European importer on behalf of the Iranian importer. In turn, the Iranian importer would make a rial-denominated payment on behalf of the European importer to its counterparty in Iran (an exporter). Through such a mechanism, there would be no need for the Central Bank of Iran to source and allocate Euros for the purchase by the Iranian importer, as monies already in Europe would be used to make the payment. In this way, reducing demand for euro allocations among Iranian importers should help the CBI more effectively operate the NIMA system, its central marketplace for foreign exchange, thereby reducing the significant inflationary pressures arising from foreign exchange markets.

In a related fashion, the facilitation of book transfers by the SPV would also help eliminate the additional transaction costs currently incurred when arranging cross-border financial transactions between Europe and Iran. Due to the higher compliance risks associated with accepting Iranian-origin funds, the few European banks that do continue to transact with Iran impose fees on clients of up to three percent of the total transaction amount. Some routine and low-risk trade currently facilitated by the few correspondent banking channels that remain between Europe and Iran could be shifted to the SPV, reducing the compliance costs associated with cross-border transactions that can depress export volumes.

Finally, the SPV will only truly succeed if it is operationalized alongside an effort to shrink Iran’s approximate EUR 1 billion trade deficit with Europe in non-sanctionable goods by increasing Iran’s non-oil exports. To be clear, it is highly unlikely that the full volume of Europe-Iran trade will run through the SPV. Where possible, companies will certainly favor using normal channels, facilitating payments through the small number of European banks that will remain willing to process payments for humanitarian trade. Nonetheless, the fundamental problem faced by Iranian importers is access to the euros necessary to sustain purchases from Europe. In this case, in the absence of oil sales, foreign finance, or foreign direct investment, Iran’s exports to Europe will remain the only reliable source of euros for the Central Bank of Iran which is responsible for making foreign exchange available to Iranian importers. 

A New Vision for Europe-Iran Trade

As such, it should be a primary goal of the SPV to increase the volume of European imports from Iran, helping to minimize the trade balance and increase the supply—and thereby reduce the cost—of Euros for Iranian importers. This may seem a difficult task. Iran’s manufacturing output is generally inferior in quality and higher in cost than that available from EU member states and from other countries with active trading relationships with the bloc.

But there are a few product categories where Iranian producers could regain or establish market share in Europe. In 2000, Iran exported EUR 316 million worth of “floor coverings” to Europe, a figure which primarily reflects the sale of traditional Persian wool rugs. By 2017, the sales amounted to just EUR 28 million. The collapse in Persian rug exports may reflect changing tastes among European consumers, as similar decreases can be seen for the same product category as exported by India, Pakistan, and China. An industry-led campaign to boost the popularity of Persian rugs among younger consumers could help reverse the trend.

Iran’s loss of market share in the export of key foodstuffs is harder to explain. European consumption of pistachios has exploded in the past 20 years, but the increase demand has been met by supply from the United States, the only other major producer of pistachios in the world. Iran lost its mantle as top exporter of pistachios to the EU in 2004. Had it captured just half of the growth in European imports since that date, pistachio exports would be around EUR 150 million higher.

Similarly, Iran’s exports of caviar to Europe have fallen from EUR 26 million in 2000 to just EUR 700,000 in 2017. In the same period, exports from the United States have risen from EUR 11 million to EUR 26 million. Exports from China have risen from less than EUR 500,000 to EUR 7 million. It is also notable that Iran’s export of shrimp to Europe has collapsed from EUR 40 million to EUR 2.7 million since 2000, despite the fact that Iran’s seafood industry remains healthy.

Altogether, by dramatically ceding market share, Iran has likely failed to realize around EUR 250 million of export potential in these categories. However, Iran’s growing exports of saffron, which have risen from EUR 24 million in 2000 to EUR 67 million in 2017, help illustrate that Iranian suppliers can achieve significant growth in the European market. This analysis does not account for the many categories of foodstuffs such as nuts and fruits where Iran’s exports to Europe remain very low, but where Iran ranks among the top global producers.  Generally, Iran could become a reliable supplier of food ingredients and herbal medicine to Europe, but it will require an effort from both sides to facilitate the growth. Iran also exported just over EUR 30 million in pharmaceutical products to the EU in 2017—another potential area for growth. Organizing relevant delegations in both directions to expand commercial ties in these sectors would be an important step.

