The Iran Project

China unexpectedly gambles on European mechanism to sustain Iran trade

Bourse and Bazaar | Maziar Motamedi: China has halted its financial transactions with Iran as part of an unexpected gamble on the future of its trading relationship with the Islamic Republic.

Earlier this month, ahead of the reimposition of US sanctions on November 4, China’s Bank of Kunlun informed its clients that it would stop handling all Iran-related payments. The news followed months of speculation that Kunlun, the financial institution at the heart China-Iran trade for more than a decade, would bow to US sanctions pressure.

According to Majid Reza Hariri, deputy president of the Iran-China Chamber of Commerce, China is hoping to sustain its trade with Iran without putting its financial system in the cross hairs of US authorities by joining the special purpose vehicle (SPV) currently being devised in Europe. In the meantime, Chinese trade with Iran has ground to a halt as no banks are available to facilitate transactions.

“It seems that the fate of our trade with China is linked to the support package being prepared by the European Union,” Hariri told Bourse & Bazaar in reference to the SPV promised by Iran’s key European trading partners.

The SPV would facilitate trade with Iran by offering a netting service between exporters and importers, reducing the need for funds to be transferred between Iranian banks and foreign financial institutions. Such financial transactions are increasingly difficult due to the risks posed to international banks by US sanctions.

“We are waiting for this financial mechanism to be finalized and for China to join the SPV,” Hariri said. In a statement in September, EU High Representative Federica Mogherini stipulated that the SPV “could be opened to other partners in the world.”

Under the previous round of international sanctions, Beijing had designated Kunlun as its primary bank to process billions of dollars payments related to Chinese imports of Iranian oil. The bank also supported the significant growth in non-oil trade between China and Iran as European companies were forced to leave the market when US and EU sanctions came into force.

Kunlun’s perseverance led to US Department of Treasury sanctioning the bank in 2012, but the so-called “bad bank,” shielded by political support from Beijing, continued to maintain its lucrative connections to Iran.

Given this history, the news that Kunlun was cutting-off Iran has served to indicate the intensity of the Treasury Department’s sanctions threats.

Hariri relayed that during his recent trip to China, it became clear that China’s major commercial banks increasingly fear being targeted by US authorities because of links to Kunlun, even if they are not involved in Iran trade themselves.

Bourse & Bazaar also spoke to the chief executive of an Iranian industrial group that conducts significant business with Chinese firms. The executive, who requested anonymity given commercial sensitivities, relayed that large Chinese suppliers do not “want to be in export list, which is where US eyes are looking” because of a pervading fear that “in the weeks following November 4, the US will be making example cases,” targeting companies to create a “system-wide scare.”

Until the situation is better understood, Chinese authorities have opted to pause their trade with Iran and to “let chips fall into place and then figure out way” to sustain commercial ties.

The sudden pause in trade with Iran may explain why China imported an “unprecedented” 20 million barrels of oil to its Dalian refinery in October, twenty times the normal volume.  Pointing to issues of energy security, oil analysts do not expect China to cease its imports of Iranian oil, and so the October purchases may have been intended to buy China some time to see if the SPV will become operational.

Two of China’s leading refiners, Sinopec Group and China National Petroleum Corporation, the parent company of Bank of Kunlun, have not placed any orders to purchase Iranian oil in November.

Reports suggest that the SPV will be legally established on or around the November 4 sanctions deadline, but it may take several months for operations to begin in earnest.  There remain many hurdles. EU member states are understandably less than enthusiastic about the prospect of hosting the financial channel that will be perceived by US authorities as an attempt to circumvent sanctions.

If SPV fails to become operational or is unable to accept Chinese participation, it will fall to China and Iran to find a new bilateral banking channel, explained Hariri. “If the EU continues with its procrastination, we can once more restart efforts to continue bilateral banking relations,” he said.

It is unclear what a new financial channel look like. On Monday, Iranian reports cited “credible sources” to claim that Beijing aims to establish “a new banking mechanism” to continue working with Iran and several meetings have already been held on the matter.

Iran may seek to hold an ownership stake in the new banking channel. The concept that Iranians could become shareholders in Chinese banks has been floated for about a decade. But new draft rules issued by the Chinese regulators may present Iran with a new window of opportunity. Regulators now allow foreign entities to set up wholly owned banks and branches in China.

As Hariri points out, any negotiations over the Chinese participation in the SPV or the creation of a new banking channel are made more complicated by the fact that Iran currently lacks an ambassador to Beijing. Nonetheless, it seems likely that sooner or later Iran-China trade will resume, even under US sanctions. Iran is too lucrative a market for China to simply ignore.

The question is how long Iran’s business community can wait for the rebound. While Iran may have sold a bumper volume of oil in October, private sector companies were caught off guard by China’s move to halt trade. In a matter of weeks, inventories of manufacturing inputs and finished goods will begin to run out.

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