With a nuclear deal now clinched between Iran and the Western world, does Iran now represent an economic opportunity for private equity or a Pandora's box?
Tehran's hotels are said to be full and foreign investors may be bargain hunting in the region, hoping to cash in on an economy that has been rewarding its predominantly domestic equities investors handsomely. However none of the sanctions have been lifted yet.
On 14 July 2015, it was agreed that the sanctions imposed by the United States, United Nations and European Union on Iran could be lifted in return for verified evidence that Iran has curbed its nuclear programme. There is still a ratification process to complete and the exact timing of sanctions relief remains uncertain, being conditional on Iran's proven compliance with its commitments under the agreement. Furthermore, Iran can be required by the International Atomic Energy Agency to grant it access to suspect sites if an eight member commission comprising the United Kingdom, China, Russia, France, Germany, the United States, the European Union and Iran so requires. China, Russia and Iran have no right of veto over the remaining five. Moreover, any sanctions relief under EU or US laws is subject to "snapback" of sanctions against Iran if there is failure on Iran's part to comply with the conditions.
Government authorities continue to discourage commercial agreements in the market, even where conditional on sanctions relief. US authorities have indicated that such executory agreements are not permitted under primary US sanctions and even negotiations could cause US persons to cross the line. Despite UK Foreign Secretary, Philip Hammond advocating a willingness to assist UK businesses in taking advantage of the opportunities that may arise, the UK Government warns of the importance of conducting appropriate diligence to ensure compliance before signing contracts, even as sanctions begin to lift. It is also important to remember that sanctions are not the only obstacle to doing business in Iran. Iran remains a "high risk" jurisdiction as identified by the Financial Action Task Force (thereby posing an enhanced financial crime risk more generally and requiring enhanced due diligence measures to be taken). Of particular relevance to US and non-US private equity houses, is the fact that Iran continues to be subject to a proposed rule designating the country as being a "primary money laundering concern" under section 311 of the US Patriot Act which raises questions as to whether financial institutions will agree to undertake financial transactions with or through Iran.
It has been reported that Iran is in need of fresh capital. On paper, it should be a hotbed of activity as the sanctions begin to fall away. With the largest of the world's gas reserves and the fourth largest oil reserve, it is understandable if there is interest globally in what it has to offer. But, as with other emerging markets, the Western world should tread cautiously. Any investor looking to cash in will be faced with a risk list much longer than its wish list.
In the financial year to 21 March 2015, those invested in the Tehran Stock Exchange (TSE) saw a market gain of 125%. But with little in terms of reliable market data and with allegations of price manipulation, inaccurate corporate forecasts and favouritism, the TSE is tarnished in the eyes of many foreign investors. Those who were able to surf the wave of speculation in the run up to the nuclear deal saw substantial gains – shored up by a herd mentality. But that didn't hold and the market has been unsettled since the deal was reached.
Geographically, Iran takes a strategic position on the world economic stage. With its cheap utilities and an eager and skilled workforce, foreign investors may view the positives as extending beyond its rich array of minerals and its extensive oil and gas reserves. If the sanctions relief is ultimately implemented and as the post sanctions economy begins to mature, growth in consumer goods, tech and pharma may offer returns for those with a sharp eye on the cultural perspectives. However, Iran's legal system is unsophisticated and outdated. Its bureaucracy is likely to be short on talent having had little exposure to foreign investment for many years. With less evolved legal as well as ethical protections, Iran may remain unattractive to all but the most robust risk takers for some time to come. Also, most of the primary US sanctions will remain in place, limiting the ability of US investors and any activities with a US nexus to proceed. One of the key questions on the lips of interested private equity houses will be – are there sufficient numbers of businesses of scale to warrant investing time and effort in the region and what will be the sector focus in which such opportunities might present? There may be a growing middle class consumer market as well as activity in areas of oil and gas.
No doubt, Iran will also be pegged against the performance of the rest of the Middle East. The Emerging Markets Private Equity Association reports a low of 13 deals in 2009 and a high of 31 in 2012. Although overall investment in the Middle East rose substantially between 2013 and 2014 when it reached US$219m, this still remains a long way short of the US$1.25bn in 2012. Sceptics will wonder how Iran might fare any better, certainly whilst it clambers from the shadows of sanctions.
Nevertheless, Western investors have been circling since President Hassan Rouhani took office in 2013. The taking of one early first mover advantage might be all it takes to invigorate the market. Iran is not quite 'open for business' though. It may be some time before President Rouhani's dream of a less economically isolated Iran becomes a reality. But with 80 million people and an output of around US$400bn per year, its re-entry into the fold would undoubtedly offer huge promise both domestically and for foreign investors willing to take the leap.