The non-oil trade deficit has been the subject of some attention among Iranian authorities. The National Development Fund of Iran, the country’s sovereign wealth fund, has a program to provide capital to Iranian commercial banks in order to fund loans for private sector export-oriented enterprises. Many of these projects are focused on agricultural production, where loans are used to implement new (often European) technology in order to increase the quality or quality of production while also creating jobs.

Nonetheless, the primary instinct for Iranian officials has been to try and reduce import demand. Recently, the government announced a measure to ban the advertisement of foreign products for which there exists a domestically manufactured equivalent. But given that demand for many imports will prove inelastic, a focus on boosting exports would be a far more prudent strategy for dealing with the trade deficit.

When looking to non-sanctionable goods and the current trade deficit of EUR 1 billion within this category, the possibility of boosting Iranian exports by EUR 250 million is significant from the standpoint of reducing pressure on foreign exchange markets. Add to this other intended improvements to the cost efficiency of trade, and it becomes clear how the forthcoming H-SPV could help Iran address some of the external drivers of inflation. Most importantly, this analysis shows that the launch of the SPV is not the end of an implementation process. It is just the first step in a much-needed reimagining of Europe-Iran trade relations and a process in which the EU can showcase its commitment to a working partnership with Iran.

Photo Credit: IRNA

Europe’s SPV Will Be a ‘Rare Victory’ Only if Iran Makes it So

This article was originally published in Persian in Etemad Newspaper.

In a recent speech, President Rouhani declared that Iran had achieved a “rare victory” insofar as Europe is seeking ways to sustain its trade with Iran in the face of US sanctions. While this may be true in a political sense, practically speaking, the President is declaring victory too soon. Iran should be doing much more to ensure Europe’s efforts result in solutions that can maximize the flow of trade while banking ties remain restricted.

As US sanctions are reimposed, European efforts to sustain trade center on the creation of a new “special purpose vehicle” (SPV) which will serve to reduce the reliance of Europe-Iran commerce on the international financial system. The SPV, which will be owned by a group of European states with strong commercial ties to Iran and will help coordinate the “netting” of Europe-Iran trade, minimizing the need for cross-border financial transactions. There seems to be serious political will. In an interview with the Financial Times, French economy minister Bruno Le Maire expressed his hope that the SPV would evolve into a “real intergovernmental institution that will serve as the financial instrument of Europe’s independence.” The new mechanism “should allow us to trade in any product, with any country, so long as it is in line with international law and Europe’s commitments.”

The necessary technical work is proving complex, but continues to move forward. While the SPV is expected to be legally registered in the next few weeks, it will take more time for the new entity to become fully operational. The Iranian government seems content to exercise “strategic patience” as it waits for the SPV to come online. But while this patience is commendable, Iran should be taking a much more active role in shaping the SPV to suit its needs.

There is a precedent for Iran to take a more active role in implementing new financial mechanisms. When the Joint Plan of Action (JPOA), the precursor to the JCPOA, was agreed on November 24, 2013, Iran received its first round of sanctions relief. This relief included the creation of a channel to facilitate humanitarian-related transactions including trade in food and  medicine at a time when strict banking sanctions remained in place.

The OFAC guidelines issued upon implementation of the JPOA outline that the “[foreign financial institutions] whose involvement is sought by Iran in hosting this new mechanism will be contacted directly by the USG and provided specific guidance.” What this means is that Iranian technical assistance was crucial in helping the United States identify the foreign banks that could facilitate humanitarian trade if given the proper assurances.

