Analysis: EU Announces Special Purpose Vehicle to Facilitate trade with Iran

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This content was originally published on RiskMonitor by our Intelligence and Analysis Services Team on 06/02/2019. Find out more about RiskMonitor now.

Executive Summary

  • On 31st January, 2019 the European Union introduced a new payment system known as INSTEX to circumvent US sanctions and facilitate trade between member states and Iran.
  • The system is in currently in its infancy and is unlikely to be become operational, and thus have a tangible impact, in the medium-term.
  • The EU will also step-up its scrutiny of Iranian foreign policy and ballistic missile development as part of a strategy to demonstrate the efficacy of economic engagement.
  • The Iranian government remains sceptical of the new measures, whilst the United States has reaffirmed its desire to impose ‘strong economic penalties’ on companies who continue to operate in the Islamic Republic.
  • The new system’s success rests on its ability to encourage growth in the key industries of agriproducts and pharmaceuticals, as well as the European Union’s ability to encourage firms to adopt the new payment method.

INSTEX – Development and Context

On 31st January, 2019, Germany, France and the United Kingdom (known as the E3) officially launched a new ‘special purpose vehicle’ (SPV) to facilitate trade between EU nations and Iran. The measures, known as the Instrument for Supporting Trade Exchanges (INSTEX), have been introduced to help European companies circumvent economic sanctions which were re-introduced by the United States in August 2018.

US President Donald Trump has sought to penalise Iran in a bid to curb the regime’s regional military ambitions and use of long-range ballistic missiles, and has used America’s economic dominance to pressure global firms to withdraw from the country.

The sanctions, which effectively brought an end to the previous Joint Comprehensive Plan of Action (JCPOA) agreement created by Mr Trump’s predecessor, have been widely condemned by the international community as a threat to global security.

Since they came in to force, the EU, along with China, Russia and India, have sought to retain trade links with Iran in exchange for the regime’s continued compliance to the existing nuclear proliferation treaty.

The development of INSTEX has been spearheaded by the EU’s Chief Diplomat, Federica Mogherini, who announced the implementation of the measure at a meeting of the bloc in the Romanian capital of Bucharest last week. According to Mogherini, the EU is still “fully behind the full implementation of the Iran nuclear deal” despite recent attestations to the contrary by the United States.

The system has been registered in France, and is to be overseen by the former German Commerzbank manager, Per Fischer, and an advisory board made up of financial experts from France, Germany and the United Kingdom. It operates by providing a bartering arrangement between EU member states and Iran which bypasses transactions in US dollars, whilst providing sovereign assurance to EU firms that their participation in Iranian markets will be protected by the governments of the three sponsoring countries.

According to the EU announcement, INSTEX will initially be used to facilitate trade in “sectors most essential to the Iranian population” such as pharmaceutical, medical devices and agricultural goods. It can also only be used by members of the European Union, although Mogherini has stated that the bloc’s long-term aim is to open it up to “economic operators from third countries who wish to trade with Iran” and that the E3 “will continue to explore how to achieve this objective”.

Such a development is likely to be actively encouraged by EU administrators as wider use of INSTEX would grant the bloc even more leverage over Tehran.


The Iranian Response

In response to the announcement, the Islamic Republic of Iran has praised “Europe’s first step in fulfilling its obligations towards Iran as per a May 2018 statement”. However, the Iranian Foreign Ministry Spokesman, Bahram Ghasemi, has also stated that the move has come too late and that the Republic “has not yet seen any tangible results and practical moves to Iran’s benefit”. He urged the bloc to “accelerate the move and the fulfilment of its other obligations to let the Iranian nation reap the economic benefits of JCPOA”, and even went as far as to suggest that some form of compensation should be paid by the EU for the “illegal US sanctions”.

When fully implemented, the new vehicle should bring crucial benefits to Iran, which is facing a growing number of economic problems, including lack of access to imported medicine and food, and growing unemployment. The move should also lend some credence to President Hassan Rouhani’s reformist agenda which has come under fire over the last year from hard-line critics, who claim that the EU is unwilling or unable to live up to its commitment to maintain trade.

However, INSTEX is unlikely to provide any immediate relief for the country, and its impact is expected to be relatively limited at first. It will likely take months for the system to be fully implemented, and perhaps a lot longer for diplomats to encourage many justifiably cautious European companies to use it.

Despite these continuing efforts to facilitate Euro-Iranian trade, the EU has also not shied away from criticising the Islamic Republic over its regional ambitions in Iraq and Syria. In fact, as INSTEX is developed, the bloc is likely to exercise a greater degree of scrutiny over the Islamic Republic’s military activity as part of a dual approach, designed to demonstrate to the US that it is possible to influence Iranian behaviour through continued economic engagement.

In the same week as the SPV announcement, an EU spokesperson also renewed calls for Tehran to curtail its ballistic missile program, which is widely believed to pose a threat to nations outside its traditional sphere of influence. However, these comments were not well received by the regime, which criticised the “clear threats against the Islamic Republic” as “not constructive, efficient, helpful or in line with regional security and the real interests of Europe”.

A number of EU countries have also used this opportunity to reaffirm their concerns that Iranian operatives have sought to carry out assassination plots against opposition figures in exile. France, Denmark and the Netherlands have all launched past investigations into the activities of Iranian embassy staff, who they claim have orchestrated attacks on European soil. These concerns are also likely to be escalated over the coming months as firms based in these countries are encouraged to work with the new financial system.


The US Response

The announcement of the new SPV has been poorly received in Washington, where key members of the Trump administration have reiterated their intention to enforce ‘strong economic penalties’ on those who continue to trade with Iran. Despite granting exemptions to Japan, South Korea, India, and China, over the import of Iranian oil and gas, the US has flatly refused to show similar leniency towards the nations of the European Union, and in July 2018 the Trump administration rejected an appeal by the EU to allow European firms to operate in certain industries.

In a recent interview, Republican Senator Tom Cotton, a key ally of President Trump, noted that Europe faces a choice as to “whether to do business with Iran or the United States”. It is likely that opposition to the INSTEX system will grow in the US as it becomes more widely used, as analysts have already expressed concerns that the SPV has the potential to circumvent the current ‘Society for Worldwide Interbank Financial Telecommunication’ or ‘SWIFT’ international bank transfer system, which is key to trans-Atlantic trade.

However, INSTEX has a long way to go before it reaches such status, and for now politicians in Washington are unlikely to go any further than issuing verbal warnings to the EU over this issue.


Outlook

In the medium-term, the SPV is unlikely to have any major impact on Euro-Iranian trade and/or the Islamic Republic’s military activity. However, the new INSTEX system does have the potential to facilitate a stronger economic relationship between the two parties in the long term.

According to the Observatory of Economic Complexity HYPERLINK, the main European economies, which include France, Germany, Italy, Greece and Spain, account for around 15% or Iran’s international trade and are therefore significant contributors to the Iranian import and export markets. The new system has been designed to stem any further decline in these figures and may even facilitate growth, depending on how readily the payment method is adopted by European firms.

However, even in this scenario it is unlikely that the Islamic Republic will sacrifice its political ambitions in Syria and Iraq for what constitutes a relatively modest increase in export revenue. Therefore INSTEX’s chances of success rest on its ability to encourage growth in the key industries of agriproducts and pharmaceuticals, where Iran has suffered the most since the re-imposition of US sanctions last year.

If the EU can guarantee significant growth in the transfer of these items in particular, then the bloc may be one step closer to achieving its key aim of demonstrating that economic engagement is a constructive method to influence Iranian behaviour.