Calls for Sovereign Funds to Follow Santiago Principles
20 October, 2015Middle East Faces Lost Decade
20 October, 2015Emerging Markets, IMF editions, October 2015
Iran has taken the first steps in a journey that will eventually bring it back into the international debt markets – but there are a number of hurdles to overcome before it gets there.
A landmark in the domestic debt capital markets took place on September 30 when arguably Iran’s first ever true bond issue in rial, an Islamic government treasury bill, was launched.
A form of a debt market has long existed in Iran, but not like local currency markets elsewhere. The structure is known as participation paper (or locally as agh Mosharekat), carries a fixed coupon and is not tradable. Buyers can return the paper to the bank at any time during its typically three-year duration and get their money back. Participation papers are underwritten and guaranteed by Iranian banks, which often issue them for specific individual projects or ministries.
“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,” said Amir Mehran, advisor to the president at Bank Pasargad, one of Tehran’s strongest banks.
The new, ‘true’ bond had a 165-day tenor and an effective interest rate of 26%. The system is that 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.
“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,” said Mehran. “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 said that project finance – which doesn’t really exist in rial at this stage – will be a natural area where the new instrument can help.
How about international issuance? 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 issue 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 in euros and handled by European banks.
“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,” said Ramin Rabii, founder of Turquoise Partners, a financial services group in Tehran. “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.
However, there are challenges ahead. There are questions as to whether even under sanctions relief, it will be permissible for a public oil entity in Iran to access the international markets.
If it is, then the next question will be rating and price. “It is important that the risk rating of the country has to improve, otherwise it will be too expensive for us,” said Mehran. “The international market has to agree on the commercial and political risk of Iran.”
One challenge here is that the major rating agencies, being US-based, will still be prohibited. “If only the secondary sanctions are lifted, the American companies will not be able to come back and rate Iran,” said 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.
Mehran said he thought the first post-sanctions international bond from Iran would be conventional, rather than Islamic, in order to ensure that western investors are attracted to it.
