Iran Trade Deal with Russia-Led Bloc Warrants Cautious Optimism

On September 30, Iranian President Hassan Rouhani arrived in Yerevan, Armenia to attend the Eurasian Economic Union (EAEU) Summit. A free trade agreement (FTA) between Iran and the EAEU will come into force on October 27, creating conditions for preferential trade between Iran and the current EEAU members: Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia. The FTA will give Iran access to a single market comprised of 183 million people and with an aggregate GDP of USD 4 trillion.

Iranian policymakers have welcomed the FTA with cautious optimism. With parliamentary elections fast approaching, the Rouhani administration and parliamentarians alike are eager to implement policies that may help bolster Iran’s economy as sanctions cause a sharp recession. Reza Rahmani, Iran’s industry minister has stated that the FTA could help counteract Iran’s isolation in the face of U.S. sanctions. Mohammadreza Jahanbiglari, an economist and member Iran’s Chamber of Commerce, has predicted that if properly implemented, the FTA could see Iran’s trade turnover with EAEU member states quadruple to reach USD 10 billion within one year—a view echoed by Mehdi Mirashrafi, the head of Iran’s customs administration. The Iran Chamber of Commerce has been invited to establish a specific body to support exchanges with EAEU counterparts.

However, the highly regarded Islamic Parliament Research Center, the research arm of the country’s legislative assembly, has issued a more conservative assessment, outlining in a June 2019 report that the “low level of Iran’s commercial complimentary” with EAEU member states will result in a “minor impact from the FTA on the country's economy.”

The Parliament Research Center nonetheless concluded that the FTA could help Iran develop its non-oil exports, a central aim of the doctrine behind the “Economy of Resistance” called for by the Supreme Leader, Ali Khamenei. Under the FTA, a list of 502 goods will enjoy preferential tariffs when exported to the EAEU. 

Utilization of the so-called “soft infrastructure” represented by the FTA may also spur the development of Iran’s geo-economic position in the Middle East through the creation of new “hard infrastructure.” Russian leadership of the EAEU is complimentary with its “Pivot to the East” strategy. In this context, Iran can provide the shortest, safest, and cheapest route for Russian goods to the Indian Ocean as envisioned in the International North–South Transport Corridor (INSTC). During the Yerevan summit, Iranian foreign minister, Mohammad Javad Zarif highlighted the pivotal role Iran can play in these plans, tweeting, “With parallel work on North-South & South-West Transit Corridors, ground paved for expansion in regional trade & cementing of our role as vital transit hub.”

Despite practical concerns about the facilitation of trade in the face of US secondary sanctions, Iran will also likely find a sympathetic group of countries among the EAEU, which has an anti-sanctions outlook. The EAEU Treaty was signed on May 29, 2014, after the first round of sanctions were imposed against Russia. Like Iran, Russia has seen the expansion of trade among the countries of the former Soviet Union as a possible bulwark against sanctions.

Before leaving Iran for the Yerevan summit, President Rouhani highlighted the potential for the FTA with the EAEU to help Iran mitigate the effects of U.S. sanctions. One of the key issues barriers for Iran’s cross-border trade is the absence of reliable banking channels. Iran and Russia have been exploring the use of local currencies in bilateral trade as well as the use of a new Russian bank messaging system called SPFS, which is intended as an alternative to SWIFT. Abdolnasser Hemmati, the governor of Iran’s central bank, has stated that Russia has agreed to Iran’s proposal to expand SPFS to the countries of the EEAU. 

Beyond banking, Iranian business leaders are concerned about the harmonization of the trading regimes. For example, while EEAU countries use the more detailed 10-digit “Harmonized System” (HS), Iran uses the 8-digit version. Proper harmonization will require input from a wide range of Iranian regulatory bodies, including the customs administration, the National Standard Organization, the Veterinary Organization, and the Food and Drugs Administration. Aside from the administrative challenges on the Iranian side, there are also concerns around the internal dynamics of the EAEU, in which economic ambitious have not been matched with the kind of political frameworks that have made the European Union customs union so successful. The FTA between Iran and the EAEU is an interim agreement that will remain in force for three years—a short period to overcome a wide range of bureaucratic hurdles.

