Trump withdrawing from the JCPOA and the impact on Europe
Monday 24th September 2018
On 8th May 2018, Donald Trump announced that the United States would be withdrawing from the Iran nuclear deal, more formally known as the Joint Comprehensive Plan of Action (“JCPOA”), as it was considered that the limits placed by the JCPOA on Iran’s nuclear fuel production were inadequate . The JCPOA signed in 2015 agreed to lift international sanctions on Iran in exchange for the country curbing its nuclear ambitions. As a result of their withdrawal, the United States outlined a plan to reintroduce the sanctions previously in place on strategic sectors of Iran's economy following a two-tiered wind down period, coming into effect after 90 days and 180 days, respectively. ‘Primary sanctions’ which focus on US entities, have remained in place since the JCPOA implementation date and comprise of asset freezes, trade embargoes, and prohibition on US citizens and companies from engaging with Iran. However, it is ‘secondary sanctions’ which have recently been reintroduced by the Trump Administration - i.e. sanctions that apply to non-American individuals and companies.
Impact of Sanctions
The first wave of sanctions which were effective as of 6th August 2018 means that the US now consider any company continuing to conduct US dollar transactions or trading in Iranian sovereign debt, trading in gold or other metals, exporting airplanes and parts to Iran, or engaging in auto-industry deals to be in violation of its sanctions program. The second wave coming into effect as of 4th November 2018 will impact areas such as Iran’s ports and shipping industry, oil and energy sector, insurance sector, and dealings with its central bank. However, the UK, France and Germany which were also parties to the 2015 agreement - along with Russia and China - have pledged to continue to operate with Iran under the terms of the agreement.
The decision by the US administration to withdraw from the JCPOA and re-impose more comprehensive economic sanctions on Iran means that companies worldwide must stop doing business with Iran, and the US have threatened that those caught violating the sanctions could be cut off from the US financial system. This will be of particular concern for China, India, South Korea, and European countries - who have become some of the largest investors in Iranian oil since 2015 .
Impact on Europe
The extraterritorial reach of the ‘secondary sanctions’ being reintroduced means that businesses based outside of the US will be significantly impacted. This will cause notable concern for a number of European companies, as it means that even if the European Union has not specifically imposed any sanctions on Iran, they must comply with American sanctions if its business or transactions have a US nexus. For example, if an entity uses US dollars for its transactions, has a subsidiary in America, or is controlled by American individuals. French-based Airbus SE would be heavily impacted by this, as they signed a $19 billion deal in December 2016 to provide 100 commercial aircraft to Iran Air, which is Iran's national airline carrier . Airbus operates under a US licence because it produces a small percentage of its aircraft components in America and would therefore would be under the remit of the re-imposed sanctions.
The European Union (EU) has announced it will continue to operate under the terms of the JCPOA provided Iran abides to its nuclear related commitments. In doing so the EU has also urged its member states and companies not to comply with the demands of the US and has pledged to protect those European companies continuing to do legitimate business in Iran. The EU had initially written to the US to request a waiver or exemptions in sectors including pharmaceuticals, healthcare, energy, auto industry, aviation, infrastructure, and banking. However, as a result of the Trump administrations hard-line approach these proposals were rejected . European companies such as Engie SA, Renault, Total SA, and Siemens AG have since announced they are to terminate their operations in Iran because such waivers could not be secured . It would appear that these European companies prefer the more lucrative opportunities available in the US markets and will want to avoid penalties and the threat of further legal action by the US, as well as potential exclusion from public procurement contracts, or reputational damage arising from sanctions breaches.
The EU in its commitments to the JCPOA, and in its attempts to protect its own economic sovereignty through legitimate bilateral trade and investment, irrespective of the action taken by the US, has adopted a ‘blocking statue’ similar to that used against the US sanctions implemented against Cuba in 1996. The blocking statute, in place as of 7th August 2018, effectively exempts European companies from complying with the extraterritorial aspects of US sanctions and makes US court decisions and administrative actions regarding sanctions on Iran void in Europe. An additional feature of this blocking statue can provide an EU company with the option to seek damages as a result of having to withdraw from an Iranian exposed joint venture, or for a European bank having to close an account due to such sanctions . There will be concerns surrounding the effectiveness of the blocking statue considering it has not been yet tested and has only been used once as a political leverage with the US, therefore, the level of protection it can provide the financial sector against US secondary sanctions is unclear. In addition to this, the introduction of the blocking stature will likely result in a dilemma for European companies who will have to manage the legislation of two competing jurisdictions. The EU has also considered an additional possibility of using state owned-banks to help facilitate any ongoing trade with Iran, such as its investment-arm the European Investment Bank, as they are largely protected from US penalties . However, this would likely not be a viable solution bearing in mind that the European Investment Bank generates significant revenue from US markets and bonds, and they would be running the risk of losing access to this capital.
It must be considered that large non-US banks are unlikely to be as heavily impacted by the reintroduction of the ‘secondary sanctions’, as they will have previously cut all ties with Iran in order to avoid running the risk of receiving fines for violating the US sanctions programme; similar to the $8.9 billion BNP Paribas were forced to pay for settlement of such violations in 2015 . In order to continue trade, some European entities had been making non-US dollar currency transfers to intermediary European financial institutions known as ‘gateway banks’, which are able to provide a link between the Iranian and wider European financial system. An example of this is the Europaisch-Iransische Handlesbank (EIH) in Germany, which is a European bank established specifically to engage in trade finance with Iran. However, following the reintroduction of the secondary sanctions in November such transactions with the EIH and similar gateway banks will no longer be permitted. In response to this, the German Central Bank has already changed its policy in relation to withdrawal of funds to these gateway banks and has increased the monitoring and approvals required around such transactions involving these entities . Despite initial retaliation, this would appear to be evidence of Germany conceding to the Trump administration’s sanctions, and it is likely that other entities and jurisdictions will follow suit. However, there have been suggestions that the EU should remain defiant and should look to expanding the number of gateway banks in operation and support efforts for European banks to open branches in Iran .
