As part of the effort to salvage the Iran nuclear deal, European governments have vowed to sustain their economic ties – not least their banking connections – with Iran. From 4 November, American sanctions targeting Iran’s banks will make it extremely difficult for European companies to engage in transactions with firms in the country. Many of the pathways to reduce the secondary impact of US secondary sanctions on the European financial sector present significant technical and political challenges – which stem from the US financial system’s global dominance and the integration of the US and European banking sectors. Moreover, the Iranian financial sector must take several proactive steps to ensure it meets the international compliance standards European banks require.
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In this series of commentaries, ECFR assesses the likely impact of US sanctions on economic ties between Europe and Iran, covering strategically important areas such as trade in essential goods, energy, and banking. The series examines how European governments can minimise the fallout of their attempts to maintain Iranian compliance with the nuclear deal.
Part 1: Trump’s Iran sanctions: an explainer on their impact for Europe
Part 2: Iran: The case for protecting humanitarian trade
Part 3: Can Iran weather the oil-sanctions storm?
Part 4: Bankless task: can Europe stay connected to Iran?
Part 5: Iran oil exports: 8 waivers and the upcoming OPEC meeting
Part 6: Trading with Iran via the special purpose vehicle: How it can work
The banking blockage
With the incoming US sanctions, European companies face an even greater struggle to engage in transactions with Iran. For instance, Swedish automaker Volvo is leaving Iran because, as one of its spokesman put it, “with all these sanctions and everything that the United States put [in place] … the [banking] system doesn’t work in Iran … We can’t get paid.”
This problem has driven most of the multinationals once active in the Iranian market to suspend their operations there, ahead of the new round of US sanctions. There is a widespread expectation that several Iranian private banks and the Central Bank of Iran will be designated entities under the measures.
Some European companies, such as Airbus and Total, require a licence or waiver from the US authorities to continue their operations in Iran, as they work in sectors subject to targeted sanctions. Many areas of Iranian trade, such as that in basic goods, are either unsanctionable or will be exempt from the measures. Yet US sanctions have adversely affected even these areas, as outlined in a recent ruling of the International Court of Justice.
Such restrictions on trade arise from the contamination risk that US secondary sanctions pose to European financial institutions, which generates unique pressure on the Iranian banking sector. This risk combines with Iran’s current shortfalls in meeting its commitments under a Financial Action Task Force (FATF) action plan – although the recent passage of the Combating Financing of Terrorism Bill suggests that Tehran is raising its compliance standards. Until the FATF changes Iran’s designation as a high-risk jurisdiction, global financial institutions will limit their dealings with Iranian banks.
Since President Donald Trump withdrew the US from the Iran nuclear deal in May this year and announced the re-imposition of secondary sanctions on Iran, banks in Europe have come under growing direct and indirect pressure from American regulators. Following the repeal of international sanctions on Iran in 2016, many large European banks began quietly facilitating transactions involving Iran for their largest industrial clients, especially those with long-standing operations in the country. Among these institutions, Danske Bank was the most visibly open to business with Iran, even opening a €500 million line of credit to support Danish firms’ expansion in the country. But as it falls into disrepute over suspected money laundering at its Estonian subsidiary, Danske Bank has opted to cease transactions involving Iran as an immediate show of responsiveness to US regulators. More broadly, banks tend to jettison their business with Iran if regulators exert pressure on them, even in the absence of a direct compliance issue.
Meanwhile, small European banks are coming under pressure from their larger competitors. When these institutions, which have relatively limited exposure to the US financial system, engage in Iran-related transactions, their routine SEPA transfers – payments to other banks within the Single European Payments Area – are often refused outright. This isolates the banks and complicates other aspects of their business. And the refusals extend beyond Europe. Asian banks have shown increasing concern about dealing with small European financial institutions that engage in business with Iran, understanding that they too could fall foul of the US authorities.
Europeans banks have been reluctant to engage with Iran due to fears about the response from their shareholders and creditors. This is most clear in the case of the European Investment Bank (EIB), which has refused to invest in Iran. European governments (which number among the bank’s shareholders) encouraged the EIB to consider lending to Iran, but the bank’s leadership felt that investing in the country would jeopardise its ability to raise capital from American institutional investors in the bond market.
Europe’s possible solutions
Despite their efforts to sustain economic channels with Iran, European governments have been unable to ease this pressure on banks. With US sanctions on Iran’s banking sector due to come into effect soon, European countries are now considering measures that would facilitate trade transactions with Iran through a new legal and institutional structure.
European countries are now considering measures that would facilitate trade transactions with Iran through a new legal and institutional structure
On the sidelines of the recent United Nations General Assembly, EU High Representative Federica Mogherini announced that “EU Member States will set up a legal entity to facilitate legitimate financial transactions with Iran and this will allow European companies to continue trade with Iran, in accordance with European Union law, and could be opened to other partners in the world”.
European governments have been reviewing this legal entity, known as a Special Purpose Vehicle (SPV), for months. The timing of this public announcement suggests that they have a degree of confidence that the SPV can become operational, and that Europe can use the model to showcase its ability to deliver on its commitments.
