As Iran reopens to international investment, risk managers are advised to proceed with caution

On 14 July, Iran and the P5+1 group – the UN Security Council members and Germany – agreed on a deal curbing Iran’s nuclear programme in exchange for sanctions relief. As the accord is implemented, Iran will gradually reopen itself to international investment. Investors will be presented with the opportunity to sell consumer goods to Iran and revamp the country’s dilapidated tourism industry, infrastructure and oil and gas sector.

Any companies that are unprepared for the deal’s complexity and its regional impacts will be left behind. The Iranian market is a difficult environment for foreign companies to do business. While Saudi Arabia and Israel oppose the normalisation of Iran’s status and will seek to derail the country’s reintegration into the world economy, only investors that fully understand the new operating landscape will be able to seize the opportunities on offer.

Regional repercussions

In the coming months, the nuclear deal will alter the balance of power in the Gulf region, reduce oil prices and anger two key US allies, Saudi Arabia and Israel. In the short and medium term, investors should remember that the Saudis and Israelis wield significant influence in Washington. They oppose any normalisation of Western relations with Iran.

In the near term, both powers will act with their allies in the US Congress to stall the removal of sanctions. In the longer term, they will lobby to maintain the spotlight not only on Iran’s nuclear activities, but also on its human rights record and support for militant groups abroad, keeping reputational risks high for investors.

To appease its regional allies and domestic hardliners, the US administration has included a clause in the deal enabling US sanctions against Iran to be reintroduced unilaterally in the case of even small Iranian breaches. Such a ‘snap-back’ can be brought against Tehran within 65 days.

This puts investments in Iran at constant risk of being stranded, should sanctions be reintroduced. Furthermore, operations in Iran will subject companies to great scrutiny, locally and internationally.

Beyond nuclear sanctions, Iran’s security services and its associates will continue to face terrorism-related sanctions, and pressure groups will closely watch companies that engage with Iranian businesses and government officials.

Both Israel and Saudi Arabia, which worry about the deal’s consequences on their regional standing, are set to create tough obstacles to its success. To Saudi Arabia, the re-emergence of Tehran as a powerful player in the Gulf clearly presents a threat to its regional dominance. Decision-makers in Riyadh worry that Iran, unfettered by restrictions, will diminish Saudi Arabia’s influence over its Gulf Co-operation Council partners by opening up new possibilities for alliances.

The Saudis also suspect that a decreased economic burden will allow Iran to redouble its efforts in Syria and Yemen, where conflicts have a strong sectarian element, pitting Shias against Sunnis.

In addition to political and military considerations, Saudi Arabia is also concerned by Iran’s projected oil output. Tehran sits atop the world’s fourth largest oil reserves, as well as the world’s second largest reserves of natural gas. When tapped, Iranian hydrocarbons will exert significant downward pressure on energy prices.

 

 

Riyadh knows that Iran will sell oil, even at low prices, to rehabilitate its finances, at least initially. The dire state of the Iranian oil industry will prevent it from ramping up oil output immediately. Yet the prospect of increased oil supplies will have an impact on Saudi Arabia’s ability to set oil prices – the all-important factor for the country’s budgeting process and its internal stability.

In Tel Aviv, Iran is seen as the ultimate threat, due to its rhetoric and its support for militant groups such as Hamas and Hezbollah. The prospect of Tehran possessing nuclear weapons or recovering economically to the point where it can contemplate serious military action is unacceptable.

As such, Israel’s behaviour towards Iran and its allies might become more aggressive, resulting in a continuation of proxy conflicts in Lebanon and the Palestinian territories.

While the long-term consequences of the region’s complex geopolitics on the business climate are as yet unclear, foreign companies that decide to operate in Iran will have to get used to greater scrutiny by regional and international actors.

The concerns of regional US allies will lead to a strong lobby against doing business with Iran – and potentially even tangible repercussions. Investors with existing interests in Saudi Arabia, for example, could find themselves in a weaker position when negotiating deals and concessions with the government if they decide to invest in Iran as well.

