Iran New Bond Suggests Move Towards International Markets

Euromoney, November 2015 

Iran hasn’t been a fixture in the international debt markets since 2002, frozen out by sanctions. But when it eventually comes back – which it surely will in a year or so – we might argue that the first step in the process was a little-noticed domestic issue that took place on September 30.

In fact, one can argue that the issue of Islamic government treasury bills was the country’s first true domestic bond.

There has been a sort of debt market in Iran for years, but it doesn’t look anything like local currency markets elsewhere in the world. The predominant vehicle is something called the Agh Mosharekat, or participation paper, an instrument which carries a fixed coupon, is not tradable, and can be returned to the bank at any time during its (typically three-year) duration and redeemed.

“The debt market as you have it in Europe or the US – that did not exist in Iran until September 30 when the first Islamic treasury bills came to the market,” says Amir Mehran, advisor to the president at Bank Pasargad.

This new, ‘true’ bond has a 165-day tenor and an effective interest rate of 26%. The system works like this: the buyer pays 90.5% of the principal up front, and then receives 100% back after 165 days. It is expected that Islamic treasury notes worth 10 trillion rials (US$300 million) in total will be traded over the counter on Iran’s Fara Bourse, issued in phases.

It will be a while before these replace the participation paper concept – which are usually underwritten and guaranteed by Iranian banks to fund specific individual projects or ministries – but they will at least create a form of local debt that is recognisable to international investors.

“We believe this market is going to develop in time, and that we are going to see more sovereign and corporate bonds coming to the market,” Mehran says. “Eventually we believe there will be a secondary market for the bonds, with a daily value going up and down depending on economic circumstances.” He says project finance – which doesn’t really exist in rial at this stage – will be a natural area where the new instrument can help.

But how does one move from here to international bonds?

Iran and its companies have not issued internationally in the sanctions era, but prior to that, the Central Bank of Iran issued Eu1 billion of paper in 2002, in two tranches of Eu635 million (at libor plus 3.75%, at a time when libor was at 5%) and Eu365 million (at libor plus 2.75%). That was a conventional issue, underwritten by BNP Paribas and Commerzbank. Two other foreign currency issues followed from the Iranian banks Mellat and Sepah.

No international issues can follow until sanctions are lifted on Implementation Day – the moment secondary sanctions on Iran formally end, probably in early 2016 – but then, there may be appetite to return to the international capital markets. Both the central bank and the National Iranian Oil Company are believed to be planning issues, which would have to be denominated in euros and handled by European banks.

“There is already a lot of interest for private placement of Iranian corporate bonds,” says Ramin Rabii, CEO of Turquoise Partners Group, a financial services group in Iran. “As soon as sanctions get lifted and Iran gets a sovereign rating from one of the agencies, we can even go public with these.

“I don’t think we will see USD denomination anytime soon. Most likely euros or dirham.”

There are, however, challenges ahead; Rabii’s reference to rating agencies touches on a particular difficulty. The major rating agencies, being US-based, will still be prohibited from doing business with Iran. “If only the secondary sanctions are lifted, the American companies will not be able to come back and rate Iran,” says Mehran. “But there are European rating agencies.” In 2002, Fitch rated Iran’s bond, assigning it a B+ rating, but Fitch removed that rating following the bond’s maturity and full repayment in April 2008.

Another question is whether, even under sanctions relief, issues like these will still be permitted. American sanctions will remain; 200 entities and individuals remain on a blacklist. Will it be permissible for a public oil entity in Iran to access the international markets?

If challenges can be overcome, there is huge potential in the debt markets, both domestic and global. “The introduction of conventional debt market products for the Iranian state and corporates could have a massive impact on the Iranian economy and the financial sector in particular,” says Rabii. “Backed up by the oil and gas reserves, the issuing of sovereign guaranteed bonds will enable the government to pay its debts and improve the balance sheet of the banking sector without relying on frozen assets abroad.” Turquoise estimates that today, traditional banking facilities account for 80% of funding in Iran, with capital markets undeveloped.

And international buyers would be interested. Abbas Ameli-Renani, global emerging markets strategist at asset manager Amundi, said in Euromoney in September that a dollar deal, though difficult, would be attractive if it paid a suitable premium. “If it sought to issue in dollars, that would be quite interesting to investors,” he says.