Europe tries to sidestep the US finance system

Bloomberg | : The vehicle being touted as a way to get around Trump’s Iran sanctions has faced plenty of skepticism. But it’s serving a political purpose already.

The standoff between the Trump administration and Iran is escalating, and Europe is caught in the middle. The U.S. is exerting pressure through renewed economic sanctions, and hardliners in Tehran are issuing fiery threats of retaliation.

Brussels and national governments in the U.K., France and Germany, meanwhile, have been criticized by both sides for promising to preserve trade with Iran while also treading softly with the Americans to avoid a full-blown diplomatic crisis. Europeans “speak eloquently”, Iran’s foreign minister Mohammad Javad Zarif said in February. “They also need to walk the walk.”

But it would be wrong to dismiss Europe’s efforts as hopeless.

A big source of contention for both Washington and Tehran is Instex, a special-purpose vehicle unveiled by Paris, Berlin and London in January. Its ambitions are bold: To keep trade between Iran and Europe going without relying on cross-border financial transactions (which might fall foul of the U.S.). While not explicitly a sanctions-busting vehicle, it was clearly designed with President Trump in mind. It was his re-imposition of the U.S. trade ban that led to Iranian banks being cut off from the SWIFT banking network, and to international businesses scrapping their investment plans in the Islamic Republic.

By using Instex like a central clearing house, the idea is that buyers and sellers in Iran and Europe could get their money without making transfers into and out of the Middle East country. It’s a complicated system, but in a very simplified form you could imagine having a European trader who wants to buy gas from an Iranian supplier and a European manufacturer who wants to sell aircraft parts to an Iranian company. Instead of the trader paying the Iranians for the gas, they would transfer the money to their fellow European manufacturer (in lieu of payment from its Iranian customer). At the same time, the Iranian aircraft company would pay its compatriot gas supplier for the supplies sent to Europe. Hence no cross-border money flows.

Combined with new “blocking regulations” that make it an offense for EU businesses to comply with U.S. extraterritorial sanctions, there’s a clear message that Europe’s leaders want to go their own way.

Criticism has focused on the everyday practicality of Instex, plus the wisdom of Europe resisting its key NATO ally, whose dominant currency affords it huge extra-territorial reach when waging economic war. For the Trump administration, the special purpose vehicle is a misguided attempt to “break” American sanctions and offer cover to the Islamic Republic. For Iran, it’s a paper tiger. Zarif says Europe has dragged its feet and is clearly reluctant to launch the system.

Neither complaint is entirely fair. Instex is obviously a work-in-progress, a sketch on paper more than a reality. But for London, Paris and Berlin, whose unity tends to crumble under U.S. pressure, a public commitment to this vehicle is a kind of success in itself. And it is being taken seriously by parts of the American establishment, who are aware of any risks – however distant – to the dollar’s dominance. “The plumbing is being built and tested to work around the United States,” former Treasury Secretary Jack Lew warned in February. “There will increasingly be alternatives that will chip away at the centrality of the United States.”

In Iran, behind the official skepticism, there are signs of progress. Press reports suggest Tehran has set up its own matching facility for Instex, which is needed to make the system work. Europe has also insisted that Tehran has to meet certain standards to participate, including conforming to global rules on money-laundering and terrorist financing. If this happens, it would be significant.

It will probably take years for Instex to become genuinely viable in terms of participating countries and trade flows. But it’s serving a political purpose already: Giving Iran an incentive to stay aboard the nuclear deal, and reminding the U.S. that sanctions overreach may harm its interests. Instex can’t stop the Middle East from sliding into war, but it’s a marker worth laying down.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.