In light of the termination of the US dollar convertibility to gold (end of the Breton Woods exchange rate system, 1971-73), there has been reported a considerable rise in the short-term volatility of the relative price between countries—a dramatic mean-reverting, fluctuating behaviour.
Detractors of the floating exchange rate regime—a regime in which the exchange rate fluctuates in response to foreign-exchange market mechanisms and it is not pegged to any measure of value—argue that its associated volatility is an important drawback for the international monetary system, which increases uncertainty about relative prices. They also state that it leads to restrict international investments and flows of goods and services, which brings negative real-effects to the economy. In parallel with detractors of the floating regimes, the Bretton Woods Commission (1994) urges political organisations to internationally coordinate policies to fight against exchange rate volatility by adopting stabilising measures that may help to avoid potential costs to the economy.
Furthermore, the implicit exchange rate volatility of floating regimes can be observed through a visual inspection of the graphs in (Fig. 1.1) for Japan, Canada and the UK. The floating exchange rate period (since 1971) seems to be systematically associated with a high volatility, in contrast to that of the fixed regime (before 1971). Interestingly, this increased volatility has been matched with a slowdown in international trade flows since 1973. For instance, the balance of trade of the US current account reached to around three hundred billion of US dollars in 1999, its highest mark in the post-war period so far (IMF, 1999). Because of this reason, research efforts over decades have centred on investigating this relationship through several approaches: from the lens of multilateral trade relationships to a more accurate perspective under bilateral approaches.
Exchange Rate Volatility of Japan, Canada and the UK
Source (Muñoz-Salido, 2016)
Notes to the table. Graph shows a PPI-based (2010=1) Real Exchange Rate (RER henceforth) for Japan (first graph), Canada (second graph) and the UK (third graph). Period covered is from 1960/1 to 2015/2, 661 monthly observations for each variable after log-transformations. Red spheres indicate fixed exchange rate periods.
After decades of research, ambiguous contributions have risen the interest of researchers in disentangling the true mechanics of the effect of the exchange rate volatility upon trade growth. Traditionally, the basic methodology for studying this effect has been to run panel data regressions through multilateral approaches. After the first divergences in the empirical literature, the methodologies have been modified and alternative models have been proposed in search of identifying the true underlying relationship between these two variables.
The empirical heritage points to the different exchange rate regimes and trade relationships between countries for explaining the divergence of directions of the aforesaid effect—particular features from different type of trade relationships may impede the true dynamics of this effect to robustly hold. Additionally, research efforts in disentangling such divergence were centred on studying either aggregate of disaggregate data, which did not substantially solve such ambiguity.
In parallel with the empirical literature, there is not consensus among theoretical predictions explaining this effect (i.e. Hooper and Kohlhagen’s, 1976; Newbery and Stiglitz, 1981; Caballero and Corbo’s, 1989). Indeed, this theoretical divergence does not arise from assumptions on the risk aversion of traders but from restrictions and assumptions imposed to the utility function of the theoretical models, which makes even more difficult to identify and correct the causes for this divergence.
By considering all of the aforementioned reflections, are we scientifically able to argue in favour or against free-floating exchange rate regimes for boosting or hindering international trade growth? Indeed, it seems as the empirical spectrum had sown the seeds of the ambiguity and the disrepute within the economic science—then, what else could be done? Is it that theoretical predictions for the macro-level are not as clear-cut as they are for the micro-level? Is it that the lack of empirical accuracy in the macro-level unhinges the theoretical discourse? Or does one has to think that economic science must succumb to Chaos Theory’s negative forces?
The War for Raw Materials
The war for raw materials amounts to a reshuffling of the power relations among Western nations, on one hand, and the emerging and/or developing nations, on the other. The rise of China, BRICS, and the growing strength of the sovereign wealth funds of Arab nations, which are oil exporters, provides the evidence. Resources are powerful weapons in economic warfare, and everything suggests that the conflict will only intensify. The International Energy Agency estimates that world demand for energy will increase by 50% from now until 2030,especially owing to the growth of India and China. Ensuring ready procurement of materials, therefore, assumes crucial importance for nations. In 2007, the Committee on Critical Mineral Impacts of the U.S. Economy published a report with a list of eleven minerals that were particularly important for the leading industrial sectors of the U.S. Economy, due to their rarity and value. The list includes rhodium, used primarily in the manufacture of catalytic converters, which is particularly abundant in Russia but also in South Africa.