US Secretary of State Mike Pompeo immediately responded that he was “disturbed and indeed deeply disappointed” at the news. US National Security Advisor John Bolton commented: “we will be watching the development of this structure that doesn’t exist yet and has no target date to be created. We do not intend to allow our sanctions to be evaded by Europe or anybody else.”
There remains scant detail on the SPV. In her statement, Mogherini added that more information will become available “as the technical work continues in the coming days”. It may be advisable for European actors involved in the creation of the SPV to keep the details private for now. Operationalising the SPV will require a period of trial and error. Making the details of the project public in its early stages would provide the structure’s opponents with further opportunities to undermine it.
Can the SPV model work?
Reportedly, an internal European Commission paper describes the European Union’s efforts to “bundle and reduce cross-border payments to and from Iran”. In this way, the SPV would “avoid or severely restrict the role of commercial banks in the payment system and protect payment transactions with Iran from US sanctions”. European policymakers’ apparent consideration of this approach indicates that they want to avoid placing critical European financial institutions, such as the EIB, in the crosshairs of the Trump administration.
To operationalise the SPV, policymakers will need to quickly make progress in several technical areas. Firstly, European governments need to determine how aggressively they will push back against US sanctions; this is a consideration of the first order for the structure and operation of the SPV. Theoretically, the SPV could facilitate payments for what the US authorities consider to be sanctionable activity. Indeed, European officials have openly discussed their intention to use the SPV to support purchases of Iranian oil.
As guidelines from the US Treasury’s Office of Foreign Assets Control make clear, even barter arrangements involving petroleum or petroleum products from Iran are sanctionable – on the basis that they provide “material support” to Iran’s oil industry “regardless of whether a financial institution is involved”. However, because the envisaged SPV would bypass the US financial system and foreign branches of US banks, the American authorities would have no direct jurisdiction over it. Thus, transactions the SPV facilitated would not give rise to the same kind of civil liability that led to hefty fines on Europe’s largest banks in the previous era of sanctions.
The US authorities could, in theory, prevent entities engaged in the SPV from accessing the US market. American officials have stressed that US sanctions will target European central banks and SWIFT – an international payments messaging system headquartered in Belgium – if these institutions facilitate transactions with Iran. Furthermore, this targeting would extend beyond entities engaged in oil purchases, covering all companies that use the SPV to engage in transactions with Iran – even those in sectors that are exempt from sanctions, such food and pharmaceuticals.
European governments working on the SPV will have to find a way to counter such measures. On a technical level, they may be able to use creative structuring solutions. The SPV could be set up primarily as a payment mechanism for only small and medium-sized companies that are content to be excluded from the US market. And the mandate of the SPV could initially facilitate just payments for trade that is exempt from US sanctions.
American officials have stressed that US sanctions will target European central banks and SWIFT
The SPV is most likely to succeed if takes this approach, starting off small and gradually expanding. The basic structure of the vehicle is replicable. One SPV could focus on sanctionable trade related to support for Iran’s oil, automotive, or aviation sectors. Another could be limited to sanctions-exempt trade in consumer goods, food, and pharmaceuticals – allowing multinationals to use it as a convenient payment channel. With multiple SPVs available, companies could engage with Iranian entities in accordance with their appetite for risk and their business models.
Each SPV could take a different form. It could be a stand-alone, state-owned bank; a conduit for payments that European central banks ultimately facilitate; or simply a clearing house for companies that transfer money to Iran, repatriate funds from the country, or engage in barter trade with it.
The process of establishing the SPV will prove instructive in testing the limits of America’s sanctions power and US willingness to use sanctions as a weapon against its putative allies. Reports indicate that the US Department of the Treasury is already starting to push back against the White House over proposals to sanction European financial institutions, particularly SWIFT, for maintaining ties with Iran.
Of course, creating the SPV will require significant technical work. For its part, Iran will need to demonstrate that its financial system is also continuing to reform in accordance with international standards on money-laundering and terrorism financing. European governments will closely watch the country’s progress in implementing the FATF action plan ahead of an important review on 14-19 October.
From a political perspective, Iran has drawn encouragement from European countries’ sustained and unanimous commitment to the nuclear agreement. Iranian President Hassan Rouhani praised Europe for taking a “big step” to maintain trade. Iran’s foreign minister, Javad Zarif, stated that while implementing the SPV will be difficult, Iran is willing to show “a little bit more patience” with Europe. The SPV is an important immediate contribution to improving conditions for trade between Europe and Iran, but both sides must view it as the start of a road map for long-term economic engagement.
Ellie Geranmayeh is Senior Policy Fellow and Deputy Head of the MENA Programme at the European Council on Foreign Relations.
Esfandyar Batmanghelidj is the founder of the media company Bourse and Bazaar and has spent the last five years working on business diplomacy projects between the West and Iran.
The European Council on Foreign Relations does not take collective positions. ECFR publications only represent the views of their individual authors.