Last year’s nuclear deal between Iran, G5+1 and the European Union, or the Joint Comprehensive Plan of Action (JCPOA), which has opened the doors for Iran to re-engage with the global economy is perhaps one of the most significant developments in the Islamic finance industry in recent years.

With total banking assets estimated at close to US$ 550 billion, the Islamic banking industry of Iran is the largest of any Muslim country, estimated to account for over 40% of the global Islamic banking assets. Following the Iranian revolution in 1978, Iran passed the Riba Free Banking Operations Law of 1983 which bans interest and requires all banking to be shariah compliant. Iran is one of only two countries where all banking transactions are conducted in accordance with shariah principles (Pakistan is the other example where local banks may only charge mark-up (and not interest) pursuant to the State Bank’s 1984 Mark- up Circulars).

Considering the size of the Iranian banking sector, the Iranian sukuk market is still relatively small compared to the international sukuk industry. The total value of the Iranian sukuk market is estimated to be around US$ 7 billion. That is a fraction of the global sukuk market, which stands at close to US$ 300 billion. However, given the estimated US$ 250 billion investment required in Iranian infrastructure, there is potential for this figure to grow exponentially in the coming years. In addition to infrastructure, Iran requires foreign investment to modernize its aerospace, tourism and oil & gas sectors and the lifting of certain international sanctions (primary US sanctions against Iran are still in place) has opened the doors for international investment to flow in.

The opening up of Iran’s economy was met with much optimism, especially within the Islamic finance industry. In particular, the sukuk market, which has seen global issuances decline on the back of the slowdown in Malaysian offerings, was expected to benefit as the Iranian government and private sector sought to tap the international sukuk market to meet funding requirements. The level of interest in the Iranian economy has, however, failed to translate into actual investment.

So why does the Iranian sukuk market continue to remain relatively subdued? A number of factors have contributed to the Iranian market failing to ignite, so to speak. Firstly, investors remain concerned about the political risks of investing in Iran and the snap-back of international sanctions. Although the JCPOA gives protection to contracts signed between implementation day and the date of snap-back, some degree of risk remains. For example, contracts entered with previously sanctioned persons, such as OFAC’s specially designated nationals (SDN) list, could be frustrated by imposition of asset freezes against such entities. This risk is likely to dissipate over time as the Iranian government demonstrates its commitment to meeting its international non-proliferation obligations and further easing of sanctions. For example, until recently it was unclear whether foreign subsidiaries of US companies are allowed to do business with Iran; this ambiguity was removed in a recent OFAC guidance, which clarified that such operations were permitted. Given the heavy fines imposed on BNP Paribas and other European banks in the past, international financial institutions are more averse to taking any risk until such time that there is greater clarity around what is permitted under the nuclear deal. Investors are still waiting for the dust to settle before they will engage with Iran in any meaningful way.

A further factor complicating the sukuk market is that global sukuk issuances are largely denominated in US Dollars. Domestic Iranian sukuk issuances have also failed to attract international investors. The restrictions on US Dollar transactions by Iranian persons presented, until recently, a further roadblock. However, on 7 October 2016, OFAC updated its JCPOA related FAQs which made it clear that foreign financial institutions are allowed to process US Dollar denominated transactions and maintain US Dollar accounts for Iranian entities. This could prove to be a shot in the arm for the Iranian economy provided the Iranian government is able to remove structural barriers and modernize local regulations. For example, Iranian laws do not permit sukuk issued in a foreign currency to be freely traded. A non-tradeable sukuk is a non-starter. According to press reports, however, the Iranian government is expected to pass laws to facilitate trading of foreign currency denominated sukuk.

It remains to be seen how Iranian interpretations of shariah will impact the structure of sukuk and Islamic finance documentation. Indications are that Iranian scholars and the Iranian government are likely to be flexible in their implementation of shariah in order to facilitate the development of the nascent sukuk market in accordance with existing international practices. For now, doubts remain about shariah structuring and whether Iranian scholars will accept existing documentation as compliant with their interpretation of shariah.

Though challenges remain, it is hopefully a matter of time before these issues will be resolved. News reports suggest that the Iranian government is looking to reform its laws in order to make investing in Iran more attractive to international investors. Iran had already enacted legislation in 2002 for the protection of foreign investment via the Foreign Investment Promotion and Protection Act (FIPPA). FIPPA gives protection to foreign businesses, including protection against appropriation of property, guarantees for repatriation of capital, and recourse in local Iranian courts. Further measures to enhance the protections given under FIPPA, including measures which will enhance the ability of foreign investors to enforce foreign law contracts and overseas judgements in Iranian courts will further boost investor confidence.

Iran has a young, educated and dynamic population which is ready to turn a new leaf in its relations with the West. The International Monetary Fund estimates Iran’s economy to grow at around 4% in 2017-18. Iran also offers attractive tax rates, with corporate tax at 25%, withholding tax on interest payments at 5% and zero tax on dividends. In addition to Iran’s vast natural resources, investors can look to opportunities in the tourism, education, healthcare, F&B, retail and aerospace sectors.

Given Iran’s vast economic potential coupled with the slow but steady dismantling of international sanctions, Iran looks well poised to become one of the major players in the global sukuk industry.