As guarantor of its national economy, every nation has, in fact, drawn up a list of the resources that it considers necessary and on which a significant number of current geo-economic conflicts depends.
As Liberalist logic goes, trade should produce closer and closer integration among the economic operators in various nations, which are linked less and less to specific reference territories, while reducing the risks of conflict and the role played by the nation at the same time.
This highly ideological vision is losing credibility. Territories have resisted and, along with them, the notion of control. The financial crisis that began in 2008 seriously undermined their citizens’ trust in the market’s capacity for self-regulation. The various factors that contribute to a nation’s power include its possession and exploitation of the riches of its subsoil, sea bottoms, and arable land. In a world expected to reach a population of 9 billion by 2050,the logic of self-sufficiency or lesser dependence now drives nations to compete in guaranteeing their supply of raw materials more than ever before. Competition for the control of raw materials – which has never stopped structuring international relations – has demonstrated a particularly significant intensification in recent years. The surge in agricultural raw material prices triggered a wave of arable land-grabbing by foreign investors in 2008, predominant among which, the United States, China, Saudi Arabia, and Arab Emirates. Most of their purchases were made in the continents of Africa and Latin America, where – by no coincidence – 90% of the world’s as-yet unutilized arable land is located. Appetites like these generate tension and rivalry. Hydrocarbons, of course, remain the center of strategic interests. After acquiring the possibility to intensely exploit its reserves of shale gas, the United States has become self-sufficient. As a result, its former supplier, Saudi Arabia, has witnessed a weakening of its bonds with the U.S., its protector against Iran. Its febrile behavior during the crises in Iraq and Syria is due in part to this evolution of international relations. The case of Greenland – whose oil reserves are now estimated as being half of those of Saudi Arabia –is also exemplary. Combined with the results of the referendum regarding autonomy (75% in favor), this new circumstance will now give greater force to the movement for independence as the larger powers are already jockeying for the best bargaining positions.
One sector that will apparently be particularly significant for international tensions in the future is that of mineral resources: more and more often nations with large mineral deposits are opting for state control. Well-known documented examples are offered by China, Russia, and Bolivia, and the list might soon include Madagascar, which, after being long subjected to crushing passive exploitation by foreign mining companies, announced in 2014 the creation of a public mining company to exploit its resources at a national level.
One vital mineral resource that is indispensable to aeronautics, given that it represents between 15 and 20% of the metal used in the construction of a modern airplane, is titanium. It is no wonder that the Boeing Company and the United Technologies Corporation have decided to stockpile it.
The world’s leading titanium supplier is the Russian VSMPO group. Will these two American companies, whose decision was revealed last August, suffer retaliation in the context of the crisis in Ukraine? It must be recalled that U.S. law prohibits companies that work for its Defense Department from purchasing titanium abroad. However, the two groups produce for both the civil and the military sector.
In addition to Ukraine, another area of international tension created by resource grabbing is the China Seas, where the level of interdependence between the leading powers (South Korea, Japan, People’s Republic of China, and Taiwan) is certainly growing, and in the opinion of Paul Tourret, Director of the Higher Institute of Maritime Economics, such a mesh of interests should have reduced the risk of conflict even if – as the expert himself seems to imply – the sharing of the same geo-economic interests is of little use in guaranteeing stability in the region.