While Iran might not find drastic gains by joining the EAEU, it certainly has nothing to lose. Over time, if enabled by the creation of more robust banking channels and investment in new transport infrastructure, Iran’s non-oil trade with the EAEU could prove a real boon for the economy.

Photo: Kremlin.ru

Can Europe Defend Itself And Iran From U.S. Sanctions?

This article was originally published in LobeLog. 

In an op-ed published in the German newspaper Handelsblatt, German Foreign Minister Heiko Maas declared that the “the US and Europe have been drifting apart for years.” Nowhere is this clearer than in the disagreement between the United States and Europe over the fate of the Iran nuclear deal. When President Trump withdrew from the Joint Comprehensive Plan of Action (JCPOA) and announced his intention to reimpose secondary sanctions that would impact European businesses, he made clear that he wouldn’t treat Europe in what Maas called a “balanced partnership.” In response, Maas believes that Europe must “bring more weight to bear” in global affairs.

In order to defend the JCPOA and protect European companies active in Iran from U.S. sanctions, Maas outlined three initiatives: “establishing payment channels independent of the US, a European monetary fund, and an independent SWIFT [payments] system.” These initiatives echo ideas expressed by French economy minister Bruno Le Maire in the aftermath of Trump’s withdrawal from the JCPOA. Le Maire has called for European governments to work together to protect Europe’s economic autonomy by creating “independent, sovereign European financial institutions which would allow financing channels between French, Italian, German, Spanish and any other countries on the planet.” Le Maire has declared that “the United States should not be the planet’s economic policeman.”

It will be difficult to realize the political designs of Maas and Le Maire within the economic structures that link Europe and global markets, including Iran. As Maas concedes, “the devil is in thousands of details.” It should be no surprise, therefore, that speaking to President Hassan Rouhani’s cabinet last week, Supreme Leader Ali Khamenei declared that Iran “must not pin hope on the Europeans for issues such as the JCPOA or the economy,” noting that promises must be examined with “skepticism.”

Iran should not take for granted the hopeful vision of more resolute European leadership, especially if that leadership promises to deliver fairer political and economic outcomes for Iran. But in light of the present economic crisis, the Iranian government and Iranian people can no longer afford to take a long-term view when it comes to fundamental questions like access to the international financial system, whether or not that system continues to be dominated by the United States. As such, it is important to try and discern the specific and short-term implications of the new political vision espoused by leaders like Maas and Le Maire.

First, there has been the greatest progress in designing possible payment channels that would help sustain transactions in the face of U.S. secondary sanctions. As an initial step, the central banks of France, Germany, the United Kingdom, Austria, and Sweden have indicated their openness to establishing payment channels with the Central Bank of Iran that would be immune to sanctions since the U.S. government is unlikely to take the extreme step of sanctioning European central banks for transacting with Iranian entities. Importantly, these central banks, which would be facilitating transactions on an ad hocbasis, would not need to rely on payment systems such as SWIFT.

However, the central banks have established a pre-condition: Iran must fully implement the Financial Action Task Force (FATF) action plan. But even if Iran does successful implement the FATF reforms, and even if European central banks fulfill their promise, the creation of limited payment channels does not amount to an independent financial system. In such a scenario, the impact of U.S. sanctions on European and Iranian banks will continue to prevent trade and investment in meaningful volumes.

Second, the creation of an independent payment messaging system is essential to enabling those smaller European banks that lack a “U.S nexus” to transact with Iranian banks, thereby enabling trade and investment at higher volumes. To this end, Maas has called for the creation of “an independent SWIFT [payments] system.” Notably, Maas’ statement makes it clear that European leaders do not expect to successfully defend the independence of SWIFT in its current form. SWIFT, headquartered near Brussels, is a cooperative owned by its member financial institutions, including major American banks such as Citibank and JP Morgan. Even so, SWIFT represents a rare global financial institution in which the United States is not dominant, but dependent. Some analysts, among them former officials from the U.S. Department of Treasury, have observed that it would be harmful to U.S. economic interests to sanction SWIFT. In fact, when SWIFT disconnected Iranian banks from its system in 2012, this was only because the organization voluntarily agreed to do so in accordance with European sanctions policy at the time, not because of the realistic threat that the U.S. would sanction the entity.

