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Middle EastAugust 1 2016

Iran plays the waiting game as Western banks hold back

In the immediate aftermath of the signing of the Joint Comprehensive Plan of Action, Iran was looking forward to reaping the benefits of a sanctions-free future. However, major UK and EU banks are holding back on entering the country. James King examines why. 
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Iran and France sign Airbus deal embedded

The Joint Comprehensive Plan of Action (JCPOA), the agreement signed between Iran and six world powers to limit the country’s nuclear development programme, was supposed to be the ultimate incentive. In exchange for its co-operation, Iran would benefit from the lifting of key US, EU and UN sanctions.

In theory, the deal was designed to be a shot in the arm for a crippled Iranian economy. Starved of vital investment after years of punishing sanctions, the JCPOA would open Iran up to the world and to much-needed investment and trade from the West and elsewhere.  

A bad bargain 

But in reality this bargain has, so far, failed. In order to facilitate these deals and grease the wheels of foreign investment, non-US banks have been asked – by their corporate clients and respective national governments – to establish full correspondent banking relationships with their Iranian counterparts. This is yet to happen. For the most part, a fear of US penalties is driving this lack of engagement. So too are the lengthy processes tied to due diligence. After years of being cut off from the international financial system, Iranian lenders are still catching up with international standards on compliance. 

As a consequence, the ‘Iran opportunity’ is not quite the gold rush that many Western investors, as well as the Iranian government, had envisaged. While unstitching years of sanctions will be an arduous process, there appears to be little prospect that many of the world’s biggest non-US banks will take the plunge and engage with Iran in a meaningful way. For now, tier-two and tier-three European banks with minimal exposure to the US are the only financial institutions transacting with Iran. 

“The majority of banks that are doing business with Iran are processing letters of credit for their customers rather than entering into clearing relationships,” says Sue Millar, partner and head of the Iran group at law firm Stephenson Harwood.

Lingering restrictions 

The nature of the sanctions relief is such that only nuclear-related secondary restrictions have been lifted on the part of the US, while the EU has terminated a much wider range of measures that were designed to stifle the Iranian economy. These cover the trade of goods, including items related to the energy and petrochemical sectors, as well as financial services and sanctions related to the transport sector. 

This means that while Iran is open to business with Europe, it is still prohibited from interacting with the US financial system. Severe limitations on the country’s use of the dollar are also in place and any institution that employs US personnel in its senior management is barred from working with Iran. This last point has been particularly challenging for British banks. 

The impact this situation is having on British, European and Asian businesses looking to deal with Iran has been severe. In the UK alone, the cost of lost trade and investment is being counted by a government that is already well behind most of its European peers when it comes to engaging with Iran. Demand for full banking relationships with Iran from the country’s corporates is strong. 

“There is significant demand from the UK’s private sector for the development of full banking services with Iran,” says Ms Millar.

At a standstill 

A number of deals and memoranda of understanding between Iran and international partners have been signed since the so-called JCPOA implementation day in January 2016, amounting to billions of euros-worth of transactions. Yet very few of them have gained any traction. From British water services companies to major European aerospace firms, a dearth of financial services offerings with Iran is hitting their ability to tap into a booming market. 

“We continue to engage with the banking community, to explore how we can support them as they consider providing financial services to UK businesses who wish to resume trade with Iran. The foreign secretary and business secretary hosted a roundtable with UK and European banks with US secretary of state John Kerry on May 12,” says a government spokesperson from the UK government. 

Indeed, that Mr Kerry and the UK’s then foreign secretary Philip Hammond (now finance minister) jointly urged non-US banks to engage with Iran is telling. The negative sentiment that surrounds the business case with Iran is such that no major lender is willing to be the first to chance its luck against US regulators. 

From the perspective of the biggest banks, there is recognition that US agencies are hardly harmonised on the issue of Iran. Most lenders know that what the government says and how the country’s myriad of state and federal regulatory agencies act are two very different things. 

“The US regulatory system is relatively fragmented. There is the potential for significant state-level activity when it comes to advancing Iranian sanctions because a number of US states still have Iranian prohibitions that apply to non-US financial institutions,” says Justine Walker, director of financial crime with the British Banking Association.

Due-dilligence procedures 

Meanwhile, many Western lenders are still in the process of executing due-diligence procedures on Iranian businesses and banks. As part of the JCPOA, a number of Iranian institutions, including the Iranian Revolutionary Guards Corp (IRGC), remain listed under other sanctions regimes. 

As such, the EU obliges businesses to avoid interactions with any funds or economic resources directly or indirectly linked to these entities. Given the complex role that many of these state institutions, including the IRGC, play in the Iranian economy, this makes know your customer regulations particularly challenging. 

“It’s too simplistic to say that non-US banks are limiting their engagement with Iran solely because of the fear of US regulators. Some of them are now doing due diligence on Iran. This process takes time and different banks are moving more quickly than others,” says Bijan Khajehpour, managing and founding partner of consultancy Atieh International. 