The dispute between China and Japan over the Senkaku Islands that began in 2010 and flared up again in 2012 and 2013 even led Beijing to lower its exports of rare metals to Japan. This group of 17metals, whose leading producer is unquestionably China, is indispensible to the production of products with high-technological content, one of the mainstays of the Japanese economy. Acknowledging that this reduction in exports had effectively weakened its economy, Japan wasted no time in reacting: on March 13, 2012, supported by the U.S. and the EU, Japan denounced China to the WTO, which in fact reprimanded the conduct of the Chinese government. This did not prompt Beijing to change its tune, however. In addition to putting its faith in procedures at this level, Japan recently set up the Japan Oil, Gas and Metals National Corporation (JOGMEC) and funds it with 15 billion euros annually. The entity operates on three levels: supporting Japanese mining companies abroad (particularly in their purchases or entry into foreign company shareholding structures), providing a diplomatic channel in the stipulation of long-term contracts between nations, and supporting national research in the energy and mining sector. In 2012, Japan’s Minister of Industry announced that new trading partners like Kazakhstan and Australia would help reduce its dependence on Chinese rare metals. The private sector supports the national effort: through its branches, auto manufacturer Toyota has become one of the prime investors in mining sectors in Canada and Australia as another way of weaning Japan from Chinese supplies. Nations take different approaches to the geo-economic problems posed by the procurement of metals and minerals. The first is to get back into the markets, which, as reported by certain experts, are impenetrable, fragmented, and do not offer sufficient information.
Some industrial societies resort to the expedient of financial insurance that guarantees the purchase of substances at a fixed price for a certain amount of time. However, this sometimes turns out to be a blunt instrument, however, given that nations often and willingly ignore the guarantees granted in defense of their own best interests. The second option nations take is when they become aware of the geopolitical necessities for territorial control and implement a long-term purchasing diversification strategy. Not all nations vaunt the same strategic prowess as Japan, however; Europe, in particular, demonstrates a deficit of awareness in this field.
The rising demand for metals and/or minerals stems from the arrival of a new tier of industrialized nations that includes China, India, and Brazil, which all have benefitted from the delocalization of certain European heavy industries and manufacturing companies.
In the end, future tensions regarding the availability of certain materials entail the question of national security in procuring the resources indispensible to strategic industry chains (nuclear, defense, aeronautics, electronics, the automobile sector, etc.). Nature has permitted the creation of monopolies over certain resources: China supplies 93% of the world’s magnesium and 90% of its antimony. Brazil meets 90% of the international demand for niobium, while the U.S. provides 88% of its beryllium. In order to hedge the risk of economic dependence on the holders of these raw materials, other world powers have already laid out specific strategies to ensure themselves resources deemed strategic by establishing closer diplomatic relations with the nations that have what they need. The United States, Russia, and China have implemented policies for stockpile management and flow control while taking steps to secure production areas, especially through the purchase of mineral deposits and companies operating there. The volume of investments for the mining of rare substances in Greece has grown since 2014. At the start of the same year, the NBC news network revealed that the government’s scientific agency, the U.S. Geological Survey, had conducted an aerial study of the soil in Afghanistan in 2006 that permitted the mapping of the mineral resources that the nation possesses in abundance. The American researchers estimated quantities of 2.2 billion tons of ferrous material, 1.4 million tons of rare materials (such as lanthanum, neodymium, and cerium), also aluminum, gold, zinc, mercury, and lithium. The crisis in the Ukraine has allegedly driven Russia to seriously consider the idea of establishing a rare materials cartel with China, with Russia having the largest holdings after China. Unlike most others, however, Russia has deposits of all 17such materials. Therefore, Russia would have every reason to exploit these resources, also bearing in mind that Chinese production in this sector is instead currently tailing off, obliging Beijing to import them. Russia’s idea of closer links to China is also fed by its desire for retaliation against the United States and the European Union.
Owing to their use in industrial processes, the so-called platinoids or platinum group metals (PGM) are the object of much contention among the world’s industrial powers owing to their use in industrial processes. Utilized not only in traditional petrochemical, arms, aeronautic, medical, and agrifood sectors and costume jewelry, they are also crucial to the telecommunications and information technology industries, especially in the production of cell phones and computers. Palladium, for example, is used in nearly every type of electronic device, primarily as a part of high-performance capacitors or microchips. Ruthenium and platinum instead play important roles in increasing data storage capacity on hard disks but also in producing liquid crystal displays. Platinum is also the key component of various types of fuel cell. Associated with rhodium (diesel vehicles), it plays a key role in the production of the catalytic converters that reduce exhaust gas toxicity.
