The Ides of May: geopolitics takes centre stage

(Opinions expressed here are those of the author only and not of Constance Financial, at the time of posting President Trump informed that his decision would be announced on May 8th, that does not alter the essence of this note).

The Roman calendar gave special importance to specific times of the month which served as the basis to count the other days. The Ides were one of these reference dates, and usually fell around the middle of our calendar month. The Ides of May is on the 13th, a date which will be of great significance this year, in addition to being the Mother’s Day celebration in many countries.

May 13th, the day after the announcement of President Trump’s decision on whether he will extend the sanction reliefs for Iran within the framework of the JCPOA (i.e. Iran nuclear deal), is likely to set in motion events that will be defining the path to the future equilibrium in the Middle East and which have the potential to greatly affect the global geopolitical scene.

So far, all indications are that President Trump is likely to exit the nuclear deal. Before discussing the succession of events this action is likely to trigger in our view, let us have a short refresher on the JCPOA. The JCPOA is a multi-lateral accord between the 5 members of the UN that hold veto-power plus Germany with Iran. It is binding on all parties and has been enshrined within a UN Security Council resolution, it is therefore neither a two-party deal nor a treaty. It is based on a framework of strict verification and compliance and if necessary there are dispute resolution mechanisms imbedded in it, that signatories can call upon.

 Why is it important to highlight these points? First, because given the above, US’ so called “withdrawal” does not practically and necessarily void the accord. Second, should the US refuse to certify Iran’s compliance, Iran can decide to trigger the dispute mechanisms included in the accord. In fact, all other signatories have signaled their support for the accord and indicated that its respect and survival is the most desirable path forward. Russia and China in particular, has been vocal about the fact that renegotiation is not an option. As you will see these points are important in our evaluation of potential outcomes.

From a legal perspective, President Trump’s potential refusal to extend sanction relief would not be justified, given that Iran has been fully compliant (Defense Secretary General Mattis confirmed as much during his testimony to Congress and the IAEA has continously inspected and certified Iran's compliance since 2015, not later than mid-March 2018). This point is crucial - as it will certainly be a pillar of how Iran will position itself and devise its counteractions.

We observe that Iran has shown pragmatism throughout the JCPOA negotiations and ever since its implementation by both fully complying with the accord and by choosing patience over action when faced with the prospect of continued de facto financial restrictions, which under the terms of the deal were to be alleviated. It has also repeated at every occasion that it will not be the first one to break the deal. This track record, and the latest information available (Iran’s foreign minister’s video message last week) point to the fact that Iran intends to underscore the “illegal” and “bad faith” aspects of a potential US exit, to build some degree of international sympathy. However, this positioning is likely followed by other actions. In our view, what will unfold after a potential US “exit” will incorporate the following aspects.

Immediately after a potential “exit” of the US: legal and compliant but strong defiant signals

It is our view that Iran will allocate some time – weeks to months - to gauge the response of other signatories and to evaluate the likelihood of a potential “survival” of the accord without US participation. However, it is all but certain that it will seek, to both demonstrate that it is defiant against what it considers a breach in “bad faith”, and to assuage a domestic audience that is disillusioned by the meager economic fallouts of the JCPOA, given continued US pressure on financial institutions worldwide, despite the terms of the deal.

In addition to a potential legal step destined to trigger the dispute mechanism under JCPOA, Iran is very likely to engage in actions which remain permitted and legal under the JCPOA and the Nuclear Non-Proliferation Treaty (NPT) but would be interpreted as defiant: long range missile tests, ramping up nuclear activity destined to civilian research (medical for instance), or increase the pace of enrichment within the 3.67% permitted by the JCPOA.

This obviously will not sit well with the US in particular and might also affect the willingness of the European trio to find alternative ways to cooperate with Iran.