Today, same kind of Iranian input is necessary to ensure the European SPV is effective, particularly for the sake of sustaining humanitarian trade. There are two areas where Iran must play a more active role in advising its European partners on the structure and operation of the SPV.

First, Iran should ensure Europe to establishes multiple SPVs so that sanction-exempt humanitarian trade can be facilitated through a separate channel from sanctionable trade such as oil exports. Presently, only a single SPV is being considered by European governments. While facilitating all trade through a single entity is consistent with EU law, which does not see trade in food as different from trade in oil, for example, creating a single SPV will make the new mechanism more vulnerable to US sanctions. Given that in the short term, the SPV will be focused on humanitarian trade, it would be sensible to create a dedicated channel for these transactions. US officials have publicly promised they do not seek to inhibit humanitarian trade. Any mechanism focused exclusively on humanitarian trade is unlikely to be targeted by additional sanctions.  

Second, the SPV will need to conduct due diligence on each of transactions it facilitates. This will be a costly and time-intensive process. In order to maximize the volume of trade that the SPV can facilitate, Iran should create tools that will make it easier for the managers of the SPV to conduct the necessary due diligence. For example, the SPV could be given access, via a portal administered by the Central Bank of Iran, to registration and ownership information of Iranian companies currently only available to Iranian banks. Iran could also nominate a list of well-established companies authorized to use the SPV, reducing the risk that the SPV will be overwhelmed with unprofessional requests or abused by untransparent actors.

If the SPV can be implemented successfully, it would indeed be a rare victory in which Iran’s trading relationships will become less vulnerable to US economic warfare. But this opportunity is as urgent as it is historic and, over the next few months, Iran must take a more active role in shaping the planned European mechanisms to ensure their optimal operation. 

Photo Credit: IRNA

America’s Latest Wave of Iran Sanctions: An Explainer

This article was originally published by the European Council on Foreign Relations.

On 5 November, the Trump administration’s latest and most significant wave of sanctions against Iran came into effect. The US Treasury has issued a list of more than 700 Specially Designated Nationals (SDNs) and Blocked Persons, which includes roughly 300 entities that did not feature in Obama-era sanctions. The designations combine with a series of briefings from senior US administration officials, along with fact sheets and guidelines from the US Treasury’s Office of Foreign Assets Control (OFAC). Below is an overview what we know so far about how the US will implement its sanctions. 

Waivers allow Iran to maintain some of its oil exports

American sanctions targeting Iran’s oil exports and related banking activity will cause many companies and countries to halt or reduce their purchases of Iranian oil. The US administration has stressed that, in contrast to Obama-era measures, the latest sanctions target Iranian condensate as much as crude oil, thereby affecting another source of energy revenue.

Yet the US administration has issued Significant Reduction Exemptions (SREs) to eight countries: China, India, Italy, Greece, Japan, South Korean, Turkey, and Taiwan. Iraq did not receive an SRE, but obtained a waiver to continue purchasing Iranian electricity.

The United States did not issue a formal response to the joint letter from the E3 (Germany, France, and the United Kingdom) issued in June 2018 to request that EU companies be exempt from secondary sanctions. Other EU member states were surprised that Italy and Greece obtained waivers, suggesting that they separately negotiated country-specific rather than EU-wide exemptions. That China sought a waiver indicates that it may be avoiding confrontation with the US as it seeks to sustain trade with Iran.

The US authorities will review these waivers periodically (it is unclear when), requiring recipient countries to prove that they have substantially reduced their imports of Iranian oil (under Obama-era sanctions, these reductions were around 20 percent). According to Secretary of State Pompeo, two of the countries will eventually “completely end imports as part of their agreements”, but – again – the timing is unclear.

The US has abandoned its stated objective of reducing Iran’s oil exports to “zero”, seemingly due to concerns that this would cause a spike in global oil prices. However, revenues from Iran’s oil sales will be held in escrow accounts and can only be used for trade in humanitarian goods or other non-sanctioned products. As such, the US administration is insisting that its oil waivers are still consistent with its aim of ensuring that Iran’s government has “zero oil revenue” that can be used for “malign activity” in the region.

