Client Alert

INSTEX and Europe’s “Legitimate Trade” with Iran

Skepticism prevails as Instrument for Supporting Trade Exchanges (INSTEX) is created but still not operational yet

21 Feb 2019

Executive Summary

Three weeks ago, France, Germany, and the United Kingdom (the “E3”) created INSTEX SAS (Instrument for Supporting Trade Exchanges, INSTEX), an entity designed to enhance business between the EU and Iran and to serve as a core element of a broader barter and clearing scheme. A joint statement by the E3 foreign ministers announced INSTEX on January 31, 2019, and noted that additional steps would be needed to make the system work. The new entity is intended to facilitate “legitimate trade between European economic operators and Iran” and thereby preserve the Iran Nuclear Deal, a political goal of the E3 and the EU strongly re-emphasized by German Chancellor Angela Merkel at the Munich Security Conference this past weekend.

While additional elements required for the system and its operationalization are still to be defined, transatlantic tensions and business risks around INSTEX and its barter scheme remain. INSTEX is said to be initially focusing on trade involving medicine, medical devices, and agri-food goods. The E3, who serve as shareholders of the company, however, stress that INSTEX would be open to becoming a broader platform involving additional goods and participants from other countries. Details of the overall structure of the mechanism as well as the entities and transactions to be involved will determine if and to what extent the use of INSTEX is “legitimate” under applicable sanctions laws, and if the overall amount of transactions will be sufficient to ensure the general viability of the system. While important details about the barter mechanism are missing, Trump administration officials raised concerns, warning that the U.S. government would closely monitor INSTEX’s activities and, if needed, sanction companies that use INSTEX for “anything other than humanitarian activity.”

The key takeaways are:

1.  Following the termination of the United States’ participation in the Joint Comprehensive Plan of Action, JCPOA), the snapback of U.S. sanctions against Iran, and the adoption of EU counter-measures, in particular the updating of the EU Blocking Statute, companies planning or conducting Iran-related business are operating in an extremely complex political and legal environment. This also applies to INSTEX itself, and to any businesses planning to use INSTEX once it is operational. Prior to acceding to the barter scheme, any participant will need to conduct a thorough compliance and business risk assessment.

2.  Details of the barter and clearing mechanism around INSTEX are still to be defined by the E3. Generally speaking, INSTEX apparently is supposed to serve as a centralized institution offsetting EU exports to Iran against EU imports from Iran, balancing the accounts of EU companies and rendering the difficult direct transfers between the EU and Iran via financial institutions largely obsolete.

3.  Recent reports suggest that INSTEX would review the transaction documentation and approve Iran-related exports and imports, adding the respective transaction value to barter accounts maintained by INSTEX. It would then clear the process allowing for a direct payment to be made from the EU importer’s bank to the EU exporter’s bank. This process would also apply on the Iranian side, where the Iranian importer would make the payment to the Iranian exporter upon clearance by an Iranian entity similar to INSTEX. If the respective amounts match, in theory no payment from the EU to Iran or vice versa would be needed. The banks involved would, however, still need to transfer money within their own jurisdictions in connection with Iran-related business, which could provide a continuing stumbling block to the success of INSTEX, given the reluctance of global banks to engage in any business involving Iran.

4.  One of the key factors for the analysis of potential compliance risks resulting from any participation in trade with Iran through INSTEX will be the types of transactions INSTEX would allow to be included in the barter scheme. Initially, INSTEX plans to focus on the sectors most essential to the Iranian citizens, in particular the health care and food sectors. However, INSTEX is supposed to cover a broader scope of industries in the future and be open to economic operators from third countries who wish to trade with Iran, making it difficult for companies to precisely assess mid-term risks when deciding whether to participate in the scheme right away. At this stage, it is thus to be doubted whether and to what extent INSTEX will succeed in providing the anticipated safe haven for “legitimate trade” with Iran, and the risk of U.S. sanctions exposure for EU companies remains.

5.  The general principle of the barter scheme requires substantial exports from Iran into the EU. Oil-related transactions would bring the transaction volume needed for the system’s viability, but would be subject to U.S. secondary sanctions if no waiver applies. U.S. government officials have already indicated that existing temporary oil waivers granted to Greece and Italy, amongst others, are unlikely to be renewed when the current waivers expire in a few months. Hence, the overall system’s sanctions exposure would be considerably increased if oil transactions were included, rendering it less attractive for EU companies to join. If oil transactions were not included, however, the sanctions risk of INSTEX would diminish, but so, too, would the system’s viability, given that there likely would be insufficient EU imports from Iran to offset EU exports to Iran.

6.  Finally, options to obtain sufficient comfort from the U.S. government are limited under the current political and legal setup. Although business with Iran beyond mere humanitarian trade is permissible under the current U.S. sanctions program, it is unlikely that the E3 and the U.S. government will agree publicly on the legitimacy of INSTEX’s broader operations and thereby provide the necessary comfort to EU businesses and their banks. Also, INSTEX and other EU operators would have to comply with the EU Blocking Statute and its prohibitions against seeking a license from U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) for their specific Iran-related transactions. However, discussions with OFAC to ascertain the exact extent of U.S. secondary sanctions and how these might impact INSTEX and its users would be allowed.

The E3 decision to implement INSTEX

In their joint statement announcing the creation of INSTEX, the E3 re-affirmed their strong commitment to preserve the JCPOA. With INSTEX’s registration as a société par actions simplifiée (a form of a simplified limited liability company by shares) under French law based in Paris, the E3 implemented the so-called Special Purpose Vehicle as envisaged since September 2018 to facilitate trade between European businesses and Iran.