In addition to their growing importance in a variety of industrial processes, these materials are rare and concentrated in only a few specific geographical areas in which a sort of semi-monopoly is held, such as South Africa and Zimbabwe. Southern Africa’s platinum-rich areas have become authentic theaters of national and international battle for the control of these materials that often degenerate into armed struggle. The fact is that no alternatives to their use have yet been found.
Competition between Anglo˗American, the world’s leading producer of PGM, and Asian, primarily Chinese competitors, in Zimbabwe’s Grand Dyke mines, is just one episode in an economic war of much wider scope. This battle is part of the long-term duel between Western nations and China for the control of Africa’s strategic resources that began with the fall of Mobutu in the Congo. After gaining control of a considerable part of the Central African Copperbelt that contains over half of the world’s reserves and mines for cobalt, an indispensable element in the production of electric batteries, China is making a similar attempt to corner the world’s supply of platinum, an essential metal for oil refineries that is mined above all in Angola.
Zimbabwe’s PGM are essential for China, which possesses only 1.1%of the world’s reserves, and play a dual role in ensuring its economic security by enabling it to set up its own complete petrochemical production chain, in this way gaining independence from Anglo˗American suppliers and by allowing Beijing to produce the catalytic converters it needs to reduce air pollution, a campaign that has turned into a national priority now that China has become the largest motor vehicle market in the world. It therefore comes as no surprise that PGM refining constituted the pivotal role of the agreement signed between China, Angola, and Zimbabwe in 2009.
This agreement poses a threat to Anglo˗American, which had until then had held a monopoly over Zimbabwe’s PGM mining. The British company continues to control the deposits in Southern Africa, which are more abundant than those of Zimbabwe, but those of the latter are distinguished in a way that makes them almost unique in their rare combination of both platinum and palladium, the two most highly desired PGM in the world.
This loss of part of the Zimbabwe reserves might spell the future end of the worldwide control of the PGM market by the Anglo˗American company, which has been the leading economic operator in Southern Africa for around two centuries.
Political instability and insecurity reign in the part of Africa that runs from Merensky Rift to Grand Dyke, where local political leaders wage wars in their attempts to gain control of the income derived from platinoid sales, basing their right to do so on their past as “freedom fighters”. In Zimbabwe, this operation is conducted by the former hero of the nation’s independence, Robert Mugabe, who adopts nationalistic, anti-imperialist rhetoric to accuse foreign companies of implementing neo-colonialism policies with support from Great Britain. He goes on to claim that the Anglo-American company has stoked political opposition against him, abetted by both the United States and the European Union. The leader of the opposition movement is Morgan Tsvangirai, formerly a company employee.
Robert Mugabe’s use of nationalist rhetoric to instrumentalize the question of international monopoly over the nation’s economy had served to both masquerade his less than exalting results in running the country and to sidestep demands for more political freedom. The fact that Mugabe’s nationalism amounted to mere rhetoric is clear from his scarcely coherent political conduct: following a hike in mineral product prices, in 2007 he proposed an Empowerment and Indigenization Bill for the economy in general and the mining sector in particular, and had it passed. Just one year later, Mugabe sold the mineral rights to an American hedge fund in exchange for a loan of around one hundred million dollars, which he then used to finance his election campaign. He proceeded in the same way in privatizing a mineral deposit that had become public property after he had previously expropriated it from Anglo˗American.
In short, Mugabe uses the nation’s mineral resources as if they were an automatic teller machine for the funding of his own political career. Also in South Africa, the ruling class that had come to power on the merits of its struggle against the previous apartheid regime has since displayed remarkable nonchalance in channeling the nation’s mineral wealth to its own advantage by stipulating agreements with foreign multinationals.
The massacre by police of miners in Marikana striking for higher wages in 2012 demonstrates the degree to which the miracle of South Africa is only a mirage for a large part of the nation’s black population.
Promoting a More Inclusive and Sustainable Development for China
China can achieve more inclusive and sustainable development with coordinated reforms across a broad range of areas that maximize development impact and address its development challenges, says the World Bank Group’s new Systematic Country Diagnostic for China.
The World Bank Group undertakes a Systematic Country Diagnostic for all its client countries to identify key challenges and opportunities in ending poverty and boosting shared prosperity. The Diagnostic is prepared in close consultation with national authorities and other key stakeholders, and forms the basis for the Country Partnership Framework, which determines the World Bank Group’s activities in a country over a four to six year period.
