The UK, Germany and France have launched a payments mechanism for European companies to continue trade with Iran.
Instex – short for ‘the Instrument for Supporting Trade Exchanges’ – has been set up in a bid to counter President Donald Trump’s move last year to pull the US out of the Iran nuclear deal – officially known as the Joint Co-operative Plan of Action (JCPOA) – and reimpose sanctions against the Middle Eastern country.
The move has posed a range of challenges to European firms looking to trade with Iran: the secondary nature of the sanctions means that even non-US companies could be punished by the US if they deal with sanctioned Iran business. Meanwhile, the sanctions have prompted the international banking system to cut ties with Iranian financial institutions, meaning that firms that have continued to trade with Iran are struggling to move money to and from the country.
It’s the latter challenge that the new special purpose vehicle seeks to solve, working as a barter system that allows the exchange of goods between Iran and Europe without money changing hands.
But using Instex could put firms on a collision course with Washington, with the Trump administration cautioning that anyone engaging in sanctionable activity involving Iran “risks severe consequences that could include losing access to the US financial system and the ability to do business with the United States or US companies”.
As a result, many companies will be hesitant to use the new mechanism, explains Anahita Thoms, who heads Baker McKenzie’s international trade practice in Germany. Speaking to GTR, Thoms explains how Instex works and the challenges it will face.
GTR: Who is Instex intended for and how will it work?
Thoms: Instex, as the special purpose vehicle is now called, is set up to be a ‘financial, legal and accounting’ advice and service centre, designed to facilitate legitimate trade between European economic operators and Iran. It is an attempt by France, Germany and the UK to solve payment problems in business with Iran. This comes after the joint announcement in November 2018 affirming the EU’s commitment to maintaining financial channels with Iran after the US withdrawal from the JCPOA.
It has been registered in France, with Germany, France and the UK as initial shareholders.
At the moment, trade between the EU and Iran is severely compromised by US sanctions, which penalise not only transactions with a US nexus. EU companies and banks also face significant consequences due to the so-called secondary sanctions, such as being excluded from the US financial market. For this reason, most banks refuse to accept money from Iran. Companies that are still interested in continuing their Iran business therefore have significant challenges to receive payments or to pay their bills.
There is little information on how exactly Instex is going to work to solve this challenge. What we know is that Instex will serve as a trustee or depositary agent to enable barter transactions. The payments are deposited by Instex as in a trust account. Instex provides for a barter system which means that it does not carry out monetary transactions for each individual import or export, but can settle the balance at regular intervals.
In the beginning, Instex will only focus on the sectors most essential to the Iranian population, such as pharmaceutical, medical devices and agrifood goods and only support trade with European countries. However, it aims in the long term to be open to economic operators from other countries who wish to trade with Iran.
GTR: Will banks play a role?
Thoms: The role of banks is a challenging one even though their involvement would only be indirectly. In consideration of the reactions announced by the US, hesitation on the part of the banks is to be expected. However, Instex’s intention to guarantee sufficient discretion with regard to the US could reassure the banks a little. Bottom line is, though, that the US market is of utmost importance and banks would not want to take any risks.
GTR: Do EU firms using the Instex risk being penalised by the US for doing business with Iran?
Thoms: The US leaves no doubt that circumvention of its sanctions will not be tolerated. US officials continuously emphasise that those who do ‘illegal’ business with Iran will be subject to US sanctions. Depending on the circumstances of the case, high fines or the exclusion from the US market and financial system are possible.
However, not all Iran transactions are prohibited, and Instex will, at least in the beginning, focus on transactions that are not subject to US secondary sanctions. The supply of pharmaceuticals or goods for agriculture, for example, are still considered by the US as legitimate trade with Iran. Therefore, Instex cannot be seen as a ‘circumventing vehicle’ as some have called it.
GTR: Who will benefit the most from Instex?
Thoms: Instex will mainly benefit companies that are small to mid-size that do not trade with the US and are of more local nature.
The US can continue to rely on many EU companies to cease operations in Iran. Very few big multinational companies are willing to take the risk of being subject to US sanctions, and many large EU companies have already withdrawn.
GTR: How effective do you expect Instex to be in facilitating Iranian trade?
Thoms: Instex will in my view not be able to secure the complete trade with Iran. Exports and imports would have to remain in a certain balance in order for the exchange system to work. For the time being, the service is limited to European countries and will initially predominantly support the trade of food, pharmaceutical products and consumer goods. In the long term, Instex is also intended to be open to third countries, which could increase its effectiveness.
Trade with oil, Iran’s main source of foreign exchange, will not be covered. Oil transactions typically require the use of other traditional financing instruments anyway. This again requires the involvement of appropriate financial institutions. The crucial factor for the functioning of Instex, however, is whether it is embraced by the European companies. I also think it will be quite a while before the setup is operational. I therefore see many banks and companies in a wait-and-see state.