Banking measures allow for limited humanitarian trade

While most Iranian financial institutions are subject to US secondary sanctions, a few of Iran’s private banks are exempt from these measures. In principle, these banks can facilitate humanitarian trade even with US companies, a situation akin to that prior to the implementation of the sanctions relief that followed the implementation of the Joint Comprehensive Plan of Action (JCPOA).

Until recently, four private companies were responsible for facilitating nearly all of Iran’s humanitarian trade: Parsian Bank, Middle East Bank, Saman Bank, and Pasargad Bank. But, on 16 October, the US Treasury named Parsian Bank as a Specially Designated Global Terrorist. This new measure bans the bank from facilitating humanitarian trade. Responding to the designation, Kourosh Parvizian, Parsian’s CEO, described the new sanctions as a “mistake” that threatened “a bank that handles the transactions behind the majority of imports of foodstuffs, medicine and other humanitarian trade items for the Iranian people.”

The US clearly intended the designation of Parsian Bank to send a message to the Iranian financial system and its international counterparties. Commenting on the thin grounds for designating the bank a terrorist organisation, sanctions attorneys have expressed concern about the US Treasury’s approach to humanitarian trade.

The Parsian designation will loom over the remaining entities engaged in humanitarian trade with Iran, reminding them that the US could block their access to the international financial system at any moment. For now, the White House has not applied new terrorism- or proliferation-related designations to Middle East Bank, Pasargad Bank, or Saman Bank. This is crucial to these companies’ capacity to facilitate humanitarian trade.

OFAC guidelines state: “broadly speaking, transactions for the sale of agricultural commodities, food, medicine, or medical devices to Iran are not sanctionable unless they involve persons on the SDN List that have been designated in connection with Iran’s support for international terrorism or proliferation of weapons of mass destruction.” Companies that use these banks to conduct transactions for humanitarian trade must ensure that no other SDN-listed entities are involved in this trade.

Overall, the manner in which the US has reimposed sanctions allows humanitarian trade to continue. But the US has not taken any steps to actively safeguard vital trade in food and medicine, leaving European companies in the lurch about the risks involved in humanitarian trade linked with Iran and placing the citizens of Iran under intense pressure.

Partly to address this urgent problem, Switzerland is negotiating directly with the US authorities to create a humanitarian banking channel with Iran. Under Obama-era sanctions, several small Swiss merchant banks maintained ties with the likes of Parsian, Middle East Bank, Saman, and Pasargad. That the Swiss government now considers it necessary to intervene could indicate that these Swiss banks are more reluctant to engage with Iranian companies due to the Trump administration’s aggressive stance on all Iran-related commerce. Home to several major pharmaceuticals manufacturers, food companies, and commodities traders, Switzerland is perhaps Iran’s most important partner in humanitarian trade.

Iran’s access to SWIFT has been significantly restricted but not blocked

For several months, there has been widespread speculation about whether the US would pressure Belgium-based financial messaging organisation SWIFT to block payments from all Iranian banks. Treasury Secretary Steven Mnuchin noted the US has required SWIFT to disconnects any Iranian entity that the country designates as a terrorist or proliferation entity. For now, a handful of Iranian banks that are not subject to designations will likely remain connected to SWIFT.

On Monday, SWIFT stated that it would suspend some Iranian banks’ access to its network, noting “this step, while regrettable, has been taken in the interest of the stability and integrity of the wider global financial system”. The move is unsurprising given Mnuchin’s warning that “SWIFT would be subject to US sanctions if it provides financial messaging services to certain designated Iranian financial institutions”. Thus, it is possible that there will be a showdown between the European Union and the US if SWIFT decides not to disconnect all targeted Iranian entities and the US Treasury responds with sanctions against the organisation.