Towards a More Inclusive and Sustainable Development highlights China’s unprecedented achievements in rapid economic growth and reducing poverty. Rapid growth was made possible by a wide range of reforms, which transformed a largely rural state-dominated and planned closed economy into becoming a more open and market-based urbanized economy.
China’s growth has been slowing to a “new normal” and economic rebalancing is under way. Managing this transition in a sustainable manner will be critical to achieving the country’s development goals, the report indicates. Policies to increase productivity-led growth by promoting innovation, market competition and the private sector would support the achievements of these goals, says the report.
“China’s remarkable progress in reducing extreme poverty has significantly contributed to the decline in global poverty,” said Hoon S. Soh, World Bank Program Leader for economic policies for China, “The World Bank Group will continue to support China’s goals to eliminate extreme poverty and ensure inclusive and sustainable growth.”
Despite the rapid reduction of extreme poverty, China’s remaining poor population remains large in number. The report projects continued strong progress towards eliminating extreme poverty and expects the extreme poverty rate to fall below one percent in 2018, based on the international poverty line of PPP US$1.90 per day. The challenge for China will be to target assistance to the remaining poor while paying attention to those who are vulnerable to falling into poverty; further improvements to the country’s social safety net program will help.
Rapid growth in consumption by the country’s poorer households indicates that they have shared in the country’s growing prosperity. Nevertheless, more can be done to address inequality, even as inequality has been steadily declining since 2008. Reforms of the intergovernmental fiscal system and further reforms in the household registration system could reduce income disparities by closing the rural-urban income gap and ensuring equal access to quality education and health services.
Other recommendations for China include a greater reliance on market mechanisms and mobilizing more private financing to boost green innovation and reduce environmental costs and waste. Reducing air pollution would require China to continue the significant gains in energy efficiency that it has achieved in past decades. It would also require lessening coal consumption while maintaining the rapid expansion of renewable energy, including by reducing the significant curtailment of renewables. Water and soil pollution also pose significant threats to the country’s environment and the health of its citizens.
Reforms of the country’s governance and institutions would underpin China’s transition to more inclusive and sustainable growth. Priorities include strengthening the management of public resources by subnational governments and reforming the government’s cadre management system so that incentives are better aligned with sustainable growth. Such reforms could be complemented by greater bottom-up accountability through enhanced government transparency and information disclosure, expanded engagement with public and private stakeholders, and a more market-oriented regulatory regime.
What an ‘Impossibility Clause’ can make possible
Since the implementation of the JCPOA in January of 2016, and throughout the current period of accelerating investment by foreign enterprises in Iran, many participants have taken for granted that in the event of a “Snapback” or the reimposition of UN, U.S. and EU sanctions under the provisions of the JCPOA, foreigners must perforce exit all investments in Iran and Iran’s major industries would be relegated to the shadows as an unlawful destination for foreign capital.
The operative assumption has been that any such reimposition of sanctions under a Snapback scenario would make it “impossible” for such foreign participants to maintain, lawfully, their investments in the various projects within Iran, investment they have made a huge effort to structure and uphold in the still-new era of significantly relaxed sanctions. In fact, the very idea of the impossibility of maintaining significant investments in Iran under such sanctions has become something of a fixation. To the dismay of Iranian partners in various ventures, their foreign partners tend to focus on securing their own interests, rights, and recompense under a Snapback. An efficient exit strategy is often sought.
In reality, those who are here on the ground in Iran know that, regardless of the whims of the American President or the vicissitudes of foreign capital flows, the continued development and renovation of Iran’s domestic economy, both in terms of absolute production, as well as in terms of sophistication, efficiency, and integration, will continue apace, and therefore, the wiser among the stewards of foreign investment in Iran understand that it is as much a question of ensuring business continuity for their Iranian-Foreign joint venture projects despite changing international sanctions regimes, which have been imposed by the West against Iran for decades.
