risk focus - JLT Specialty

RISK FOCUS CREDIT, POLITICAL & SECURITY RISK BULLETIN APRIL 2016

Iran Despite the relaxation of international nuclear-related sanctions on Iran in January 2016, elevated geopolitical risks will inhibit investor enthusiasm over the next year. The divided political sphere means that the potential duration of Iran’s new relatively open stance is uncertain.

POLITICAL & SECURITY ENVIRONMENT It is likely that the next year will be marked by increasing friction between moderate and hard-line factions as Iran’s interaction with the international community aggravates pre-existing ideological tensions. The first round of the parliamentary elections in March 2016 saw moderate candidates perform strongly in the polls, winning 83 seats against the conservatives’ 64 seats.

While this has raised hopes that

Hard-line factions remain highly

President Rouhani may be able to

influential in key institutions including the

secure an effective majority, the

judiciary and the Iranian Revolutionary

composition of the 290-member body

Guard Corps (IRGC). The banning of

remains unclear, with a large number of

thousands of reformist candidates by

candidates yet to join a political bloc and

the conservative Guardian Council in the

nearly 60 seats still to be decided in a

lead-up to the parliamentary elections

run-off in April 2016. Even if moderate

demonstrates that such groups remain

candidates succeed in dominating

strongly opposed to President Rouhani’s

the legislature, President Rouhani will

reformist agenda and will continue to

nevertheless face an uphill struggle to

attempt to obstruct meaningful political

consolidate Iran’s recent openness with

and economic change.

the international community.

2 CREDIT, POLITICIAL & SECURITY RISK BULLETIN | Iran | April 2016

Much depends on President Rouhani’s

are likely to escalate further in 2016/17,

countries. Both are increasingly involved

ability to maintain relations with Ayatollah

although a major military confrontation

not just as sponsors of domestic

Ali Khamenei. Iran’s Supreme Leader

remains relatively unlikely. The execution

actors such as the Syrian authorities

is seemingly in favour of economic

of Shi’ite cleric Nimr al-Nimr in Saudi

and Iraqi militias, but on the ground.

progress, demonstrated by his support

Arabia in early January 2016 was met

Iran’s military presence in Iraq and Syria

of negotiations over the removal of

with outrage in Iran, culminating in

is estimated at 2,000-3,000 fighters

international sanctions, but not at the

the storming of the Saudi Embassy

including members of the IRGC and

expense of the regime’s ideological

in Tehran on 3 January 2016. Saudi

the al-Quds force. Saudi Arabia, which

principles. With President Rouhani

Arabia’s subsequent decision to cut

has been launching airstrikes against

seemingly bypassing such revolutionary

diplomatic ties elevates geopolitical risk

Iranian-backed Houthi rebels in Yemen

ideals by favouring foreign investment

in the Gulf region. This comes at a time

since March 2015, has also offered

over self-sufficiency, there is likely to

when the Saudi royal family reportedly

to deploy ground troops to Syria,

be increasing tension between the two

faces growing internal destabilisation, a

possibly in conjunction with Turkey.

political figures in 2016/17. This heightens

scenario that was highly unlikely before

In February 2016, it deployed military

the risk of Iran tightening restrictions on

King Salman’s rise to power in January

personnel and aircraft to Turkey’s Incirlik

trade and foreign investment.

2015. This may cause it to take a more

military base, raising the likelihood of

aggressive stance towards external

a possible ground operation in Syria.

issues in 2016 as it attempts to divert

Saudi Arabia is expected to maintain

attention from its domestic troubles.

this robust stance throughout 2016.

More importantly, President Rouhani faces re-election in June 2017. In the meantime, hard-line factions will look to re-establish their authority and weaken

On-going proxy conflicts in Yemen, Iraq

his leadership. Regardless of the political

and Syria, which are unlikely to settle

outcome, President Rouhani’s successor

down in the next year, raise the risk of

is unlikely to be as moderate, which may

direct confrontation between the two

lead to a realignment in Iran’s stance to the international community.

REGIONAL VOLATILITY AND IRAN Regional volatility will also continue to impact business confidence. Political tensions between Saudi Arabia and Iran

Political tensions between Saudi Arabia and Iran are likely to escalate further in 2016/17, although a major military confrontation remains relatively unlikely.

