Decades of sanctions have left Iran with one of the oldest fleets in the world, in desperate need of major fleet renewal. Following the recent easing of sanctions this process should now start, but because the sanctions regime is not yet fully lifted a myriad of issues remain that require careful review when dealing with Iran.
On 16 January 2016 the International Atomic Energy Association (IAEA) issued a report confirming that Iran had completed the necessary preparatory steps (i.e. reduction in stockpiles of low-enriched uranium) to start the implementation of the Joint Comprehensive Plan of Action (JCPOA), which is a plan for the reduction of Iran's nuclear program agreed by Iran, China, France, Germany, the Russian Federation, the US and the UK reached in Vienna in July 2015. This triggered much awaited sanctions relief from the EU and the US and a major move towards the end of a sanctions regime that commenced in 1979 and has been in place in relation to Iranian aviation since 1995. Iran's economy of 80 million people, already the second largest in the MENA region even after years of sanctions, stands to benefit hugely, as do many foreign investors looking for growth in an otherwise sluggish international economy.
In January the European Union lifted all sanctions which had targeted, amongst others, Iran's oil, gas, shipping, petrochemicals, insurance and financial sectors. Over 400 entities that had previously been designated for asset freezes by the EU were de-listed.
The US broadly lifted "nuclear-related secondary sanctions" which had targeted non-US companies/persons dealing with Iran's energy, shipping, financial, shipbuilding and automotive sectors, Iran's port operators, providers of related insurance, Iran's trade in gold and other precious metals, and trade with Iran in graphite and raw or semi-finished metals, such as aluminium, steel and coal. The US also de-listed a number of "specially designated nationals" (SDNs). Further relief was also offered to Iran's aviation sector which will benefit from a Statement of Licensing Policy establishing a favorable licensing policy regime to request specific authorization from OFAC. This will allow the provision of US civilian aircraft and parts to Iran for the first time in decades and to foreign subsidiaries of US companies, which ought in some circumstances to be able to deal with Iran without exposing their parent company to penalties. A number of Iranian banks will be reconnected to the SWIFT network, facilitating the electronic transfer of funds, and helping to inject cash from Iran's frozen assets into the country's economy. About USD 30 billion of Iran's estimated USD 100 billion of frozen assets are expected to be released.
However, caution must still be exercised. Not all of the EU and US sanctions against Iran are being lifted. There are residual asset freezes in place against individuals and entities linked to Iran's ballistic missile program and human rights violations, and foreign businesses must carry out proper due diligence on their counterparts before concluding contracts. Furthermore, the US "primary" sanctions will continue to prohibit US persons in general from carrying out business with Iran outside the few exempted areas such as food, medicine and the newly liberalised aviation sector. Banks will still be unable to clear US dollars for Iran-related business and financial institutions generally are likely to tread carefully before re-engaging wholesale with Iran and Iranian related business.
As a brief summary therefore of the progress which has been made in reconnecting Iran to the global economy:
- The EU's "nuclear" sanctions and US secondary sanctions have been lifted
- Legal restrictions on doing business in Iran's oil, gas, petrochemical and shipping sectors have been lifted
- Iran can sell its oil on the open market and repatriate its foreign currency earnings
- Iranian banks are no longer cut off from the world's banking sector
- The SWIFT financial messaging system has been reconnected to Iran
- Foreign investors can make capital investments in Iran's estimated USD 250 billion projects market
- IP rights to protect brands can be registered
The new normal is not an unfettered ability to trade with Iran
There are many residual restrictions still in force and businesses need to be aware of these restrictions before entering Iran. Restrictions connected with ballistic missile and human rights violations remain. There are also a number of designations on Iranian entities. For example, both the EU and the US have maintained the designation of the Islamic Revolutionary Guard Corps ("IRGC") which has interests in many areas of the Iranian economy. Businesses are unable to deal with these entities under these residual sanctions.
Iran remains designated by the United States as a "state sponsor of terrorism". The Financial Action Task Force reiterated its concerns in February 2016 about Iran's failure to address anti-money laundering and combatting financing of terrorism deficiencies. The threat this poses to the integrity of the international financial system was highlighted.
Counterparty risks and KYC remain significant issues
The first key step for any international investor in Iran will be to identify not only whether its counterpart is designated in any way, but whether that counterpart is owned or controlled by persons who are designated. That is likely to be a difficult conversation for a foreign investor (particularly a Western investor) to have with an Iranian counterpart. Without a culture or history of "client due diligence" in Iran, requests for information about shareholders and directors of Iranian companies, not to mention passport copies, are likely to be met by strong resistance.