As a result, the most basic and fundamental considerations for any prospective foreign project participant and its Iranian partner become:
1. How the foreign participant can, through appropriately drafted “Impossibility Clause(s)”, remain invested in the Iranian venture for as long as possible under the threat of renewed or reimposed sanctions, and without incurring unacceptable risk.
2. How the foreign participant can contractually envision the broadest range of adverse sanctions scenarios through a single and efficient impossibility mechanism.
3. How the foreign participant can provide for a gradual approach to any putative withdrawal procedure, as opposed to the simplistic solution of outright termination upon Snapback after a period of suspension.
4. How the foreign participant can, in the event of the extinguishment of impossibility, subsequent relaxation or obtained exemption of sanctions, reasonably provide for the right, or at least the option, for itself to reenter an investment project which it may have exited because of Snapback.
The legal thought process underpinning successful solutions which industry practitioners may be likely to embrace is beyond the scope of this article, but the conceptual summary can be a useful guide for all of us as we come to grips with what can be made possible by “Impossibility Clauses”.
1. Remaining invested, minimizing risk: Of course, it is true that for many projects, a direct investment by the foreign participant though its stake in an Iranian joint venture entity may be the most straightforward means of effecting the transfer of capital that allows the foreign party to have a stake in a project. It also allows for the simplest mechanism by which a foreign party may apply for and successfully obtain an investment license in accordance with the Foreign Investment Promotion and Protection Act.
Nonetheless, such a direct investment may, particularly in the case of European entities which also do business in U.S. jurisdictions or in jurisdictions which have significant links with the U.S. financial system, provide little or no cushion under even the most benign reimposition of any form of secondary sanctions. This is because the direct investment leaves the foreign party little room to maneuver by way of restructuring or otherwise allocating its participatory interest in the project as sanctions change.
For this reason, a more effective solution could include the formation of a foreign special purpose vehicle to act for the project entity. In the case of a joint venture, an SPV incorporated in a jurisdiction less likely to be adversely affected by reimposition of sanctions would allow for a more flexible platform to facilitate intelligent solutions such as exit and re-entry options, trustee or agency relationships, and contingent sale-repurchase strategies to prepare for the worst outcome of a sanctions scenario which may force a foreign party to exit Iranian investment.
2.Knowing unknowns, counting uncountables: Even now, with the most recently issued ultimatum by the American President declaring that the end of the JCPOA as we know it is nigh (to be either amended or abrogated, if Mr. Trump is to be believed), there exists a wide variety of circumstances involving the reimposition of sanctions, ranging from those that would make the maintenance of an interest in a project by a foreign party merely inconvenient to those which would make maintaining such an interest lawfully untenable. These may range from largely toothless, otherwise symbolic targeted secondary sanctions which apply only to the entities of specific countries, as we have continued to see since Trump’s October 2017 decertification, or those which may apply only to certain economic sectors or types of goods or projects, to those which render further financial flows in support of such a project functionally impracticable. Most challenging of all would be the failure of the UN to continue to waive the imposition of sanctions against Iran.
Thus, a single mechanism to classify sanctions in some way as materially adverse changes and evaluate consequences seems a more pragmatic solution than contemplating what may constitute an “impossibility” event, and including it under grounds for termination.
Under a scenario in which the foreign party has made appropriate structuring preparations as suggested, the determining exit remedies depends on compliance with mandatory applicable laws of the project vehicle’s jurisdiction. To put it another way, the most straightforward test of whether the foreign party may have to adjust, or exit from its participation, comes down to whether it can fulfill project obligations while abiding by all applicable regulations that may apply to it. Beyond such a litmus test, imagining or prognosticating about the myriad complexities of a possible Snapback scenario may be fruitless and contractually inefficient.
3.Avoiding the black-and-white trap: Of course, a foreign project participant can easily avail itself of the opportunity to stipulate that under any kind of scenario of project impracticability caused by sanctions, certain or envisioned, termination shall be the one and only prescribed remedy.
But this is likely to disadvantage the foreign party in the context of negotiations over comprehensive project terms with its Iranian counterparty, and it may limit the scope of the project work itself and fail to allow for a more complex investment structure which cannot survive the threat of termination overnight due to a “Snapback” of one kind or another.