In a show of strength, the Kingdom held a multinational military exercise in February 2016, involving troops from 20 countries including Jordan, United Arab Emirates (UAE), Bahrain, Senegal, Malaysia and Tunisia. Iran and Saudi Arabia’s military operations, combined with a lack of diplomatic dialogue, heighten the threat of an incident occurring along the lines of Turkey’s shooting down of a Russian jet in November 2015. While it is unlikely that Iran or Saudi Arabia will actively seek to engage in a major interstate conflict in the next year, it is conceivable that a small-scale (even accidental) incident could escalate into a localised sectarian conflict. This is a worst case scenario, but should not be ruled out. The regional and global impact of a major military confrontation between Saudi Arabia and Iraq would be considerable, with key land and maritime trade routes such as the Persian Gulf affected and oil production from the two countries and wider region heavily restricted (although global oil surpluses would cushion the impact of such a scenario on oil markets in the medium term).

www.jltspecialty.com | Iran 3

It would also provide Islamic State (which has carried out a number of attacks in both countries) with the perfect environment to exploit existing Sunni/Shia divides, which would likely translate into an increase in acts of terrorism in Saudi Arabia and Iran. That said, confrontations between Saudi Arabia and Iran are likely to remain political in nature (excluding indirect involvement in Yemen, Iraq and Syria) in 2016, with the underlying possibility of isolated military incidents.

TRADING ENVIRONMENT The relaxation of international sanctions has set the stage for Iran to re-energise its USD400bn economy over the coming years. The country has strong economic growth potential, being more diversified than other oil exporting nations, and offers an array of commercial opportunities. Ironically, the weight of sanctions forced Tehran to initiate structural reforms much sooner than its competitors, which has equipped it with a strong fiscal base. Iran’s reintegration into the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network will improve investment and trading conditions, further strengthening its non-oil sectors. It will also benefit from a USD50bn windfall in unfrozen foreign reserves, which will boost liquidity and enhance the ability of the central bank to manage the exchange rate. These factors should underpin significant GDP growth in the coming years, with rates forecast to increase from 0.9% in 2015, to 4.5% in 2016 and 5.4% in 2017. Medium term economic growth will be largely driven by Iran’s return to global oil markets, in spite of continuing low oil prices. Iran’s crude oil exports fell by roughly 50% between 2012 and 2015, with the country dropping from the second-largest producer in the world to the seventh. It is now predicted to increase total crude exports by 600,000bpd by the end of 2016, with further raises expected in 2017 and 2018.

INVESTMENT ENVIRONMENT Iran offers significant commercial

to Tehran’s aim to achieve a fourfold increase in steel production to 55m tons per year by 2025.

opportunities, although its fragile and

Unsurprisingly, Iran’s energy sector,

relatively untested investment environment

which encompasses the world’s second-

will be a major obstacle to foreign

largest proven natural gas reserves

involvement in the medium term. President

and fourth-largest crude oil reserves,

Rouhani aims to generate foreign direct

is seeing strong foreign interest. The

investment (FDI) inflows of at least

government has suggested that over

USD90bn in 2016. Given the country’s

USD100bn is needed to rebuild ageing

long term economic isolation, many key

energy infrastructure. International energy

sectors require substantial investment,

companies are therefore poised to take

particularly oil and gas, mining, aviation,

advantage of this. Major oil contracts

auto industries and infrastructure.

have already been signed with French company Total, Spanish Cepsa and Russian Litasco, amongst others. Many

Iran offers significant commercial opportunities, although its fragile and relatively untested investment environment will be a major obstacle to foreign involvement in the medium term.

such agreements are being pursued in order to widen the scope for involvement in exploration and production activities, particularly in Iran’s major South Pars field. Meanwhile, German industrial group Siemens, which halted its involvement in Iran in 2010, has agreed to aid Iranian firm Mapna in enhancing the country’s

So far in 2016, Iran has reached

power infrastructure.

agreements totalling an estimated

Foreign interest is also high in Iran’s

USD50bn with a number of countries

auto and aviation sectors. French

including France, Russia, South Korea,

company Peugeot-Citroen, which sold

Japan, Austria, Germany and Italy, while

nearly 500,000 vehicles annually in Iran

major trade delegations from France,

before 2012, has signed a USD436m

Italy, Germany and China have visited

agreement with major car firm Iran

Tehran. Business agreements worth

Khodro. Airbus has also reportedly

USD18bn were signed in Italy alone in

agreed to sell 118 planes worth

January 2016, including a joint steel

USD27bn to Iran Air, while German

production venture involving Italian steel

aviation firm Lufthansa is to provide

company Danieli. This should contribute

maintenance services to the airline.


