Post-sanctions Iran: risk and reward

This year, the world could bear witness to a comprehensive agreement between Iran and the P5+1 (the five permanent members of the UN Security Council plus Germany) over the Iranian nuclear issue.

Since the arrival of moderate President Hassan Rouhani and his administration in August 2013, there has been renewed optimism that the 12-year deadlock can be overcome and the nuclear dossier can be put to rest. Thus far, a spider’s web of sanctions imposed by the United Nations, U.S. and the European Union has deprived Iran of much needed foreign investment. Looking ahead, multinational corporations are already eyeing a return to the Iranian energy sector and consumer market and, although opportunities are abundant, they continue to carry potential regulatory, reputational and business risks for investors.

One need not look too far back to see the cost of those who fail to follow the appropriate mode of conduct with Iran. In June 2014, BNP Paribas paid a record USD 8.9 billion fine over deals with U.S.-blacklisted countries, including; Iran, Cuba and Sudan. Furthermore, in December 2012, Standard Chartered paid a USD 674 million fine to U.S. regulators and authorities for illegally hiding transactions with Iran and other sanctioned countries. Other banks, including HSBC and the RBS Group, have also paid the price for their dealings with sanctioned Iranian entities. On the other hand, the toxic mix of poor economic management and economic sanctions under the Ahmadinejad administration meant that incumbent President Hassan Rouhani inherited a country with USD 75 billion in public debt, inflation at 25%, and youth unemployment at 24%.

While these cases may demonstrate the perceived success of sanctions in securing Iranian economic isolation, should the plethora of sanctions be removed and not simply suspended under a comprehensive accord, Iran could become a very different investment environment.

This will inevitably take time as, by their very nature, sanctions regimes are not designed to dissipate overnight, and banks and investors will remain highly cautious to ensure and maintain compliance. But, as WPP chief executive Sir Martin Sorrell said in October last year, “Iran is one of the last remaining places short of Mars and the moon where there is significant opportunity”. Investors who look towards Iran will see significant economic potential in a country with vast natural resources, and an untapped 80 million population with a sizeable middle-class.

Renewed investment in the energy sector is most apparent for Iran, home to the world’s third largest oil reserves and second largest natural gas reserves. In the upstream sector, years of underinvestment as a result of sanctions and dated buy-back contractual terms mean that, while there is significant opportunity, movement could be slow. But, investors will be ready, and Iranian Oil Minister Bijan Zanganeh has already named Total, Royal Dutch Shell, ENI, Statoil, BP and Exxon Mobil and ConocoPhillips as companies to which investment terms will be presented. Furthermore, of the USD 70 billion of investment that Iran requires in its upstream and downstream sectors, 30% of it will be needed in the downstream.

Elsewhere, Iran’s mining sector remains undeveloped, and accounts for just 0.6% of GDP despite being ranked among the 15 major mineral-rich countries. The country sits on 57 billion tonnes of potential reserves worth USD 770 billion. Nevertheless, beyond natural resources, it is Iran’s population itself – young, educated and equipped with medium-level per capita income – which means that foreign consumer goods would receive a welcome and financially-ready audience. Furthermore, Iran’s tourism and leisure industry has considerable potential. Between March 2013 and 2014, 4.5 million foreign tourists visited Iran, bringing in some USD 6 billion in revenue, despite suffering from a hugely underdeveloped tourism infrastructure.

However, as with any emerging market, particularly in the Middle East, a range of regulatory, reputational and business partner risks are present, and in many cases heightened in the Islamic Republic after years of economic isolation.

First of all, business partner risk is high in Iran. Although since the 1990s under President Hashemi Rafsanjani’s presidency, Iran has actively pursued the privatisation of industry, an understanding of who yields economic power in Iran must be appreciated. The commercial power of the Revolutionary Guards (IRGC), combined with complex shell companies and structures which have been associated with senior public officials, suggest that KYC, enhanced due diligence and in-country source enquiries are key to get to the root of source of wealth and asset tracing issues. Employment of local staff will benefit from the large pool of available and highly-educated individuals, but a lack of experience, particularly relating to international business practice, is common.

Secondly, Iran’s business environment is held back by a deeply entrenched bureaucratic process, in which basic administrative resources, such as searchable corporate and public records databases, are sparsely available and, as a result, opportunities have a tendency to be misrepresented with scarce legal assurances. This can vary depending on sector and the level of government involvement in that respective sector. Appropriate risk strategies to deal with corruption and bribery must be assumed to maintain full compliance. In the post-sanctions environment, legislators in the West, particularly the U.S. and EU, will closely monitor business activity with Iranian entities and the government.

Thirdly, a degree of reputational risk remains for businesses operating in Iran, and this is something which could continue irrespective of compliance standards. For example, in 2012, Maersk – the world’s largest shipping company – stopped calling at Iranian ports as a result of reputational damage. Trust, and the development of a public narrative that favours global relations with Iran, could take time to establish, even if there were to be modest U.S.-Iran rapprochement. This is also largely dependent on Iranian government and its capacity to build foreign relations in the near future.
The last element of risk to draw on for Iran is currency risk. Over the past four years, due to intensified sanctions during the Ahmadinejad era and failed economic policies, particularly subsidy reforms, the Iranian Rial (IRR) has lost around two-thirds of its value. Iran’s floating exchange rate is highly volatile and could cause instability, presenting a lack of security for foreign investors. This is, however, directly related to the financial fragility that has resulted from sanctions.

As multinational corporations and banks look in the year ahead at the two impending deadlines for the Iranian nuclear deal – 31 March 2015 for the broad political agreement and 30 June 2015 for the comprehensive accord – a hard pressed decision on return or entry to the Iranian market may have to come soon. Whether it comes this year or not, a comprehensive nuclear deal and the opening-up of Iran comes with plenty of potential risk, but also with plenty of potential reward.

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