How does it impact the banks?
Following the reintroduction of the sanctions, European banks and financial institutions which had previously been able to engage in business with Iran since the implantation of the JCPOA, will again have to be cautious in handling transactions which may have a direct or indirect connection to Iran. Banking policy in relation to companies trading with Iranian entities or even receiving or delivering goods shipped through Iranian territory is designed in such a way that allows the bank a certain level of discretion when it comes to processing these transactions; meaning they can delay, reverse, or freeze payments if required. If a bank were to processes a transaction which it later identifies as being indirectly linked to Iran it would be required to make a mandatory disclosure to the relevant authorities.
To avoid inadvertently facilitating transactions with sanctioned entities both during and after the wind-down period, banks’ compliance departments will be required to increase their risk assessment of all existing contractual and operational business relationships. One of the ways this can be achieved is by conducting Enhanced Due Diligence (EDD) on business relationship and transactions - this involves thorough investigations of relevant businesses, shareholders and individuals, and probing the source of funds. Drawing on personal experience from being involved in the EDD process on behalf of a tier 1 investment bank, the additional sanctions could dramatically increase the time and effort required to conduct such reviews, and it can have an impact on the on-boarding of new clients and on the approval of business transactions as a result of the client having to satisfy additional regulatory requirements. The heightened caution around such transactions will likely cause delays, as business dealings will require more stringent reviews and additional approvals in order to reduce the risk to the bank; this may also result in increased costs as they will require extra resources to remain compliant. Furthermore, the bank may be required to engage in undesired outreach to their client’s in order to fulfil additional compliance requirements, this can be seen as a deterrent from the client’s perspective and in some instances can put a strain on the relationship between the parties.
In response to the sanctions it will be important that banks ensure their business compliance programme is appropriately updated and that they are screening parties they are engaging in business with against relevant sanctions lists, on an ongoing basis. One potential way for banks to reduce the likelihood of any undesired connections is through the improvement of their pre-transaction monitoring where they could consider additional factors which may suggest a ‘red flag’ and a resultant Iran nexus. One such factor to consider is that general traders in the United Arab Emirates are often serving as fronts or middlemen for Iranian-related activity . This could be incorporated into the bank’s screening systems in the form an additional filter which would allow the systems flag the transaction for further review before being approved. However, the addition of such ad-hoc requirements can be costly to implement and may result in delays for important transactions depending on the availability of personnel to review and approve the transaction, and on the resources of the bank’s compliance function.
In order to avoid the secondary sanctions, European financial institutions with no direct US parents or affiliates wising to continue their operations in Iran could potentially re-structure itself in such a way that it would be effectively ‘ring fencing’ their business and banking arrangements into two separate corporate entities, with one engaging exclusively in Iranian business and the other operating in all other matters. Again, this would not only be considered costly, but it would also require careful consideration around the structure and management of such Iranian operations and transactions to also allow them to retain their engagement with US related customers and ventures. As such, the efforts required for restructuring may be too significant when weighted against the potential benefits of engaging in Iranian trade.
After reviewing the underlying issues, it is evident that the reintroduction of the comprehensive sanctions by the Trump Administration is going to result in a dilemma for European companies as they will have to effectively choose whether it is feasible to continue to operate in Iran or whether it would be best to sever ties all together. Iran will be depending heavily on the European signatories of the JCPOA to continue as trade partners to help avoid the collapse of its economy but the legal uncertainty and risk of running afoul of the US will compel many European entities to fall in line with the sanctions, despite the counter acting efforts of the EU.
Over the coming months, compliance concerns will continue to be a growing challenge for banks and financial institutions as they will have to adjust their risk assessment and monitoring in relation to the operations of their client’s, and also increase the efforts in areas such as sanctions screening and Enhanced Due Diligence to avoid their business and any related transactions having a potential Iranian nexus. Whilst some European financial institutions may consider options such as ringfencing to avoid sanctions exposure, the willingness of these institutions to continue to facilitate Iran transactions will be determined on their ability to manage increased regulatory scrutiny and rising compliance costs.
The wider political impact of the sanctions, in full effect come November, are still unfolding but the United States will be judging their effectiveness on the impact they have on Iran's oil exports and through doing so will be hoping they can force the Iranian government into an entirely new deal that will deter their nuclear ambitions indefinitely. Until then, it is clear that the complexity of the prohibitions being reintroduced will cause a significant hindrance for countries and entities alike.
Ryan joined FinTrU in October 2016 through our fourth Financial Services Academy after graduating from Heriot-Watt University with a MA in Accountancy.
At FinTrU, Ryan works as part of a Global Financial Crime team for a Tier 1 Investment Bank where he performs Enhanced Due Diligence (EDD) and Politically Exposed Person (PEP) reviews on both new and existing High-Risk clients. He was previously was engaged in Negative News Screening and Sanctions Screening as part of this same team.
Prior to this, Ryan also worked for another Tier 1 Investment Bank on a remediation project which involved using client specific programs to clear adverse alerts raised against clients.
Whilst at FinTrU, Ryan has obtained the Investment Operations Certificate with the Chartered Institute of Securities & Investments (CISI) following completion of the three modules – Introduction to Securities and Investments, UK Financial Regulation, and Combatting Financial Crime.