INVESTMENT CHALLENGES While these agreements are a promising sign, the realities of operating in Iran will ensure that investor sentiment is rightly marked by extreme cautiousness in the medium term. First and foremost, the compliance burden for foreign companies looking to conduct business in Iran remains significant. Tehran declared the country ‘open for business’ following the relaxing of nuclear-related sanctions in January 2016. However, the political assertions surrounding the removal of these measures are considerably more advanced than the legal and practical changes required by

sanctions, which has seen international

inconsistent judicial decision-making,

banks pay billions of dollars in fines to

not to mention high levels of political

US authorities in recent years. Most

interference. An inherent distrust of

significantly, in 2014, BNP Paribas was

foreign companies means that local

fined USD9bn by the US authorities.

businesses are likely to benefit from

Several Iranian banks remain black-listed,

preferential treatment with regards to

including Ansar Bank, Bank Saderat

credit and state contracts. These factors

Iran, Bank Saderat PLC and Mehr Bank.

are underpinned by endemic corruption

Trading restrictions on US dollars also

at all levels of government and business,

remain in place, a limitation exacerbated

raising the risk of costs to foreign

by the lack of an effective mechanism

companies stemming from bureaucratic

for non-dollar transactions. Moreover,

delays and legal disputes.

the domestic banking sector is weak and undercapitalised, affected by years of sanctions and state interference. As such, financing options are limited.

AN ELEVATED RISK OF ‘SNAP-BACK’ These factors are compounded by the

foreign entities. There continue to be

Another prominent concern for exporters

risk that sanctions could be re-imposed,

high legal risks associated with residual

comes from Iran’s high tariff rates, which

a scenario that remains a distinct

European Union (EU) and US non-

currently range from 4% to 100%. In

possibility, albeit supposedly a last resort.

nuclear sanctions. For EU companies,

2011, the mean tariff rate for all imported

In March 2016, the IRGC carried out

a key concern is unknowingly engaging

products was 25.36%. The impact

ballistic tests ostensibly involving nuclear-

with individuals and entities listed under

of this may force companies to move

capable missiles, ensuring that fears

EU and US terrorism-related sanctions,

production into Iran itself or to work in

regarding the escalation of the missile

particularly the IRGC and its subsidiaries.

partnership with domestic firms. The

programme and a subsequent sanctions

The IRGC controls large sections of the

wider tax system is equally challenging,

‘snap-back’ will remain prominent. It is

economy and its use of front companies

being renowned for its complex and

worth noting that re-imposed UN and

means that its business presence is often

inconsistent nature.

EU sanctions would not be imposed

unclear. It is therefore crucial for foreign businesses to conduct extensive due diligence before signing contracts. A number of other activities remain banned under EU sanctions, largely those relating to the trading of military goods and technology and related brokering and financial services. In March 2016, two UK-registered companies, Aviation Capital Solutions and Aircraft, Avionics, Parts & Support (AAPS) were sanctioned by the US for securing financing and equipment for the blacklisted Iranian airline Mahan Air. The caution being shown by global banking markets is another key obstacle for foreign companies. Despite strong political appetite for trade and investment with Iran to open up, major EU banks will be reluctant to process Iranian transactions in the medium term due to the enduring risk of violating US

Basic legal protections needed to support foreign investment are underdeveloped due the country’s long term economic isolation. Key concerns include intellectual property (IP) protection, ownership of assets, and

retroactively to contracts signed with Iranian businesses prior to the date of ‘snap-back’, thereby granting companies a limited period of time in which to phase out their activities. However, a clear exit strategy and crisis management framework is nevertheless crucial.

