Five lessons learned and our outlook for 2017
Iran on 16 January marked the first anniversary of the suspension of sanctions related to the country’s nuclear programme. This note summarises five lessons we have learned over the past year while working with multinational clients that were evaluating whether and how to do business with Iran.
- Sanctions are not everything. Achieving and demonstrating compliance is an important first step, but it is not sufficient for managing risk. Iran’s business environment is complex and politicised, and companies will need to carefully consider the country’s internal dynamics as well as the geopolitical risks that come with doing business there.
- Successful market entry requires a continuous dialogue with other stakeholders about sanctions compliance and reputational risks. Any organisations looking to do business in Iran will need to talk to their banks, insurers, major shareholders and partners in order to align their compliance standards and agree on the overall level of reputational risk they are prepared to tolerate. This will enable them to avoid setbacks in their planned transactions or projects.
- Organisations’ approach to doing business in Iran should not be based on their approach towards markets in the Gulf Co-operation Council (GCC). Iran’s business environment is markedly different from those in the Gulf Arab states – for example, foreign ownership and property ownership laws in the Islamic republic are more flexible than those in better-known markets elsewhere in the Middle East.
- Iran’s security forces do not have monopoly control over the country’s economy. The army, the Islamic Revolutionary Guards Corps (IRGC), the Basij paramilitary force and the police have diverse business interests. However, our experience suggests that companies can avoid engaging with businesses that are either owned by these entities or associated with them.
- Iran is unusual in terms of political risk. Companies’ access to the country is predicated on the Joint Comprehensive Plan of Action (JCPOA), which has eased sanctions on Iran in exchange for closer monitoring of its nuclear enrichment activities. The fate of this international political arrangement is dependent on geopolitical developments and domestic political changes in a number of countries.
Sanctions are not everything
Companies will continue to require legal advice and due diligence in order to achieve compliance, given both the terms of the JCPOA and the remaining sanctions on Iran. However, companies should not focus their risk management efforts and resources solely on sanctions compliance. Iran’s business environment is among the most politicised in the Middle East: the awarding of contracts and regulatory changes are subject to political interference from a range of public and private sector interest groups. Changes in the country’s regulatory framework also tend to be unevenly implemented.
Companies are most likely to succeed in Iran if they put time and resources into understanding the external geopolitical context as well as the domestic political, integrity and regulatory risks to which they will be exposed. Sanctions compliance should be seen as the start rather than the end of any prospective investor’s risk management processes.
Dialogue with other stakeholders about compliance is essential
Our clients’ compliance and legal teams have spent more time engaging with external stakeholders as their companies have gone into Iran than would have been the case during the entry into other markets. This is understandable, given the heightened sanctions and broader compliance risks that Iran poses.
However, it is also because companies requiring support from other organisations – such as financial institutions, suppliers, and partners within consortia – have had to agree a common position on their sanctions compliance and risk management standards. If various non-Iranian parties to a trade or investment deal have incompatible approaches to compliance – or different tolerances for the reputational risks associated with doing business in Iran – then the deals will probably not go ahead. Companies therefore need to engage in dialogue with external stakeholders about sanctions compliance and reputational risk as early as possible in their negotiations.
Iran is not the GCC
Many companies have used the UAE and other GCC countries as their base from which to explore business opportunities in Iran. The consistency in regulations affecting inward investment within the GCC’s six members means that companies often assume that Iran has a similar business environment to those of the Gulf Arab states. However, there are several key differences. Iran does not have a law governing relationships between foreign companies and their local agents in the country. Companies looking to invest in Iran can discuss agency agreements from scratch without worrying about the 51-49 ownership split that is typically required in the GCC. Foreign nationals can also wholly own Iranian legal entities and in turn – albeit with some caveats – own land and real estate.
The security forces do not have monopoly control over the economy
Our due diligence work has shown us that Iran’s security agencies are involved in every sector of the economy through a complex range of banks, investment vehicles, pension funds and corporate entities. However, our research also shows that the only sector over which security agencies have monopoly control is defence.
Our clients have been able to identify Iranian companies they could work with in the major sectors that would not expose them to sanctions risks. Nevertheless, security agencies will remain influential actors in the economy over the coming years. Although there appear to have been attempts by parts of Iran’s civilian government to limit and define the areas in which the security agencies can do business, there is no indication that they will retreat from the economy as a whole.
Iran is an unusual political risk proposition
Doing business with Iran involves an inherent political risk: the potential for the JCPOA to collapse and for nuclear-related sanctions to return. Companies would then have 180 days to settle any outstanding financial payments and end their business activities. There has not been a comparable situation elsewhere in the world. As such, foreign and Iranian companies need to think carefully about how they phrase contracts and structure their financial agreements. They should also monitor developments relating to the JCPOA, including statements from either the Iranian or the US authorities suggesting that the agreement may be in jeopardy.
Import-export banks and export credit agencies have been unable to reach agreement with Iran over which party will assume the risk associated with ‘snapback’ – the swift reimposition of sanctions if the country were found to be in breach
of the JCPOA – in any financial agreements. We expect them to reach a settlement that would allow larger infrastructure projects in Iran to be financed. Nevertheless, the ‘snapback’ provision will loom over any business done under the JCPOA.
Looking into 2017
Iran will continue to feature highly on companies’ strategic agendas and risk registers this year. Iran’s administration hopes that in 2017 all the talk and plans about trade and investment opportunities will start to be realised. Iran has received its first new civilian aircraft from European carrier Airbus, with US company Boeing to follow. We also expect Asian and European oil companies to proceed beyond memoranda of understanding and to actually invest in Iran, and for work to begin on some of the country’s bolder infrastructure plans.
However, whether these things materialise will depend on issues that Iran can control and on matters over which the country will have little influence. Iran could choose to implement the regulatory reforms that it needs to encourage major investments: the banking sector needs urgent attention, further efforts are required to stabilise the currency, and the bureaucracy needs to become more efficient, consistent and streamlined. Yet Iran may feel that it is unable to control the position adopted by Donald Trump’s incoming US administration or the willingness of international banks to facilitate the trade and investment that the country needs.
Nevertheless, we believe that Iran can and will have an influence over these issues. It will need to avoid provoking the Trump administration, and engage non-US signatories to the JCPOA to highlight the damage – in both economic and security terms – that scrapping the agreement would do to the region. Iran will also need to ensure that its banking reforms go some way towards improving transparency and boosting confidence in the sector’s governance. This in turn would be likely to encourage some international banks to return.
Iran’s ability to influence these issues will depend on the resilience of President Hassan Rowhani. We expect Rowhani to be re-elected during this year’s presidential election, which is scheduled to take place in April or May. He is well positioned to win votes from major constituencies because of his association with the JCPOA, the country’s economic revival, and the steps he has taken to improve cultural and political liberties. However, the gains have not been as good as many voters had hoped for, and there is a small chance that he will be outmanoeuvred either by a reformist or a hardline candidate.
We expect 2017 to end with Rowhani as president, improved trade and investment figures, some piecemeal but important economic reforms, and with the sanctions risk more or less the same. Investing in Iran will remain a high-stakes game. Compliance with sanctions, managing reputational risks, incoherent regulation and decision-making, difficulties with banking, and the presence of sanctioned and politically exposed entities will continue to challenge companies, irrespective of their nationality and the sector in which they operate.