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Escalating political tensions between the US and Iran are placing further pressure on European firms hoping to revive trade with the embattled Middle Eastern state.

After a US air strike in early January killed Qasem Soleimani, commander of Iran’s elite Quds Force, the Iranian government announced it would formally withdraw from the 2015 Joint Comprehensive Plan of Action (JCPOA), commonly known as the Iran nuclear deal.

That historic agreement initially resulted in US and EU sanctions against Iran being lifted in exchange for a winding down of its nuclear programme. The move gave an immediate boost to EU imports, from €1.25bn in 2015 to €9.45bn three years later, but has stalled since US President Donald Trump’s decision to withdraw the US from the plan in May 2018.

There have been hopes that Instex, a controversial mechanism developed to sidestep US sanctions against banks, could be used to facilitate trade between Europe and Iran. The vehicle was initially envisaged as a means to support the provision of medical supplies before expanding to cover agricultural goods.

However, for the financial sector, rising hostilities between the US and Iran mean any prospect of supporting Instex is becoming even more distant.

“There was already very little incentive for European banks to want to participate in Instex,” says John E. Smith, a partner at Morrison Foerster in Washington DC.

Smith, a former director of the Office of Foreign Assets Control (OFAC) – the US Treasury’s formidable sanctions regulator – tells GTR: “The rewards of food, medicine and medical device trade with Iran are not substantial, and for many of them not worth the risks of running afoul of US sanctions and the wrath of the US government.

“This development makes that even more of a difficult prospect. The already substantial risks involving Instex have grown substantially just in the last days.”

Anahita Thoms, head of Baker McKenzie’s international trade practice in Germany, tells GTR that larger companies currently “don’t know how secure the situation is, or whether they would be put on the spot as a company that uses or supports Instex”.

“Big non-financial and financial companies continue to be in a wait-and-see situation, and even mid-sized companies may face challenges,” she says. “The current tension just makes it more challenging for them to take the risk, and no one wants to be first.”

Although Instex is not understood to have handled an end-to-end transaction so far, there had been signs of progress.

Founding members France, Germany and the UK announced in June 2019 the mechanism was “operational”, and the governments of Belgium, Denmark, Finland, the Netherlands, Norway and Sweden confirmed in November they would join as fellow shareholders.

Theoretically there is nothing stopping Instex from supporting trade between EU member states and Iran. The vehicle works by using a system of credits that let firms import and export goods without the need to transmit money across international borders.

Persuading banks to support in the financing of that trade is much more challenging.

OFAC has earned a reputation for taking tough enforcement actions against banks deemed to be in breach of the US’ sanctions regime. In 2019 it handed out fines of US$639mn and US$611mn to Standard Chartered and UniCredit Group respectively for sanctions offences, including historic violations of restrictions against Iran.

Crucially, OFAC is able to act against banks that provide services to entities involved in trade with a sanctioned country or entity, even if they have no direct contact themselves.

“Big global banks have shied away from Instex and not wanted to be a part of it just because the risks were so great, given the aggressive US rhetoric,” says Morrison Foerster’s Smith.

“Whether this will impact the desire of small and medium-sized European businesses to conduct trade with Iran is an open question, but they will need the support of the governments and the support of at least some banks to make it happen.”

Smith adds that even if trade is restricted to humanitarian products such as medical supplies, there are concerns within the US those products could be diverted to military units or other sanctioned parties.

There are also risks to non-financial companies involved in trade between Europe and Iran, adds Baker McKenzie’s Thoms. She says: “The political and reputational risk is there, but also what can happen is that if the name of the non-financial company is revealed, the transaction could be looked at with higher scrutiny to see whether it infringes secondary sanctions.”

Another complication is the nature of trade between Iran and the EU.

European Commission data shows the union was the primary trading partner of Iran prior to the current sanctions regime, and exported goods worth over €10.8bn in 2017. The majority consisted of machinery, transport equipment, chemicals and manufactured products.

The same year, the EU imported €10.1bn-worth of goods from the country. However, the vast majority of those imports – just under 89% – were mineral fuels, notably oil. Since the US imposed fresh sanctions against oil from Iran in November 2018, imports have dropped sharply.