Expanded targeting of civilian aircraft and maritime vessels

American sanctions on aircraft belonging to Iran Air, the country’s national carrier, will complicate its operations. Under Obama-era sanctions, such measures made it difficult for Iran Air to receive ground handling and refuelling services at many European airports. This forced Iran Air planes flying between Europe and Iran to refuel in third countries.

Notably, the US Treasury has targeted Iran Air’s recently acquired ATR regional aircraft, which largely conduct domestic flights. The move may be designed to complicate maintenance of the aircraft, increasing safety risks for Iranian passengers.

The US Treasury has also sanctioned a wide range of Iranian oil tankers, as well as other cargo vessels and container ships. This will restrict Iran’s ability to engage in trade, as ports may refuse to service the vessels.

Civilian nuclear cooperation is permitted in limited cases

The US has placed the Atomic Energy Agency Organization of Iran on its SDN list, subjecting it to secondary sanctions. The organisation is the main entity responsible for implementing Iran’s nuclear-related obligations under the JCPOA.

To fully comply with the agreement, Iran must make several adjustments to its nuclear programme, such as redesigning its heavy water reactor at Arak and converting the Fordow enrichment facility into a research complex. To carry out this technical work, Iran is cooperating with the United Kingdom, China, and Russia.

The US has clarified that “all nuclear cooperation with Iran, except for the limited activities for which waivers are being granted, will be sanctionable”. Nonetheless, the US has granted sanctions waivers to non-proliferation projects at Arak, Bushehr, and Fordow facilities, noting that “each of the waivers we are granting is conditional on the cooperation of the various stakeholders”.

The US is monitoring Europe’s planned SPV

In response to America’s reimposition of sanctions this year, the EU and E3 governments reiterated their intention to create a Special Purpose Vehicle (SPV), a new mechanism to facilitate trade with Iran while reducing Iranian reliance on the international financial system. European officials still hope to legally establish the SPV in the coming weeks, but the mechanism is unlikely to become operational for several months. When asked by reporters about the SPV, US policy adviser Brian Hook noted that the “United States will not hesitate to sanction any sanctionable activity in connection with our Iran sanctions regime”.

European governments could establish an SPV to facilitate humanitarian trade alone, thereby minimising the risk that the US will target the mechanism. But it appears that they are planning a single SPV that would include trade the US regards as sanctionable.

That the White House has issued some waivers to allow for civil nuclear cooperation with Iran signals its desire to maintain the JCPOA’s limitations on Iran without allowing the country any of the tangible economic benefits envisaged under the deal. According to one senior Iranian official, unless the remaining JCPOA parties can provide Iran with a meaningful economic package in the coming months, Tehran is likely to re-evaluate its stance on the agreement. In this respect, it is crucial that Europe demonstrates its ability to successfully launch the SPV and, together with China and Russia, takes both economic and political measures to signal that the JCPOA can weather the American sanctions storm.

Photo Credit: IRNA

Bankless Task: Can Europe Stay Connected to Iran?

This article is re-published with permission from the European Council on Foreign Relations. 

As part of the effort to salvage the Iran nuclear deal, European governments have vowed to sustain their economic ties—not least their banking connections—with Iran. From 4 November, American sanctions targeting Iran’s banks will make it extremely difficult for European companies to engage in transactions with firms in the country. Many of the pathways to reducing the secondary impact of US secondary sanctions on the European financial sector present significant technical and political challenges—which stem from the US financial system’s global dominance and the integration of the US and European banking sectors. Moreover, the Iranian financial sector must take several proactive steps to ensure it meets the international compliance standards European banks require.

The Banking Blockage

With the incoming US sanctions, European companies face an even greater struggle to engage in transactions with Iran. For instance, Swedish automaker Volvo is leaving Iran because, as one of its spokesman put it, “with all these sanctions and everything that the United States put [in place] ... the [banking] system doesn’t work in Iran … We can’t get paid.”

This problem has driven most of the multinationals once active in the Iranian market to suspend their operations there, ahead of the new round of US sanctions. There is a widespread expectation that several Iranian private banks and the Central Bank of Iran will be designated entities under the measures.