It is not entirely clear whether Maas wants Europe to insist on SWIFT’s independence or to devise new messaging systems altogether. A new system would be technically easy to establish but would prove difficult to monitor for possible money laundering or terrorist financing, an important political consideration. Although the former approach would certainly deliver Iran a more immediate solution on banking challenges stemming from U.S. sanctions, given that Iranian banks were reconnected to the SWIFT following implementation of the nuclear deal, Europe will more likely take the latter, more time-intensive approach. German Chancellor Angela Merkel responded to Maas’ op-ed (which she called an “important contribution”) by noting that “on the question of independent payment systems, we have some problems in our dealings with Iran…on the other hand we know that on questions of terrorist financing, for example, SWIFT is very important.” Merkel’s comments suggest that political capital will most likely be spent creating a minimal, ad hoc messaging system in support of transactions with Iran rather than defending the independence of SWIFT in the face of a U.S. sanctions threat.

Finally, if payment channel and payment messaging solutions can be devised, Europe will need to ensure financing flows through these channels to Iran, in order to spur economic growth and support infrastructure and energy projects led by European companies. Here, Maas has pointed to the creation of a European Monetary Fund. Plans for the creation of such a fund have been circulating in European capitals for over a year and are based on upgrading the European Stability Mechanism (ESM), the entity that managed the bailouts of Eurozone states made necessary by the global financial crisis. Currently, ESM borrows on capital markets by issuing bonds. Such a reliance on capital markets has proven the critical barrier to the European Commission’s effort to get the European Investment Bank (EIB), which finances capital projects around the world, to invest in Iran. Like ESM, EIB raises capital by selling bonds, often to American institutional investors. Understandably, the CEO of EIB has publicly rejected calls to invest in Iran, stating that to do so “would risk the business model of the bank.”

The creation of a European Monetary Fund would be supported by financing drawn directly from European central banks and not capital markets, limiting exposure to U.S. investors, and therefore to the risk of U.S. sanctions. Such an institution would also reduce European reliance on the International Monetary Fund and World Bank, which remain politically dominated by the United States. Whereas countries such as Turkey and Egypt have readily used IMF financing to fuel growth and weather economic crisis, longstanding tensions between the United States and the Islamic Republic mean that Iran has been unable to secure IMF loans.

European governments are aware of the need to support Iran’s economic development through capital allocation. The European Commission’s recent move to allocate to Iran 18 million euros of a planned 50 million euros of development aid in order to “widen economic and sectoral relations” demonstrates the desire to fund growth. The European Commission simply lacks the right financial institutions to provide such capital to Iran at a meaningful scale.

Overall, Maas’ message contains real, practical ideas about how to not only sustain trade and investment in Iran in the face of secondary sanctions but also strengthen Europe’s economic sovereignty in lasting ways. However, Iran must recognize that there is no readymade “economic package” that Europe can deliver to save the JCPOA. There is only an “economic process” where improvements in the facilitation of trade and investment will occur over time and in sequence.

In the coming months, it will be feasible to institute a payment channel between central banks. In the coming year, it will be feasible to establish a new payment messaging system. Finally, over the course of several years, Iran could benefit from the creation of a European Monetary Fund, financing from which could truly transform prospects for Iran’s economy. For its part, Iran must remain willing to undertake its own economic process, beginning with critical FATF reforms. In this way, if Europe and Iran each grow stronger, through a renewed insistence on independence and autonomy, the prospects for political and economic cooperation will actually improve. The United States cannot be the fulcrum on which all partnerships must balance.

Photo Credit: German Federal Foreign Office

Europe's SWIFT Problem

This article was originally published by Moneyness. 

German foreign minister Heiko Maas recently penned an article in which he said that "it’s essential that we strengthen European autonomy by establishing payment channels that are independent of the US, creating a European Monetary Fund and building up an independent Swift system."