All of these obstacles should be on the minds of companies that are planning to enter the Iranian market.

Gradual sanctions relief

In addition to reputational issues, the Iranian deal will not end sanctions-related regulatory risks for foreign investors. The decision to remove sanctions in stages reflects US and regional scepticism towards Iran. The maze of residual sanctions imposed by US, EU and UN authorities will continue to challenge companies’ compliance units. The first wave of sanctions relief is set to enable most non-US companies and individuals to trade with Iran, although for US companies, nationals and residents, most sanctions will remain in place. This will discourage international firms with a large US presence from entering Iran.

Furthermore, the US has warned companies eyeing the Iranian market not to rush into the country before the deal is implemented over the coming year. The Department of Justice has prosecuted companies for corruption and for sanctions violations in recent years, including major European and US oil companies. And the threat of prosecution is not over.

In particular, high risks remain for foreign companies choosing local partners. Iran’s security services, particularly the sanctioned Iranian Revolutionary Guards Corps (IRGC), are estimated to control 40% of the economy, and often own companies through opaque structures known as bonyads, or charitable trusts.

Among the companies owned by the IRGC is Gharargah Sazandegi-ye Khatam al-Anbiya (GSKA), which employs more than 40,000 Iranians through hundreds of affiliated companies involved in construction, hydrocarbons, infrastructure and tourism. This highlights how difficult it is for foreign companies to avoid the security services when conducting business in Iran.

Successful market entrants will devote sufficient resources to disentangling the overlapping sanctions regimes and identifying reliable local partners. In a recent estimate, the time needed to create a navigable picture of the residual restrictions has been placed at several months, emphasising the importance of patience and planning before entering Iran.

Iran will remain a difficult place to do business, even after a deal is implemented and its consequences have become clearer. A corrupt bureaucracy and politicised judiciary will keep compliance officers up at night and challenge foreign companies’ adherence to global business legislation, including the US Foreign Corrupt Practices Act and the UK Bribery Act.

State control of the economy, estimated to be about 80% overall, will present another big challenge. Companies able to steer clear of entities such as IRGC may please regulators, but will face another problem: protectionism. The security services see sanctions removal and the arrival of foreign companies as a threat to their economic holdings. They will resist competition, whether by using allies in the bureaucracy to block approvals or by direct threats.

Joint venture path

One solution is to form a joint venture with a regional company experienced in operating in the Iranian market. UAE-based companies are well positioned to be partners for ventures in Iran – they have acted as a gateway to the country for several years. Companies from the Gulf have knowhow in tourism, construction and infrastructure, and can build on existing trade ties.

However, this position could enable them to shun Western outfits for a greater share of the profits. Emirates hotel operator Rotana has already announced plans to expand existing capacity in Iran. Regional competition will increase pressure on Western companies to move quickly without cutting corners on compliance.

Companies entering Iran will face repercussions from the deal’s regional effects, the complexity of residual sanctions and pervasive corruption in Iran. But while the geopolitics of the region will remain an immutable threat to business, there are ways to make ventures in Iran less risky – and more profitable. Thorough preparation and due diligence will determine success or failure of investments in Iran.

Ensuring adequate resources to confront Iran’s tough domestic market is key for foreign investors. For compliance teams and risk managers, monitoring the state of the sanctions framework will form the basis for a successful strategy. The costs of failure – major fines for sanctions violations – are prohibitively high. Adequate expertise, in-house or external, will allow companies to navigate the complex post-deal framework.

Gaining a solid understanding of the actors in Iran’s economic landscape is a crucial ingredient for the success of cost-intensive ventures in the tourism industry, infrastructure and hydrocarbons. Investors that are able to advance cautiously will find Iran to be rich with opportunities.

Omar El-Nahry is an analyst at risk management firm Stroz Friedberg