On January 31, 2019, France, Germany and the UK (the “E3”) announced the creation of the Instrument in Support of Trade Exchanges (“INSTEX”), a special purpose vehicle intended to facilitate legitimate trade between European companies and Iran, registered in France. This initiative is supported by the European Union. The vehicle was created in the wake of the U.S.’ withdrawal in 2018 from the Iran nuclear deal (the Joint Comprehensive Plan of Action (“JCPOA”)), in addition to the EU Blocking Regulation, and as part of the EU’s response to the re-imposition of U.S. secondary sanctions on Iran through the U.S. Executive Order 13846 (the “Executive Order”). The Executive Order re-imposed the secondary sanctions regime against Iran that it have been suspended while it was a party to the JCPOA.
The Operation of INSTEX
Development of the SPV is still in the early stages and concrete details on the functioning of this entity have not yet been finalized. The E3 have noted that they “will continue to work on concrete and operational details to define the way the company will operate” and that they will collaborate with Iran to “create an effective an transparent corresponding entity”. At this point, it is expected that INSTEX will operate as a euro-denominated clearing and bartering system, in order to co-ordinate transactions between European companies and their Iranian counterparties. To effect this, a parallel entity is expected to subsequently be established in Iran.
The central purpose of INSTEX would be to create a trading system which avoids direct payments between the EU and Iran via financial institutions, and steers away from the use of US dollars. While operational details are still unclear, reports have suggested that INSTEX could operate by permitting European exporters to run their purchase orders from Iranian businesses through the SPV. It would attribute a value to these transactions and “clear” them. It would also match those exporters with European importers making equivalent-value orders to Iranian businesses and enable payment from the European importer to the exporter via payments between European banks, avoiding the usage of funds originating in Iran. The corresponding Iranian vehicle could then simultaneously match up the Iranian importer and exporter and co-ordinate payment between them. This essentially creates a system where EU exports to Iran are offset against EU imports from Iran.
Nevertheless, given the current imbalance of trade between Europe and Iran (with Iran importing more European goods than exporting goods to Europe), INSTEX would require a sufficient amount of working capital to make up the shortfall and balance payments in a timely manner. In principle, these funds could be raised from EU shareholders (currently the E3, and expansion to other countries is possible) or through transaction fees paid by users.
Risks and Concerns
Although INSTEX is expected to coordinate transactions between parties, rather than engage in direct transactions or cross-border payments, if it operates as a “clearing system”, there is a risk that its functions could still be caught by the Executive Order. “Clearing corporations” are set out in the Executive Order as an example of a “foreign financial institution” subject to sanctions as a result of providing financial assistance to Iran or facilitating certain “significant financial transactions” with Iran. In addition, the Executive Order specifically contemplates the sanction of persons that provide “financial, material or technological support” to certain Iranian persons.
The U.S. government has been critical of this initiative and has warned that “entities that continue to engage in sanctionable activity involving Iran risk severe consequences that could include losing access to the US financial system and the ability to do business with the United States or US companies”. The U.S. Ambassador to the EU, Gordon Sondland, has also reportedly stated that “anyone actually using [INSTEX] to trade on anything other than humanitarian activity will be sanctioned by the United States”.
Current Focus on Essential Sectors
According to the joint statement by the E3, INSTEX will initially focus on “sectors most essential to the Iranian population – such as pharmaceutical, medical devices and agri-food goods”. Notably, these products are currently not subject to US sanctions – thus, facilitating trade in these areas are unlikely to incur risk of US sanctions. The scope of goods covered by INSTEX may, however, be extended to other sectors in the future and a thorough assessment of sanctions risk with respect to trade in any new products would be essential.
The E3 will continue to flesh out the technical aspects of INSTEX to bring this mechanism into operation. Concurrently, a mirror-entity in Iran will need be created.
As the U.S. government will likely enforce Iranian sanctions strictly, and the consequences of the imposition of U.S. sanctions on an entity are severe, businesses seeking to transact with Iran should monitor the development of all elements of the SPV closely and consider the adequacy of INSTEX as a means for facilitating their potential commercial exchanges with Iran.