So what exactly is Maas's quibble with SWIFT, the Society for Worldwide Interbank Financial Telecommunication? SWIFT is a proprietary messaging system that banks can use communicate information about cross border payments.  President Trump has threatened to impose sanctions on SWIFT if it doesn't remove a set of Iranian banks from the SWIFT directory. 

For Heiko Maas, this is a problem. Iran and Germany remain signatories to the same nuclear deal that Trump reneged on earlier this year. The deal committed Iran to cutting back its uranium enrichment program and allowing foreign inspectors access to nuclear sites, in return obligating signatories like Germany to normalize economic relations with Iran, including allowing the unrestricted sale of oil. If Iran is bumped from SWIFT, it could prevent Germany from meeting its side of the deal, potentially scuppering the whole thing. So a fully functioning SWIFT, one that can't be manipulated by foreign bullies, is key to Germany meeting its current foreign policy goals. 

SWIFT is vital because it is a universal standard. If I want to send you USD 10,000 from my bank in Canada to your bank in Singapore to pay for services rendered, bank employees will use SWIFT terminals and codes to communicate how to manipulate the various bank ledgers involved in the transaction. If a bank has been banished from SWIFT, then it can no longer use what is effectively a universal banker's language for making money smoothly flow across borders. 

It would be as-if you were at a party but unlike all the other party-goers were prohibited from using words to communicate. Sure, you could get your points across through hand gestures and stick drawings, but people would find conversing with you to be tiring and might prefer to avoid you. Without access to SWIFT, Iranian banks will be in the same situation as the mute party-goer. Sure, they can always use other types of communication like email, telex or fax to convey banking instructions, but these would be cumbersome since they would require counterparties to learn a new and clunky process, and they wouldn't necessarily be secure. 

It seems odd that Maas is complaining about SWIFT's independence given that it is located in Belgium, which is home territory. But Trump, who is on the other side of the Atlantic, can still influence the network. The way that he plans to bend SWIFT to his will is by threatening members of its board with potential asset expropriations, criminal charges, travel bans, as well as punishing the companies they work for by restricting them from conducting business in the U.S.

How credible is this threat? SWIFT's board is made up of executives from twenty-five of the world's largest banks, including two Americans: Citigroup's Yawar Shah and J.P Morgan's Emma Loftus. No matter how erratic and silly he is, I really can't imagine Trump following up on his threat. Would he ban all twenty-five banks, including Citigroup and J.P. Morgan, from doing business in the U.S.? Not a chance, that would decimate the global banking system and the U.S. along with it. Requiring U.S. banks do stop using SWIFT would be equally foolish. Would he risk ridicule by putting two American bank executives—Shah and Loftus—under house arrest for non-compliance? I doubt it.    

If SWIFT doesn't comply with US requirements that Iranian banks be cut off from its network, SWIFT board members (such as Yawar Shah) will face asset freezes & travel bans, and the banks that employ them (Citigroup) will be cut from the payments system: https://t.co/tVntv3USzs pic.twitter.com/XAiLOKPdtk

— JP Koning (@jp_koning) June 6, 2018

No, the SWIFT board is TBTP, or too-big-to-be-punished. But even if Trump's threat is not a credible one, surely SWIFT will fall in line anyways. Large international businesses generally comply with the requests of governments, especially the American one. But there's a kicker. European law prohibits European businesses from complying with foreign sanctions unless the have secured EU permission to do so. This leaves SWIFT in an awfully tight place. Which of the two jurisdictions' laws will it choose to break? Assuming it can't get EU permission to comply with U.S. sanctions, then it can either illegally comply with U.S. law, or it can legally contravene U.S. laws. Either way, something has to give.   

Europe can win this battle, a point that Axel Hellman makes for Al-Monitor. After all, SWIFT is located in Belgium, not New York, and jurisdiction over SWIFT surely trumps lack of jurisdiction. Indeed, on its website SWIFT says that its policy is to defer to the EU on these matters:

"Whilst sanctions are imposed independently in different jurisdictions around the world, SWIFT cannot arbitrarily choose which jurisdiction’s sanction regime to follow. Being incorporated under Belgian law it must instead comply with related EU regulation, as confirmed by the Belgian government."