Aside from termination, and its precursor remedy, suspension, there should also be the possibility to contemplate a variety of concepts including assignment, agency and delegation, in order to benefit from the vagaries of sanctions regulations and their exemptions. In some cases, project obligations which would be in violation of sanctions for some foreign entities may not be so for others. As has been shown by the agreements between foreign export credit agencies (“ECA”s) such as EKF, BPI and Invitalia, developments at an international level, especially where adequate sovereign support and sufficiently ringfenced banking facilities exist, are being contemplated to facilitate the kind of continuity required for the decades-long projects now underway in Iran. In addition to these ECAs, other parties such as quasi-sovereign corporations, particularly those from less dollarized jurisdictions, can play a role as fallback transferees of the exiting foreigner’s project interest or shares under Snapback. Moreover, it should always be noted that under even the most negative circumstances, the potential for a foreign party to obtain a waiver does exist and can be specified for the benefit of all parties.
4.Saving face, weighing options: Although some foreign entities have a checkered past derived from cutting and running under the threat of or the actual imposition of sanctions against Iran, time has shown that many of the same foreign parties which were forced, or chose, to exit their project ventures are the first ones to have returned since the JCPOA. Such is the compelling nature of Iran as a destination for foreign capital.
Iranian parties to a project know both this history itself and its implications. Foreign participants may wish to keep close to the exits, but foreign companies that have been victimized by their own government’s whims regarding sanctions, and the slippage inherent in exiting and reentering, cannot be understated.
For this reason, foreign project partners may choose to consider the solution of exit and entry “options” for themselves under adverse sanction scenarios, and thus it is important for all parties involved to understand what an “option” precisely means, and how to value such an option.
In financial speak, an option is defined as the right but not the obligation to sell (or buy) an asset in a fixed quantity at a fixed price on (or before) a fixed date in time. In the case in question, the asset is the participatory interest of the foreign party in the Iranian project, and the date is that point in time at when the parties to a project agree that the foreign party must leave due to sanctions (or is able to re-enter due to easing of sanctions).
However, it is not obvious immediately what the fixed price should be for foreign project interest at the time of exit or re-entry, and, most importantly, what may be overlooked is the tremendous value that such an option has. In finance, the greater the underlying uncertainty about an asset, the more valuable any option on that uncertain asset is. Similarly, the longer the life of an option on an asset, the more valuable that option is. In the context of long term investments, any option to exit (or re-enter) should be linked with a significant premium (that is, the worth of the option), and the contract parties should ensure that they successfully negotiate an appropriately fair value for the flexibility the options offer. As an illustrative example, the alternative to any exit put option for the foreign party is a fire-sale in the face of illiquid conditions for its share interest under the menace of reimposed international sanctions, or more problematic still, the inability to exit its share interest altogether, which an option is supposed to protect against.
Absent a foreign investor’s legal immunity to the whims of the UN, OFAC, or other authorities, there is no perfect panacea for fool proofing long-term Iranian projects against the kind of uncertainty which the spectre of sanctions create. But although this threat, to a certain extent, has forestalled the growth in Iran’s industry and economy despite the strengthening of Iran’s relationships with the international community, it is now apparent, moreso than ever before, that foreign parties can be expected to take an increasingly pragmatic approach in efforts to remain engaged with their Iranian projects for as long as possible. They can effectively do so by allowing for the most flexible and broad classification of sanctions-related termination risks, by specifying a menu of contractually stipulated responses to reimposed sanctions (in conjunction with intelligent and pre-emptive project structuring) and by exchanging due consideration with the Iranian party for the invaluable options which allow them to remain confident that they can, if absolutely necessary, exit the project and someday re-enter, at a fair price.
Thus, it seems that the operative watchword for all foreign investors in Iran is continuity: continuity of the progression towards innovation, development and growth, and continuity of the participation of foreign interests in that process, bolstered by intelligent structuring solutions, both legal and financial, for dealing with the complicated reality of international economic sanctions. With a measure of foresight, and a functional, flexible contractual framework, all participants in long-term, large-scale project joint ventures can move closer to the ideal of mitigating most, if not all, of the adverse consequences of sanctions regulations on investment decisions and risk management.
First published in our partner Tehran Times
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