The creation of INSTEX is a reaction to the U.S. government’s withdrawal from the JCPOA and the U.S. re-imposition of Iran secondary sanctions. The second phase of snapback, implemented on November 5, 2018, targeted in particular Iran’s financial sector as well as its energy sector and oil exports. As a result, non-U.S. individuals and entities investing in Iran as well as foreign financial institutions financing the respective transactions are confronting a significant risk of U.S. sanctions enforcement. In particular, financial institutions that engage in the targeted transactions risk being excluded from access to correspondent banking accounts in the United States. INSTEX was created to bridge the gap left by financial institutions. Small and medium-sized businesses in the EU are particularly waiting to make use of this alternative, and the Iranian government is pushing the E3 to operationalize INSTEX and the overall barter mechanism promptly.

EU-Backed Barter System as alternative to Transfer of Money

INSTEX is meant to serve as a core institution for European businesses seeking to establish an alternative mechanism to the transfer of money via global financial institutions. In particular, the proposed system aims to avoid any use of U.S. dollars or the U.S. financial system, and to limit the need for money transfers between non-U.S. entities based in the EU and its Iranian business partners (and their respective banks).

According to comments published on INSTEX, the key role of INSTEX would be to approve sales by EU companies to Iran and include the transactions’ value in barter accounts maintained by the new vehicle. This would equally apply to imports of Iranian products by EU companies. INSTEX would review the respective documentation of the registered export and import. It would then clear the process so that a direct payment from the EU importer’s bank to the EU exporter’s bank can be issued. This process would also apply on the Iranian side, where the Iranian importer would make the payment to the Iranian exporter following clearance by the (future) Iranian clearing entity.

At a first stage, the E3 as the entity’s shareholders will govern INSTEX. The French company will be managed by a German banker and it is reported that a UK representative will head the supervisory board composed of diplomats from the E3 countries. Further EU Member States are expected to contribute to INSTEX at a second stage of development while the EU itself supports the creation and operationalization efforts of the entity. EU High Representative Federica Mogherini welcomed the E3 initiative and registration of INSTEX and indicated that the scheme may be opened for non-EU countries at a later stage.

To make the envisaged scheme work, Iran must establish an effective and transparent corresponding entity, which remains a difficult challenge given the lack of transparency in the Iranian financial system. The E3 emphasized that INSTEX will respect and apply the highest international anti-money laundering (AML) and combating the financing of terrorism (CFT) standards as well as ensure EU and UN sanctions compliance. Iran officials responded that the E3 should implement the system quickly, and that Iran does not accept additional conditions to those agreed under the JCPOA.

Business Risks Remain at times of an apparent Conflict of Laws

INSTEX plans to support “legitimate trade with Iran” and refers to its compliance with EU and UN sanctions as well as AML and CTF standards. Also under the JCPOA, certain EU sanctions against Iran remain in effect, have even further evolved recently with the listing of additional Iranian persons, and may continue to do so. The Council of the EU, in its conclusions on Iran of February 4, 2019, expressed again its concerns with regard to Iran’s role in the context of growing tensions in the region, including Iran’s involvement in the Syria conflict. The Council is even more concerned about Iran’s ballistic missile activity and the hostile activities carried out against individuals within EU territory.

In addition to remaining EU sanctions against Iran, EU businesses will have to comply with the EU Blocking Statute. According to the EU Commission’s guidance note, the EU Blocking Statute does not allow EU companies to immediately apply for an OFAC license with respect to a specific Iran-related transaction. Rather, the company, and technically also INSTEX, would need to ask the EU Commission to grant an authorization for any application to OFAC. It remains in doubt whether the E3 and/or the EU will agree to cooperate with the U.S. government to define the exact scope of “legitimate transactions,” a path that Switzerland seems to have taken with respect to the Swiss payment channel currently planned especially for transactions in the pharmaceutical sector. However, the EU Commission clarified in its guidance note to the EU Blocking Statute that discussions with OFAC to understand the exact scope of the U.S. secondary sanctions and the potential impacts on business are still allowed, a step which INSTEX and companies using the barter scheme may want to consider.

The U.S. government’s initial reaction to INSTEX was relatively muted, but the tone is getting sharper. Vice President Pence, in a speech in Poland last week, said the E3 “call this scheme a ‘Special Purpose Vehicle.’  We call it an effort to break American sanctions against Iran’s murderous revolutionary regime.  It’s an ill-advised step that will only strengthen Iran, weaken the EU, and create still more distance between Europe and the United States.” According to media reports, more recent statements also include a warning by the U.S. ambassador to the EU who stressed that EU companies that use INSTEX for anything other than humanitarian activity would be sanctioned.


With important elements of the barter system around INSTEX still a “work in progress,” it remains doubtful whether INSTEX will provide the anticipated safe haven for “legitimate trade” between EU businesses and Iran. European companies with U.S. business will likely remain hesitant to trade with Iran over concerns they could be hit with U.S. penalties. At least initially, INSTEX will thus likely only attract small and medium-sized European companies with no or little links to the U.S. While the backing by three powerful EU Member States as shareholders of INSTEX and the blessings of EU institutions may help to lower the risks of immediate U.S. sanctions enforcement against those involved in the barter mechanism to a certain degree, the U.S. government should be expected to strictly enforce its sanctions program should the barter system enable trade with sanctionable products or services, or reach an overall amount which contributes to a significant improvement in Iran’s economy.



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