Thus, despite the best efforts of both the US and various European governments, there is little immediate prospect for the growth of full correspondent banking relationships with Iran. This situation has transpired even though a number of high-profile deals have been signed between Iran and large Western corporates. In January, Airbus signed a $25bn civil aviation co-operation package with Iran in a deal that will provide about 118 new aircraft to the country’s civil air fleet. 

“The agreement is progressing and it’s heading in the right direction. In terms of financing, I think it’s not a secret that we’re looking at a deal in euros. There are lessors and banks that could be interested in facilitating the deal. But of course the banks are a bit reticent when it comes to dealing with Iran,” says a spokesperson from Airbus. 

Indeed, Airbus and a number of other aviation groups are still waiting to gain export licences from the US's Office of Foreign Assets Control (OFAC) for their respective deals. Under the terms of the JCPOA, any technology transfer of civil aircraft with at least 10% of the parts originating from the US must be licensed for re-export. This challenge is being compounded by the reticence of major non-US banks and their dealings with Iran. 

But in a sign of how difficult doing business with Iran can be, in early July the US House of Representatives approved measures to block US aircraft sales to Iran. This has the potential to impact the Airbus deal, as well as a similarly sized agreement signed between Iran Air and Boeing. But for now it remains unclear what kind of impact these measures will have on existing deals.

Small steps 

Nevertheless, smaller companies have found more success when it comes to financing structures. ATR, a French-Italian producer of turboprop aircraft, has signed a deal for the sale of 40 aircraft to Iran. The limited size of the deal likely means that the company has been able to engage with small financial institutions and ones that are less exposed to the US. But, like Airbus, ATR is also waiting for export licensing approval from OFAC. 

“Our deal with Iran Air is signed in euros. [Though] international banks are evaluating in which conditions they can do business with Iran, ATR has identified banks capable and willing to support our transactions with Iran,” says David Vargas, a spokesman for ATR. 

A senior figure in the Iranian business community in Europe told The Banker that a number of mid-sized exporters in Germany were able to get their business in Iran facilitated by some of the country’s small regional banks. With their limited exposure to the US, these lenders are able to adopt a more forthright approach to dealing with Iran. The source noted that the relatively small scale of these business operations was an advantage in executing these transactions, though the clients were long-standing customers of the banks involved. 

“The remaining sanctions are so deep and so complex that many financial institutions remain reluctant to start or resume  business with Iran. So the banks that are beginning to take the first steps in trade finance are small European and Asian banks that don’t have exposure to the US,” says Toby Chinn, a partner with consulting firm Control Risks.

As the Financial Times reported in April 2016, Belgium’s KBC Bank, Germany’s DZ Bank and Austria’s Erste Bank all confirmed that they were either facilitating transactions with Iran or intended to imminently. But the real question facing both Europe and Asia’s wider corporate community remains: when will the big banks take the first step?

Taking the plunge 

Getting a precise answer to this question is difficult, not least because of the lack of clarity around what US regulators will and will not allow. “The UK and EU are keen to build trade and investment ties. But from a US perspective, there is a sanctions policy in place indicating that it wants these relationships to develop but that still makes it illegal for US banks to be involved in any unlicensed way. That messaging is going to take a while for banks to fully comprehend in the long term,” says Ms Walker. 

The complex and often opaque environment facing global banks has been well illustrated by Reid Whitten, an international trade partner with law firm Sheppard, Mullin, Richter and Hampton. In a test scenario, Mr Whitten points to a situation in which a French construction firm wins a bid for an infrastructure project in Iran. The government of Iran pays the French firm in euros, from an account in Dubai, into a German bank. Assuming there has been no infraction of export violations, this scenario is so far sanctions-compliant. 

But as Mr Whitten goes on to illustrate, if the French construction firm wants to pay for consulting services in US dollars with funds from its German account, some of which comes from the euro-denominated payment from Iran, the lines of sanction compliance begin to blur. Since a US correspondent bank would have to be used, the German bank would have to report the source of the funds despite the euro denomination. 

“We are working with our contacts to get a definition of what is an Iranian-related fund. OFAC needs to define what Iranian assets are. If there was a clearer line it would make the facilitation of business with Iran much easier,” says Mr Whitten.

Private sector 

Beyond issues of clarity, private sector demand will ultimately play the decisive role in breaking the correspondent banking deadlock. With disgruntled voices emerging from within Iran over the outcome of the JCPOA, which has until now failed to deliver material benefits for Iran’s economy, as well as growing frustrating from corporate groups in the UK, Europe and beyond, the hope is that any change will happen sooner rather than later. 

“I think [the deadlock] will be broken due to commercial pressure. There is likely to be a lucrative, emerging business opportunity that will encourage one of the big banks to step up. And this could happen with the approval of the US authorities. I think a scenario like that could occur in the near to medium term,” says Mr Chinn. 

With presidential elections coming up in both Iran and the US, the stakes are high. Hardliners on both sides could yet derail the progress being made. But if the benefits of full trade and investment flows – facilitated by deeper financial arrangements between Iran and non-US institutions – can be promoted then it may go some way to easing Iran’s re-entry into the international system. Doing so would starve the hardliners of much-needed oxygen.

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Read more about:  Middle East , Iran