Sanctions at Dusk: The Impact of JCPOA on Iran's Private Banks
The Joint Comprehensive Plan of Action— a document comprised of 159 pages, negotiated over 23 months—represents a triumph of diplomacy. It also represents one of the most important single documents ever drafted for Iran’s economy.
The first attachment of the second annex lists the various Iranian entities which can expect to receive tangible sanctions relief beginning on the so-called “Implementation Day,” or the day that the IAEA verifies that Iran has successfully completed the measures required for the curtailment of its nuclear program. Most experts expect implementation to take about six months, which, in the scheme of nearly a decade of biting sanctions, seems imminent.
Sanctions relief will be operationally significant and allow free and unencumbered transfer of funds to and from Iran, the development of correspondent banking relationships, the facilitation of trade finance, and the reopening of offices and subsidiaries in Europe.
Many banks will even earn bank access to SWIFT, although those that are designated under US Iran Transactions and Sanctions Regulations (ITSR) on the Specially Designated Nationals (SDN) list will only have assured access to SWIFT after “Transition Day,” which can occur as soon as the “Director General of the IAEA submits a report stating that the IAEA has reached the Broader Conclusion that all nuclear material in Iran remains in peaceful activities.” As such, several major banks will be to wage independent campaigns to be delisted in order to gain access to SWIFT.
Even without such financial messaging services, the range of revenue-generating activities within Iran’s banking sector is set to expand. Yet, while the range of operations will expand, it is unclear to what extent Iranian banks will become more attractive targets for investment.
Looking to specific banks that are set to benefit from the JCPOA, the private banks listed on the Tehran Stock Exchange deserve particular mention. These include Eghtesad Novin (EN) Bank, Karafarin Bank, Khavarmianeh (Middle East) Bank, Mellat Bank Pasargad Bank, and Parsian Bank.
Mellat, Eghtesad Novin, Parsian, and Pasargad Bank rank among the 30 largest companies on the TSE measured by market capitalization, and when accounting for Khavarmianeh and Karafarin Banks, the total market capitalization of these firms approaches USD $10 billion.
With a wider range of banking activities available, these companies will become more attractive investment targets for individuals and institutional investors within Iran. Therefore, we should expect Iran’s banking sector to grow as a percentage of the overall economy in the next 1-2 years as domestic investment drives growth and rising valuations.
However, it is unclear if foreign investors will be among those to invest in Iranian banks. A research note from Renaissance Capital predicts that Iran will see “$1 billion of inflows to equities within a year of sanctions ending” from foreign investors, and overall “portfolio flows could be significant as early as 2016.” However, although Global Chief Economist Charles Robertson, expects, “investors to explore opportunities ahead of time, find custodians and earmark key stocks to buy” he doubts that these target stocks “will include many banks.”
The question is whether Iranian private banks are a high-risk or low-risk investment. On one hand, the regulation of the banking sector and shareholder insistence on a degree of financial transparency will mean that Iranian private banks are probably easier due diligence targets than many of the listed Iranian industrial conglomerates. The operations of the bank itself are probably not a major source of risk. This is in contrast to the much-vaunted infrastructure, energy, and extractive industries where operations can be byzantine within sprawling companies working across many verticals.
However, two other areas of risk will remain. First, many Iranian private banks have major shareholders or clients that are quasi-state funds or holding companies. For example, 30% of Mellat bank is held by “provincial investment companies,” which are entities that hold “justice shares” designed to benefit the “poorest members of society.” The justice shares program, begun under the populist economic policy of President Mahmoud Ahmadinejad, which will remain a barrier to foreign investors who will see shareholding as exposed to ongoing political risk and issues such as money laundering.
Additionally, the presence of particular Iranian institutional investors can also expose investors to legal and political risk. Parisan Bank is 10% owned by Tadbir Investment Company, a holding company long on the radar of the US Treasury Department for its connections to Iran’s political leadership in the form of quasi-state control.
Furthermore, at a practical level, most Western investors will rely on professional portfolio managers in order to gain exposure into the Iranian market. As a recent client brief on the JCPOA from the UK law firm Stephenson Harwood notes, EU banks have been “subject to investigations by US regulators” and are “generally now taking a more risk averse approach.” As such, “time will tell what appetite there is for reengagement with the Iranian banking sector.” If there is a diminished appetite for correspondent banking, trade finance, and insurance, it is unclear how European investment banks and asset management firms will approach Iran’s equities markets. Most likely, only investors with an appetite for risk, working through emerging markets specialists, will be seen investing in Iran in the next 1-2 years.
Two actions will need to be taken for Iran’s private banks to become destinations for foreign investment in their own right. First, US and EU authorities, in the lead up to “Implementation Day” will need to announce guidelines and make public statements that will enable a better understanding of the legal and political risk landscape as it pertains to Iran’s financial sector. Second, Iranian banks must actively optimize their corporate structures, reporting practices, compliance regulations, and shareholder compositions to ensure that they can be perceived as a “safe” bet with a suitably attractive set of risk and reward.
Many have said that JCPOA is an agreement based on verification, rather than trust. The same commitment to verification will be necessary for Iranian banks to prove their worthiness to investors looking for post-sanctions wins.
Photo Credit: Unkown