Bourse and Bazaar | Ellie Geranmayeh and Esfandyar Batmanghelidj: 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.
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.
This article has been republished with permission from the European Council on Foreign Relations.