Banking issue remains a key concern
There was no relief for US clearing banks, or for foreign financial institutions who deal in US dollars. The potential for settlements such as those agreed by BNP Paribas and Commerzbank for allegedly engaging in US dollar transactions with Iran has not diminished. Indeed, it has arguably increased as more business is anticipated to be carried out with Iran. This is a major problem for the aviation industry, which is of course a predominantly dollar-dominated industry: current US sanctions ensure that no transactions in Iran can be dollar-dominated. All dollar payments need to be cleared through a US clearing bank and therefore have an intrinsic US nexus. Banks that can work in euros are likely therefore to be the initial beneficiaries of the sanctions relief, provided they can structure deals to entirely avoid any dollar payments.
Whilst Iranian banks are connected to the SWIFT financial messaging system, few, if any, tier one financial institutions are listening at the other end. There is a reluctance to support business with Iran in any currency because of the risks associated with accidentally handling US dollars. Whether that reluctance translates into a substantial handbrake on the potential for trade with Iran is the great unknown.
Foreign subsidiaries of US companies are now permitted to engage in business with Iran. This is provided that it does not conflict with the purposes of the JCPOA and that it is not with the Government of Iran. The US parent company will need to be wary of unwittingly "facilitating" trade with Iran by giving any approvals for its subsidiary to carry out such business. General Licence H permits US parent companies to pass the necessary approvals to divest themselves of the decision making authority for the entry of that business, allowing the foreign subsidiaries to take the ultimate decision to engage in that business themselves. Understanding General Licence H is therefore a means by which conglomerates with links to, or even headquarters in, the US could carry on business with Iran, via their subsidiaries.
Selling and leasing aircraft to Iran
We turn now to looking at the impact on transactions involving aircraft.
In implementing the Joint Comprehensive Plan of Action, the US has opened the door for sales and leasing of US aircraft and related parts and services to Iran. It is of course well known that following years of isolation the Iranian commercial aircraft fleet requires substantial upgrading: to take but one example, Iran Air owns three of the last four 747-200Ms in existence, aged up to 40 years old. Iran's fleet of 273 commercial aircraft has an average age of 23.8 years.
The re-exportation of goods to Iran is regulated by the US Department of Treasury through the US Office of Foreign Assets Control ("OFAC") and by the US Department of Commerce through the Export Administration Regulations.
The Iran Transactions and Sanctions Regulations address transactions with Iran. These Regulations do not define the term "reexport". However, the EAR provide a definition, which is illustrative as to how OFAC likely would interpret the term. The EAR broadly define "reexport" to include the shipment of an item subject to the EAR from one foreign country to another foreign country.
On 16 January 2016, OFAC issued a "Statement of Licensing Policy for Activities Related to the Export or Reexport to Iran of Commercial Passenger Aircraft and Related Parts and Services" (the "SLP"). The SLP establishes a favorable licensing policy under which US and non-US persons may request specific authorization from OFAC to engage in transactions for the sale of commercial passenger aircraft and related parts and services to Iran, provided such transactions do not involve any person on OFAC's Specially Designated Nationals and Blocked Persons List ("SDN List"). It should be noted that the SDN List still includes Mahan Air, Iran's second largest carrier, "for providing financial, material and technological support to the Islamic Revolutionary Guard Corps-Qods Force (IRGC-QF)".
Under the SLP, US companies and, where there is a nexus to US jurisdiction, non-US companies may apply for licenses to engage in transactions for the (i) export, reexport, sale, lease or transfer to Iran of commercial passenger aircraft for exclusively civil aviation end use, (ii) export, reexport, sale, lease or transfer to Iran of spare parts and components for commercial passenger aircraft; and (iii) provision of associated services, including warranty, maintenance and repair services and safety-related inspections, for all the foregoing, provided that licensed items and services are used exclusively for commercial passenger aviation.
Within only 12 days from the SLP, on 28 January, Airbus announced an order by Iran Air for 118 new aircraft (made up of 21 A320ceo family, 24 A320neo family, 27 A330ceo family, 18 A330-900neos, 16 A350-1000s and 12 A380s) in a deal worth USD 25 billion at list prices, signed in the presence of presidents Hassan Rouhani of Iran and Fran.ois Hollande of France. The first deliveries are said to be scheduled to take place as early as July 2016, with the A380s beginning to arrive in 2019 and the entire order to be fulfilled by 2022. Iran's flagship carrier, Iran Air, has said that it will require as many as 580 new aircraft (including the Airbus order) over the next ten years, with 300 of those required in the next five years. It is not publicly available knowledge how these aircraft will be financed, although Airbus has said that it might provide some temporary finance. It should also be noted that it is uncertain how committed this transaction is, and that because the aircraft have more than 10% US-origin equipment on them OFAC approval will be required (we discuss this further below).