Some European companies, such as Airbus and Total, require a licence or waiver from the US authorities to continue their operations in Iran, as they work in sectors subject to targeted sanctions. Many areas of Iranian trade, such as that in basic goods, are either unsanctionable or will be exempt from the measures. Yet US sanctions have adversely affected even these areas, as outlined in a recent ruling of the International Court of Justice.

Such restrictions on trade arise from the contamination risk that US secondary sanctions pose to European financial institutions, which generates unique pressure on the Iranian banking sector. This risk combines with Iran’s current shortfalls in meeting its commitments under a Financial Action Task Force (FATF) action plan – although the recent passage of the Combating Financing of Terrorism Bill suggests that Tehran is raising its compliance standards. Until the FATF changes Iran’s designation as a high-risk jurisdiction, global financial institutions will limit their dealings with Iranian banks.

Since President Donald Trump withdrew the US from the Iran nuclear deal in May this year and announced the re-imposition of secondary sanctions on Iran, banks in Europe have come under growing direct and indirect pressure from American regulators. Following the repeal of international sanctions on Iran in 2016, many large European banks began quietly facilitating transactions involving Iran for their largest industrial clients, especially those with long-standing operations in the country. Among these institutions, Danske Bank was the most visibly open to business with Iran, even opening a €500 million line of credit to support Danish firms’ expansion in the country. But as it falls into disrepute over suspected money laundering at its Estonian subsidiary, Danske Bank has opted to cease transactions involving Iran as an immediate show of responsiveness to US regulators. More broadly, banks tend to jettison their business with Iran if regulators exert pressure on them, even in the absence of a direct compliance issue.

Meanwhile, small European banks are coming under pressure from their larger competitors. When these institutions, which have relatively limited exposure to the US financial system, engage in Iran-related transactions, their routine SEPA transfers – payments to other banks within the Single European Payments Area – are often refused outright. This isolates the banks and complicates other aspects of their business. And the refusals extend beyond Europe. Asian banks have shown increasing concern about dealing with small European financial institutions that engage in business with Iran, understanding that they too could fall foul of the US authorities.

Europeans banks have been reluctant to engage with Iran due to fears about the response from their shareholders and creditors. This is most clear in the case of the European Investment Bank (EIB), which has refused to invest in Iran. European governments (which number among the bank’s shareholders) encouraged the EIB to consider lending to Iran, but the bank’s leadership felt that investing in the country would jeopardise its ability to raise capital from American institutional investors in the bond market.

Europe’s Possible Solutions

Despite their efforts to sustain economic channels with Iran, European governments have been unable to ease this pressure on banks. With US sanctions on Iran’s banking sector due to come into effect soon, European countries are now considering measures that would facilitate trade transactions with Iran through a new legal and institutional structure.

On the sidelines of the recent United Nations General Assembly, EU High Representative Federica Mogherini announced that “EU Member States will set up a legal entity to facilitate legitimate financial transactions with Iran and this will allow European companies to continue trade with Iran, in accordance with European Union law, and could be opened to other partners in the world”.

European governments have been reviewing this legal entity, known as a Special Purpose Vehicle (SPV), for months. The timing of this public announcement suggests that they have a degree of confidence that the SPV can become operational, and that Europe can use the model to showcase its ability to deliver on its commitments.

US Secretary of State Mike Pompeo immediately responded that he was “disturbed and indeed deeply disappointed” at the news. US National Security Advisor John Bolton commented: “we will be watching the development of this structure that doesn’t exist yet and has no target date to be created. We do not intend to allow our sanctions to be evaded by Europe or anybody else.”

There remains scant detail on the SPV. In her statement, Mogherini added that more information will become available “as the technical work continues in the coming days”. It may be advisable for European actors involved in the creation of the SPV to keep the details private for now. Operationalising the SPV will require a period of trial and error. Making the details of the project public in its early stages would provide the structure’s opponents with further opportunities to undermine it.

