Recent legal developments in the Iranian financial markets
Behnam Khatami and Farid Kani
Atieh Associates
Tehran
In furtherance of the policy of the government to de-regulate the banking industry, four developments have occurred since 2009 with the aim of opening Iranian banking to foreign participation and investment.
- In March 2009, the Council of Ministers issued a regulation (Banking Regulation) authorising the establishment and operation of branches of foreign banks in mainland Iran. This was the first time that such establishment was made possible outside the free trade zones.
- On May 17 2011, the Credit and Monetary Council added a provision to the Banking Regulation allowing such branches to introduce their own rate of interest on deposits and facilities.
- Parliament, on May 25 2010, approved the Law Adding One Note as Note 5 to Article 5 of the Law Amending Certain Provisions of the Fourth Development Plan to further facilitate foreign banking operations inside Iran and to attract foreign investment. The Law has substantially removed the limits on participation by foreigners with Iranian nationals in setting up private banks. Previously, there existed a 5% limit on participation by legal persons and a 10% limit on natural persons.
- In a very recent move to develop the banking sector and to promote Islamic financial tools, the Law on the Fifth Development Plan dated January 5 2011 provides for structures such as istisna (exchange with deferred delivery), murabaha (deferred sale) and debt purchase agreements in addition to structures already in existence.
Capital markets
Parliament has recently ratified two items of legislation designed to further develop activities in the capital markets. These two items were (i) the Law Developing New Financial Instruments and Institutes 2009 (Law) and (ii) the Regulations on Foreign Investment in Exchange and OTC Markets 2010 (Capital Markets Regulation).
The Law Developing New Financial Instruments and Institutes 2009
On December 16 2009, Iran's Parliament approved the Law to expand the type of activities in the capital markets. The Law has essentially three objectives: firstly to develop new financial instruments, secondly to develop new financial investment vehicles and thirdly, to tailor the tax treatment to such new instruments and vehicles.
New financial instruments
In addition to previously introduced security instruments (such as sukuk (Islamic bond), mortgage-backed securities and certificates of deposit), the Law introduced an 'investment certificate'. This instrument is defined under the Law as:
'A uniform security issued by an investment fund in return for investment in that fund bearing the particulars of the investor, the fund and the amount of the investment.'
New financial institutions
Under the Law, the legal personality of investment funds was recognised for the first time. An investment funds is defined as:
'A financial institute investing financial resources acquired from the issuance of Investment Certificates in approved areas.'
By virtue of such legal personality, investment funds are now able to open bank accounts and to obtain facilities in their own name.
The minimum capital requirement for the creation of such an investment fund is currently IR5 billion (roughly $500,000).
Tax provisions
One of the main impediments to the development of the capital markets was the uncertainty as to the tax treatment of financial instruments and institutes. The Law removed much of the uncertainty by providing the following:
- all revenues earned from new security instruments are exempt from income tax and value added tax;
- the transfer of stocks and pre-emption rights of Iranian and foreign companies in the stock exchange or over-the-counter (OTC) market was made subject to a flat 0.5% rate of tax;
- intermediary institutions were exempted from transfer tax and their revenues earned from public offerings of securities and the transfer of such securities were excluded from taxation; and
- revenues earned from the sales of assets to intermediary institutes for securitisation purposes as well as any transfer thereof were made exempt of tax.
In addition to the above, the Law provides for nondisclosure provisions, dispute settlement procedures and financial penalties for issuers, financial institutes as well as self-regulated establishments and their managers in case of violations of the relevant laws.
In addition to the above, there are other instruments which are planned to be introduced in the near future including stock options, futures, murabaha sukuk, istisna sukuk, etc.
Foreign Investment in the Stock Exchange and OTC Market
The Capital Markets Regulation was approved by the Council of Ministers on April 18 2010 and removed several restrictions on foreign investment in the stock exchange. Most notably, the requirement for foreign investors in the stock exchange to obtain an investment license under the Foreign Investment Protection and Promotion Act 2002 (FIPPA) was removed.
As a result, the only requirement on such foreign investors is now to obtain a transaction authorisation from the Securities and Exchange Organisation (SEO). Foreign investors however continue to be able to apply for investment protection under FIPPA if they choose to do so.
In addition to foreign nationals, the Capital Markets Regulation considers Iranian nationals with foreign sourced capital as foreign investors, providing the opportunity for such persons to apply for a transaction authorisation and benefit from the provisions of the said regulations.
The Capital Markets Regulation further divides foreign investors into the two categories of non-strategic and strategic investors and set limits on the level of investment of non-strategic investors. Those limitations are as follows:
- 10% of the stocks of a company listed in the stock exchange or OTC market by any one such investor; and
- 20% of all stock listed in the stock exchange and OTC markets by all such investors.
A strategic foreign investor is defined as:
'An investor having more than 10% of the stock of a company listed in the stock exchange or OTC market, or after acquiring the stocks becomes a member of the board of directors of that company.'
Strategic investors must observe a two-year lock up period. Any sales of stocks within this lock up period require the authorisation of the SEO. No such limitation will apply to non-strategic investors.
Further, investors who have been granted a transaction authorisation are able to open bank accounts in foreign or local currency as well as to transfer foreign currency into Iran and repatriate funds abroad subject to currency regulations.