Despite the deputy head of Iran's Civil Aviation Organization being quoted as specifying that 80 new aircraft will be purchased each year, to be split between Airbus and Boeing, it is unclear how soon a deal with Boeing would be agreed. Boeing was given clearance in February by the US government to hold talks with Iranian airlines about potential deals, and has conducted talks over the past few months. Aside from Airbus and Boeing, Iran Air agreed on 1 February to purchase 40 ATR-600s turboprops from ATR, the French-Italian manufacturer. This deal, valued at USD 1.1billion at list prices, included firm orders for 20 aircraft and 20 options.
It is important to note that OFAC has not issued a general license, which would have permitted the above transactions to take place without any further authorization from OFAC. Rather, OFAC will evaluate and provide case-by-case licensing of the export, reexport, sale, lease or transfer to Iran of commercial passenger aircraft, spare parts and components for such aircraft, and associated services, all for exclusively commercial passenger aviation. Specific licenses issued pursuant to the SLP will include appropriate conditions to ensure that licensed activities do not involve, and no licensed aircraft, goods or services are resold or retransferred to, any person on OFAC's SDN List.
The SLP addresses US-origin commercial passenger aircraft or commercial passenger aircraft that contain 10% or more US-origin content (i.e. where US-origin goods comprise more than 10% of the total value of the foreign-made goods). The affected aircraft include: wide-body, narrow-body, regional and commuter aircraft used for commercial passenger aviation. The types of aircraft not eligible for licensing under the SLP include cargo aircraft, state aircraft, unmanned aerial vehicles, military aircraft and aircraft used for general aviation or aerial work. The 10% US-origin issue is a major consideration when proposing to deal with Iran: prospective sellers and lessor are well aware that most aircraft have at least 10% US-origin equipment on them, so they will need OFAC approval for any sale/lease (including a wet lease). This rule applies to both second-hand and new aircraft – OFAC has yet to approve the Airbus and ATR deals with Iran referred to above.
US persons are authorized to engage in transactions that are "ordinarily incident to a licensed transaction and necessary to give effect thereto". According to the FAQs issued by OFAC, such services include transportation, legal, insurance, shipping, delivery and financial payment services provided in connection with the licensed export transaction. An example provided by OFAC of a service ordinarily incident to the licensed export transaction service would be where a US person provides insurance to cover the shipment of a licensed component from a US manufacturer to an Iranian customer. In contrast, a US person's provision of insurance to cover the component over a period of years after it has been exported to Iran would not be ordinarily incident to the licensed export transaction and would require separate authorization from OFAC.
Finally, as previously mentioned, the SDN List and the Department of Commerce's Denied Persons List and Entity List should be consulted in connection with compliance due diligence procedures.
Transactions authorized by OFAC pursuant to the SLP generally do not need separate authorization from the Department of Commerce, which regulates exports of US-origin and US-content goods pursuant to the US Export Administration Regulations ("EAR"). The Bureau of Industry and Security (BIS) maintains licensing requirements on exports and reexports to Iran under the EAR. The EAR could be implicated irrespective of the percentage of US origin content in the Aircraft. The EAR provides a list of categories of items that cannot be reexported to Iran without a license. To avoid duplication, exporters or reexporters are not required to seek separate authorization from BIS for an export or reexport subject both to the EAR and to OFAC's Iranian Transactions Regulations. Therefore, if OFAC authorizes an export or reexport, such authorization is considered authorization for purposes of the EAR as well. Transactions that are not subject to OFAC regulatory authority may require BIS authorization.
It is clear from Iran's recent orders with Airbus and ATR that its appetite for new aircraft is high and, with the recent lifting of sanctions, there is a clear opportunity for suppliers of both aircraft and aircraft parts and providers of related services to do business with Iran. One risk concerning lessors in particular is snap back – the possibility of Iran violating the conditions of the sanctions lifting regime, leading lessors to be forced to repossess aircraft from a jurisdiction where repossession rights are not yet fully defined. For this reason many market participants are saying that for now they are more comfortable with selling rather than leasing. Many market commentators believe that lessors will lease aircraft into Iran but will begin wet leasing them before dry leasing them.