Can the SPV Model Work?

Reportedly, an internal European Commission paper describes the European Union’s efforts to “bundle and reduce cross-border payments to and from Iran”. In this way, the SPV would “avoid or severely restrict the role of commercial banks in the payment system and protect payment transactions with Iran from US sanctions”. European policymakers’ apparent consideration of this approach indicates that they want to avoid placing critical European financial institutions, such as the EIB, in the crosshairs of the Trump administration.

To operationalise the SPV, policymakers will need to quickly make progress in several technical areas. Firstly, European governments need to determine how aggressively they will push back against US sanctions; this is a consideration of the first order for the structure and operation of the SPV. Theoretically, the SPV could facilitate payments for what the US authorities consider to be sanctionable activity. Indeed, European officials have openly discussed their intention to use the SPV to support purchases of Iranian oil.

As guidelines from the US Treasury’s Office of Foreign Assets Control make clear, even barter arrangements involving petroleum or petroleum products from Iran are sanctionable – on the basis that they provide “material support” to Iran’s oil industry “regardless of whether a financial institution is involved”. However, because the envisaged SPV would bypass the US financial system and foreign branches of US banks, the American authorities would have no direct jurisdiction over it. Thus, transactions the SPV facilitated would not give rise to the same kind of civil liability that led to hefty fines on Europe’s largest banks in the previous era of sanctions.

The US authorities could, in theory, prevent entities engaged in the SPV from accessing the US market. American officials have stressed that US sanctions will target European central banks and SWIFT – an international payments messaging system headquartered in Belgium – if these institutions facilitate transactions with Iran. Furthermore, this targeting would extend beyond entities engaged in oil purchases, covering all companies that use the SPV to engage in transactions with Iran – even those in sectors that are exempt from sanctions, such food and pharmaceuticals.

European governments working on the SPV will have to find a way to counter such measures. On a technical level, they may be able to use creative structuring solutions. The SPV could be set up primarily as a payment mechanism for only small and medium-sized companies that are content to be excluded from the US market. And the mandate of the SPV could initially facilitate just payments for trade that is exempt from US sanctions.

The SPV is most likely to succeed if takes this approach, starting off small and gradually expanding. The basic structure of the vehicle is replicable. One SPV could focus on sanctionable trade related to support for Iran’s oil, automotive, or aviation sectors. Another could be limited to sanctions-exempt trade in consumer goods, food, and pharmaceuticals – allowing multinationals to use it as a convenient payment channel. With multiple SPVs available, companies could engage with Iranian entities in accordance with their appetite for risk and their business models.

Each SPV could take a different form. It could be a stand-alone, state-owned bank; a conduit for payments that European central banks ultimately facilitate; or simply a clearing house for companies that transfer money to Iran, repatriate funds from the country, or engage in barter trade with it.

The process of establishing the SPV will prove instructive in testing the limits of America’s sanctions power and US willingness to use sanctions as a weapon against its putative allies. Reports indicate that the US Department of the Treasury is already starting to push back against the White House over proposals to sanction European financial institutions, particularly SWIFT, for maintaining ties with Iran.

Of course, creating the SPV will require significant technical work. For its part, Iran will need to demonstrate that its financial system is also continuing to reform in accordance with international standards on money-laundering and terrorism financing. European governments will closely watch the country’s progress in implementing the FATF action plan ahead of an important review on 14-19 October.

From a political perspective, Iran has drawn encouragement from European countries’ sustained and unanimous commitment to the nuclear agreement. Iranian President Hassan Rouhani praised Europe for taking a “big step” to maintain trade. Iran’s foreign minister, Javad Zarif, stated that while implementing the SPV will be difficult, Iran is willing to show “a little bit more patience” with Europe. The SPV is an important immediate contribution to improving conditions for trade between Europe and Iran, but both sides must view it as the start of a road map for long-term economic engagement.

Photo Credit: Depositphoto