www.jltspecialty.com 5

WORLD RISK REVIEW RATINGS FOR APRIL 2016 - IRAN Currency Inconvertibility & Transfer Risk 10

9

Country Economic Risk

Sovereign Credit Risk

8

7

6

5

4

3

War & Civil War

Expropriation

2 1

Contractual Agreement Repudiation

Terrorism

IRAN

1 = Low Risk 10 = High Risk

Strikes, Riots & Civil Commotion

= Under Review

Legal & Regulatory Risk

Iran Strikes, Riots & Civil Commotion

3

Terrorism

4

War and Civil War

6

Country Economic Risk

6

Currency Inconvertibility & Transfer Risk

8

Sovereign Credit Risk

7

Expropriation

8

Contractual Agreement Repudiation

8

Legal & Regulatory Risk

7

Countries are rated between 1 and 10. 1 = Low Risk, 10 = High Risk.


JLT Specialty Limited provides insurance broking, risk management and claims consulting services to large and international companies. Our success comes from focusing on sectors where we know we can make the greatest difference – using insight, intelligence and imagination to provide expert advice and robust - often unique - solutions. We build partner teams to work side-by-side with you, our network and the market to deliver responses which are carefully considered from all angles. As one of the world’s strongest credit, political and security risks teams we help banks, commodity traders and corporations to understand, mitigate and transfer the effects of political and country economic risk, counterparty (credit) risk, political violence and kidnap & ransom. Through a relationship driven, consultative approach we use a systematic methodology to quantify, prioritise and minimise your company’s political risk, security and trade credit exposures.

CONTACTS RUTH LUX Senior Consultant, JLT Specialty +44 (0) 20 7886 5409 [email protected] JAMES CUBITT Consultant, JLT Specialty +44 (0) 20 7466 6697 [email protected]

INSURANCE IMPLICATIONS Sanctions relief will affect insurers to varying degrees dependent upon which sanctions regime(s) they are subject to and which sanctions regime(s) the parties they deal with are subject to, such as EU and US regimes. UK and US regulators issue regular guidance and insurers should ensure they keep up to date. A series of due diligence recommendations have been made by Lloyd’s, when exploring potential Iranrelated business. These include but are not limited to: • Extensive screening on a case

by case basis, including of counterparties. There is a risk of reputational exposure and residual EU and US secondary sanctions must be considered; • Lead/ follow concerns – ahead of

finalising any commitment, contract alterations including binding a risk formerly subject to sanctions and the deletion of territorial exclusions on policies must be committed to on a slip by all underwriters, with reference to all relevant Iranian sanctions; • ‘Snap-back’ provisions must be

considered and suitable exclusion clause(s) and rights of termination should be used;

• Activities which are prohibited

under US primary sanctions must not be paid for in USD, where Iranrelated business is concerned; • Reinsurance and retrocession

cover may be inhibited by continuing sanctions. This should be duly considered; • Position of managing agents’

banks - Iran-related risks can only be underwritten if banks agree to process financial transactions, however internal compliance policies and legal constraints may affect this; • Bribery risk and money laundering

should be duly considered; • Claims – Covers legally bound after

Implementation Day are not subject to sanctions. A cover legally bound prior to Implementation Day, with payment obligations arising after Implementation Day, will be respected. It is not significant whether the entity was previously subject to sanctions. However, claims related to covers bound prior to Implementation Day may not necessarily be paid if they were in breach of the sanctions in place at the time; there is no retrospective effect to the sanctions relief implemented from Implementation Day.

JLT Specialty Limited The St Botolph Building 138 Houndsditch London EC3A 7AW www.jltspecialty.com Lloyd’s Broker. Authorised and regulated by the Financial Conduct Authority. A member of the Jardine Lloyd Thompson Group. Registered Office: The St Botolph Building, 138 Houndsditch, London EC3A 7AW. Registered in England No. 01536540. VAT No. 244 2321 96. © April 2016 271746

This publication is for the benefit of clients and prospective clients of JLT Specialty Limited. It is not legal advice and is intended only to highlight general issues relating to its subject matter but does not necessarily deal with every aspect of the topic. If you intend to take any action or make any decision on the basis of the content of this bulletin, you should first seek specific professional advice.