Consider too that SWIFT itself is supposed to be committed to a policy of non-censorship. Chairman Yawar Shah once said that “neutrality is in SWIFT’s DNA.” So from an ideological perspective it would seem that SWIFT would be aligned with Europe's more inclusive stance.

Of course, SWIFT's stated commitment to neutrality conflicts with the fact that it has banned Iran from the network before. In early 2012, U.S. pressure on SWIFT grew in the form of proposed legislation that would punish the messaging provider should it fail to ban Iranian users. SWIFT prevaricated, noting in early February that it would await the "right multilateral legal framework" before acting. In March 2012, the EU Council passed a resolution prohibiting financial messaging providers from servicing Iranian banks, upon which SWIFT disconnected them. It was only in 2015, after passage of the nuclear deal, that SWIFT reconnected Iran. (I get this timeline from the very readable Routledge Global Institutions book on SWIFT, by Suzan Scott and Markos Zachariadis).

The takeaway here is that SWIFT only severed Iranian banks in response to European regulations, in turn a product of a conversation between American and European leaders. SWIFT will seemingly compromise its neutrality if there is a sufficient level of global agreement on the issue followed up by a European directive, not an American one. 

If Heiko Maas wants an "independent SWIFT," the above analysis would seem to illustrate that he already has it. Thanks to its European backstop, SWIFT is already independent enough to say no to U.S. bullying. As long as they are willing, European officials can force a showdown over SWIFT that they are destined to win, thus helping to preserve the Iranian nuclear deal. 

But maybe European officials don't want to go down this potentially contentious path. Perhaps they would prefer to preserve the peace and grant SWIFT an exemption that allows the organization to comply with U.S. sanctions, thus cutting Iran off from the messaging network, while trying to cobble together some sort of alternative messaging system in order to salvage the nuclear deal. Maybe this alternative is what Maas is referring to when he talks of a building an "independent SWIFT."

An alternative messaging service would have to be capable of providing bankers with sufficient usability so that Iranian oil sales can proceed fluidly. In a recent paper, Esfandyar Batmanghelidj and Axel Hellman give some clues into what this system would look like. During the previous SWIFT ban, several European banks were able to maintain their relationships with Iranian financial institutions by using "ad hoc messaging systems." These ad hoc solutions could be revived, note Batmanghelidj and Hellman. 

Using this ad hoc system, so-called gateway banks—those that have both access to the ECB's large value payments system Target2 and limited exposure to the U.S. financial system—would conduct euro transactions on behalf of buyers and sellers of Iranian oil. Since presumably only a few gateways would be necessary to conduct this trade, it would be relatively painless for them to learn the new messaging language and the set of processes involved. For instance, instead of using SWIFT bank identifier codes to indicate account numbers, Batmanghelidj and Hellman point to the possibility of using IBAN numbers, an entirely different international standard. 

This independent ad-hoc system would probably work, on the condition that the European monetary authorities continue providing gateway banks that serve Iranian clients with access to the ECB's Target2 payments system. This is a point I stressed in my previous blog post. It isn't access to SWIFT that is the lynchpin of the nuclear deal, it is access to European central banks. But as long as folks like Heiko Maas get their way, I don't see why this sponsorship wouldn't be forthcoming. In response, Trump could always try to sanction the European central bank(s) that allow this ad-hoc system to continue. But an escalation of U.S. bullying from the mere corporate level (i.e. SWIFT) to the level of a friendly sovereign nation would constitute an even more nutty policy. I just don't see it happening.

At stake here is something far larger than just Iran. As I recently wrote for the Sound Money Project, financial inclusion is a principle worth fighting for. If one bully can unilaterally ban Iran from the global payments system, who is to say the next victim won't be Canada, or Qatar, or Russia, or  China? Europe needs to stand up to the U.S. on this battle, either by forcing a SWIFT showdown or by sponsoring an ad hoc alternative—not because Iran is an angel—but because we need censorship-resistant financial utilities.

Photo Credit: B&B