A new chapter
Iran is preparing for an economic boom after a U.N. nuclear watchdog ruled in January that the country had abided by an agreement reached last July with six world powers to curb its nuclear programme, lifting sanctions that have stifled its economy for several years.
On January 16, the International Atomic Energy Agency (IAEA), the United Nations’ nuclear watchdog, verified that Iran had met its nuclear commitments under the Joint Comprehensive Plan of Action (JCPOA), paving the way for the lifting of a number of international sanctions that have crippled the Iranian economy for several years. The JCPOA, which was reached in July 2015 between Iran, the P5+1 (the five permanent members of the U.N. Security Council – China, France, Russia, UK and the U.S. – plus Germany) and the European Union, provides a roadmap for Iran to commit not to pursue nuclear weapons and to instead seek civil uses of uranium as part of a nuclear energy policy, in exchange for the lifting of economic sanctions. Over the next few months, Iran drastically reduced the number of centrifuges installed at the Fordow and Natanz enrichment sites, shipped tonnes of low-enriched uranium materials to Russia, and removed the core from its Arak nuclear reactor to comply with the JCPOA.
Tens of billions of dollars worth of Iranian assets have now been unfrozen and many international companies that have been barred from doing business there will be able to tap into a market with a young, well-educated population of just under 80 million and some of the world’s largest energy reserves. Iran is set to be the biggest economy to rejoin the global trading and financial system since the break-up of the Soviet Union more than two decades ago.
While there are great opportunities for foreign investment in Iran, it is important to stress that there has not been a blanket lifting of all sanctions, says Christopher Hunt, a disputes partner at Herbert Smith Freehills in Tokyo, who has been advising clients on anti-bribery, corruption and sanctions. The JCPOA deals with three different sets of sanctions from the U.N., the U.S. and the EU. “The previous U.N. sanctions on Iran are going to be terminated and replaced with very specific restrictions, including around the transfer of goods which might involve nuclear or fissionable material. The U.S. is taking a twin-track approach, with primary sanctions that affect American persons and entities, and secondary sanctions that affect non-U.S. persons and entities. In very broad terms, the secondary sanctions have been lifted but the primary sanctions remain,” says Hunt. Lastly, the EU has revoked most sanctions against Iran, including those related to banking and finance, insurance, and various activities concerning the oil and gas industry, and has ended many asset freezes and visa bans too. However, it is important to note that the EU has maintained a range of sanctions, including those targeted at assistance with a nuclear programme or connected with human rights abuses, adds Hunt.
Economists estimate that a third of Iranian industry may have been idled by the sanctions, which the U.S. Treasury estimates cut Iran’s GDP by a fifth. Iran’s trade with the EU in 2014 totalled 7.6 billion euros ($8.4 billion). In 2011, before banking sanctions hit, it was 27.8 billion euros – a measure of the ground that may be recovered with the lifting of sanctions. Meanwhile, Iran’s oil production had fallen to 2.7 million barrels per day (bpd), down by one million bpd since the start of 2012, depriving the country of billions of dollars in revenue. The OPEC member aims to raise oil output by one million bpd from March. “Iran has been closed to substantial FDI over the past ten years, and is in dire need of the transfer of knowledge and technology in all sectors,” says Hamid Mojtahedi, a senior associate at Al Tamimi & Company in Dubai, and head of the firm’s Iran practice group. Major opportunities for investors lie in the infrastructure, projects, oil and gas, natural resources, hospitality and aviation sectors, says Mojtahedi.
The Iranian government has been vocal about its intentions to attract foreign investment, remove obstacles for free investment and reduce government interference in private investment. At the same time, Iran’s Central Bank is trying to improve its regulatory framework, and the Tehran Stock Exchange is making its rules more transparent and consistent with international standards, says Adrian Nizzola, a partner at Simmons & Simmons, who splits his time between the firm’s offices in Qatar and the UAE. Iran will also soon be able to rejoin the SWIFT global electronic payments system, which will help enable inflows of foreign money, says Nizzola. International companies will then be welcome to enter Iran’s economy through joint ventures – including those in the banking sector – and direct investment.
International players looking to cash in on opportunities in Iran will benefit from an already diverse and mature investment environment, says Joanna Addison, a partner at Herbert Smith Freehills based in the Middle East, and chair of the firm’s Iran Working Group. “You can have 100 percent foreign ownership in many sectors in Iran, which is not the case in many of the other Persian Gulf countries. Iran also has bilateral investment treaties with more than 50 countries, double taxation agreements with more than 20 countries, and the basic infrastructure in place to attract foreign investment.”
Furthermore, in November last year, the government released regulations to explain their new integrated petroleum contract (IPC) model, which has garnered much interest from oil companies, and other services and construction businesses that support the oil and gas industry. The new contracts address a number of concerns surrounding the older buy-back system, and will support joint ventures between operators and national Iranian oil companies, and allow foreign investors and contractors greater input during the operating and production phase she says.
