Trading to Iran – P&I Insurance and the Legacy of The Iran Sanctions Programme

On January 16 last year the European Union and the US ended sanctions introduced in response to Iran’s nuclear programme, putting into effect the implementation day under the Joint Comprehensive Plan of Action.

It might be assumed that the Iranian legal and trade regimes would then have been restored to the same position as they were in before the introduction of that programme. In other words, full and unrestricted trade with Iran and membership of International Group P&I Clubs by Iranian shipowners and charterers.

However, notwithstanding the significant work done by the International Group to facilitate such trade, this has not been the case. The continuation of non-nuclear related US primary sanctions when coupled with banks’ reluctance to do business with Iran has meant that the insurance of Iranian shipping and the payment of Iran nexus claims is, and is likely to remain, fraught with difficulty.

The long-term legacy of the Iran sanctions programme may well turn out to be an increased concern about the consequences of breaking international sanctions, which in turn impedes the resumption of lawful trade to such states following the termination of a sanctions programme.

A New Type of Sanction

On July 1, 2010, the US Comprehensive Iran Sanctions Accountability and Divestment Act came into force. CISADA was intended to cause commercial harm to Iran by preventing certain trades, such as the importation of refined petroleum products into Iran, from taking place.

Previous national and international sanctions regimes had targeted only the primary sanctions breaker. However, CISADA and subsequent EU regulations and US measures introduced penalties not only for the party actively engaged in sanctions breaking, but also those which directly or indirectly provided support for such activities, such as the provision of insurance and other financial services. Moreover, the penalties for non-compliance were so severe that breach of such measures would potentially cause a business to cease trading.

This legislation proved to be highly effective in reducing trade to and from Iran, but in doing so presented a direct challenge to the certainty of compensation that underpins the insurance provided by the International Group.

When addressing the challenges arising out of the Iran sanctions programme, the International Group had two goals. First, to facilitate trade in and around the Gulf region, including lawful trade to Iran. This was particularly important to shipowners at a time when freight rates were under pressure and margins being squeezed. Second, the protection of the group’s collective membership from the potentially catastrophic consequences of a sanctions breach.

To realise its objectives, the International Group engaged directly with the US, UK and EU authorities to highlight the unintended consequences of the Iran sanctions programme. The group adopted a two-tier approach. At a macro level the International Group argued against the principle that third-party liability insurance, which benefits the victims of casualties rather than the sanctions target, should be subject to measures the effect of which were to deprive innocent third parties of their right to recover. The group repeatedly pointed out to governments, and indeed continues to point out, the potentially catastrophic consequences of a major casualty to which a vessel’s P&I insurance could not respond.

The group also engaged in more detailed discussions with the EU, UK and US authorities to explain the unintended consequences of specific legislation, seeking amendments where necessary and obtaining clarification on the application or interpretation of particular measures. The Group has enjoyed considerable success in this.

By way of examples, in February 2011, at the group’s behest, the US State Department published shipping-specific clarification on the application of CISADA. Then in 2012, the group was successful in persuading the EU to amend Regulation 267/2012 to legitimise the supply of bunkers containing fuel oil originally from Iran but supplied to the vessel by a third country.

Effectiveness of the Iran Sanctions Programme

However well-articulated the downside of the Iran sanctions programme may have been, for the US and Europe its benefits were plain to see.

The nuclear-related sanctions programme against Iran is credited with being one of the main reasons why Iran agreed to co-operate with the international community to ensure that its nuclear programme has no military application. Undoubtedly, the sanctions have had a significant effect on Iran’s economy. Of particular interest to the maritime industry is the impact of sanctions on Iran’s oil exports, which is illustrated by Table 1.

Top Oil Buyer from Iran and Reductions

The table illustrates that oil exports (the majority of which were carried by sea prior to the imposition of sanctions) fell by approximately 60% as a result of the Iran sanctions programme. Those states that have continued to import Iranian oil were able to do so only as a result of the waiver programme under the US National Defence Authorisation Act, or NDAA, under which the US permitted those countries that were able to demonstrate that they were taking real steps to reduce their dependence on Iranian oil were permitted to continue to buy oil from Iran, albeit in reduced quantities.

It is estimated that Iran’s gross domestic product shrank by 15% to 20% as a result of sanctions. Over the same period the currency declined by 56% of its pre-sanctions value and inflation increased somewhere between 50% and 70%.

The Iran sanctions programme has also shown states how easy it is to police sanctions through the financial services industry. Those businesses which either ignored or deliberately breached US secondary sanctions were subjected to eye-watering fines, Table 2.

Facilitating the Resumption of Trade to Iran — Fallback Cover

Following the lifting of sanctions under the JCPOA, it became lawful for non-US vessels to trade to Iran and for P&I clubs to provide insurance for such trades —  but because US primary sanctions remained in place, neither the American Club (at least until it obtained a licence in February 2016) nor the US-domiciled reinsurers on the group’s reinsurance programme were able to pay their share of any claim which benefited an Iranian person or entity.

The International Group uses reinsurance to provide cover for large claims in excess of $80m. The continuation of US primary sanctions meant that US participants in that reinsurance programme were unable to pay Iran nexus claims, leaving shipowners with a potential shortfall in cover.

To plug the gap, the International Group was able to put in place a ‘fallback’ cover which to a large extent made good on any shortfall in those recoveries. Through fallback, and within two months of sanctions being lifted, the group was able to provide shipowners with a practical solution to loss of cover resulting from the continuation of US primary sanctions.

Furthermore, it gave the clubs valuable time to continue negotiations with reinsurers and the US government to put in place a permanent solution in time for the 2017 policy year.

Enduring Legacy of the Iran Sanctions Programme

Western governments view the Iran sanctions programme as a success. Those governments also have a much better understanding of the vital role played by financial services in facilitating seaborne trade.

From the perspective of both the shipowner and its P&I club, strict sanctions compliance programmes are here to stay. Clubs and shipowners should anticipate that the use of primary and secondary sanctions will be further refined in future sanctions programmes. Sanctions are now seen by states as an effective foreign policy tool and are likely to be used more frequently and as an alternative to other policies — such as the use of force — in future crises.

However, it is in the realm of enforcement that the effects of the Iran sanctions programme are likely to endure longest. With some notable exceptions — such as the International Group — the risk appetite for Iran trade for much of the financial service industry has significantly reduced when compared to the period before the Iran sanctions programme began. It is one thing for the International Group to provide insurance cover for such trades; it is rendered ineffectual if banks obstruct the payment of Iran nexus claims or premiums.

We now have the prospect of Donald Trump’s US presidency. Given the very public condemnation of the JCPOA made by Mr Trump while campaigning for office, there is little incentive for cautious banks to resume transactions which may once again be made the subject of sanctions under the new administration.

Mike Salthouse is Deputy Global Claims Director of North P&I Club and Chairman of the International Group of P&I Clubs sanctions sub-committee.

mike.salthouse@nepia.com

This article first appeared in Lloyds List on 12 January 2017.