CLEARING THE HURDLES
While Iran’s economic potential is undeniable, conducting business there is not without its challenges. With many of the sanctions now lifted, Iran needs to ensure that it keeps the economy stable as money flows back into the country and growth accelerates. The government has to tackle a number of issues, ranging from corruption and a weak banking system to anti-money laundering and third-party risks. Another obstacle for foreign investors is the lack of transparency in conducting business in Iran, as well as the lack of experience in handling major projects, says Nizzola. “It’s very difficult to get public information about shareholders, companies and markets. The skill set and education in Iran is very high, but you are still restricted by the limited amount of information available, and this is a key area that needs to be addressed,” he says.
Furthermore, doing business in Iran can be challenging due to a tremendous quasi-public sector presence in all sectors of the economy, says Al Tamimi’s Mojtahedi. During the sanctions years, the government often favoured state firms over private ones on the grounds of economic survival. “The challenge for the government is to ensure the role of the public sector and government in major projects is minimised as private investment starts to come in, whether it is domestic or foreign. Foreign private sector companies looking at Iran will also want to make sure that there is no connection with the paramilitary and no military involvement in the economy,” adds Mojtahedi.
Foreign investors eyeing Iran are also faced with an uncertainty as sanctions could “snap back” if Tehran is seen to violate the agreement. With the risk of having an entire deal unravel and the sanctions kick back, foreign investors have been working closely with their external legal advisors to formulate effective entry strategies. “Clients need to think about the different sanctions regimes for each country, and consider the U.S. and EU positions, and also the position of the client’s jurisdiction,” says Hunt. “We’ve been telling our clients that this is a very tricky area, and stress that a bespoke approach is the best option,” says Hunt. “A common request of late has been requests for drafting exit and termination rights for potential investors to mitigate the effect of any future “snap back”. In addition, we have drafted sanctions declarations for clients to put to their counterparties, that seek warranties and outline the consequences should sanctions be breached. This kind of drafting puts sanctions at the forefront of the business dealing, and ensures that everyone knows what to expect in the event that sanctions ‘snap back’ or a counterparty engages in any activities that could contravene the sanctions. However we are expecting push back to including these sorts of protections with Governmental entities,” says Hunt.
TREADING WITH CAUTION
While the lifting of sanctions has spurred a number of foreign investors from the West into action, the Gulf Arab countries are also preparing to face additional competition for funds from Iran, which has as large a population as the six wealthy Gulf Arab oil-exporting states and Iraq combined. Many of the Gulf Arab oil exporters have minimal commercial ties with Iran so they stand to gain little. Instead, financial pressures on them may increase if the return of Iran to the global oil market forces them to give up market share. Although most Gulf Arab oil exporters may lose out as the prospect of more Iranian supply pushes down crude prices, trading centres such as Dubai could be used as a hub for foreign companies going back into Iran.
The expected influx of investment into Iran is also likely to spark more competition in the legal space in the Middle East. Lawyers in the region expect international firms to beef up their headcount in their existing Middle East offices, and eventually look at entering into associations or partnering with local Iranian firms. As this story went to print, CMS launched an office in Tehran, becoming the first international firm to set up shop in Iran. Due to the lack of transparency in most sectors in Iran, clients are spending a lot of time gathering market intelligence on potential local business partners, looking at who their likely competitors are, considering how to protect their intellectual property rights, and finding out more information on the tax regime and the labour laws in terms of recruitment, says Nizzola.
For his part, Mojtahedi notes that most foreign investors are still proceeding with caution, especially since most international banks still do not have a very healthy appetite for – or engagement with – Iran. “Even though companies are looking at Iran and wanting to enter, their banks aren’t quite ready to facilitate this. But the international business community certainly sees Iran as a great investment opportunity, and at this stage they are identifying potential counterparties in Iran. The need for proper due diligence is paramount, and that requires some fairly sophisticated local knowledge of the country. There is an element of uncertainty in Iran, but this administration in particular is very keen to ensure that there is that seamless implementation, adherence and compliance with the terms of the JCPOA,” says Mojtahedi.
In addition to complying with the JCPOA and developing a robust legal and regulatory framework, the continued construction of social infrastructure has been cited as a priority for Iran, says Addison. “There has been huge population growth in Iran, but the social infrastructure, including roads, power, water and waste water, has lacked investment both technically and financially as a result of the sanctions regime. It will be important to show that it’s not just the foreign investors that are coming in and making money as a result of the JCPOA, but that things are changing for the general population in Iran and that this deal is making their lives better,” says Addison. Indeed, while the lifting of key sanctions in January signals a new chapter for Iran, the real challenge lies ahead as the government seeks to attract investment, enhance its banking, legal and regulatory standards, develop its infrastructure and promote greater transparency across all sectors. The results will not be immediate, and it will be a while yet before Iran manages to restore its economy back to where it was several years ago, and win over cautious foreign investors.
There have been some success stories, though. The Iranian government recently reported that it had sealed a deal with Airbus to purchase 100 passenger planes, and is in the process of signing a raft of other deals. “This is the biggest new opportunity in the world, and that is why we are seeing such a high level of interest. The firms looking at Iran – the banks in particular – are excited but cautious, and before you see huge amounts of investment the underlying investment framework will need to be improved,” says Nizzola. “The money that goes in quickly is not necessarily the money that will stay or get the best returns.”