Clarity on what the “day after” plan might be (from US perspective) only after the “exit”

So far, the US administration has offered no insights into what its plans and strategy are following an exit. It is only after a potential “exit” that we will have more clarity of what the “day after” plan (hopefully there is one) of the US administration is with regards to the Iran dossier. We will have a glimpse of it through the messages, the tone and direction the administration will take: either one of “wait and see” on how the other signatories and Iran proceed ahead – a more benign outcome – or that of a crescendo rhetoric and widespread media coverage, that will signal we are heading down the road of crisis, a less desirable outcome with more uncertainty embedded in it.

The hawks will be the determining factor

On both sides of the issue, the determining factor will be the hawks and their ability to steer policy in their favor. It is a well-known fact that M Bolton (National Security Advisor) has been a proponent of confrontation with Iran since his days in the Bush administration in early 2000. Whether Secretary Mattis will weigh more in the balance or the duo composed of the Secretary of State Pompeo and M. Bolton is key to where all this will head to. Meanwhile, in Iran the hawk camp is increasingly impatient, and the perceived or actual failure of the JCPOA to produce economic fallouts as promised, gives them an upper hand in making a case for it uselessness. To what extent the hawks on both sides will influence the decision-making process will determine a wide array of outcomes from status quo and verbal postures to potential and more palpable confrontation.

Any confrontation is likely to be indirect (at first)

A relatively benign outcome is a survival of the “deal” in some shape or form without US participation. This will require tremendous leadership on the part of European signatories. While possible, most specialists seem to give increasingly lower probability to this scenario. The situation is further complicated by the Syrian developments, as well as Saudi Arabia and Israel’s regional strategies.

The Syrian situation is a very complicated one where Russian and Iranian forces have supported the regime while there is American and Turkish presence on the ground. Israel has been particularly vocal about its opposition to Iranian presence in Syria. So far, it appears that Russia has been able to play a moderating role and act as a buffer in this tense situation between Iran and Israel.

Additionally, Saudi Arabia sees Iran’s desire to assert itself as a regional power as a challenge to the long-term equilibrium with which they were comfortable, and more recently has aspirations of its own for playing such a regional role.

Both Saudi Arabia and Israel are close US allies and both are geographically close – almost directly - to Iran: Israel with Iran’s presence in Syria and Saudi Arabia via the Persian Gulf.

It is very likely in our view that should the US exit the deal, Iran will be less likely to exert what it probably perceives as restraint vis a vis these allies. So far Iran has not reacted directly neither to the latest confrontation in Syria where Israel targeted two Iranian sites killing a number of military personnel, nor to Saudi coalition’s strong handed Yemen war of which the occupation of Yemen’s Socotra Island by UAE coalition forces in the Gulf of Aden this last week is the latest episode.

Consequently, with US out of the “deal”, Iran is more likely not to perceive any upside to exert restraint and a probable scenario is a first confrontation in tense and volatile settings with one of US’ close allies.

This scenario is far from improbable and is particularly worrisome in our view.

The ramifications are extremely hard to predict as they will depend on the conjuncture and will be both time dependent and rely heavily on the specific of such skirmishes.

Conclusion

It appears to us that not enough consideration is given by pundits and financial market participants to a potential unraveling of the JCPOA and its consequences. Essentially, there is a great degree of desensitization with regards potential geopolitical tensions as we had a number of “false” alerts since the start of the Trump Presidency: the war of words with Russia at multiple occasions, nuclear threats with North Korea and other less strained "Twittowars" with China for instance. The general feeling might be one of, “another one of those” or this shall somehow pass too. Additionally, many wrongfully rely on the North Korean case, which is fundamentally distinct as a comparative case study.

In our view, the JCPOA situation is very specific with many complicating characteristics. First, this is a situation that will result from the breakdown of an accord which was laboriously reached after nearly 37 years of tension between parties. For illustration purposes, imagine that the US and other world powers reach a deal with North Korea next month. Then less than two years down the road the US pulls out of the deal while North Korea is compliant, citing that the accord was “bad”. One can very well imagine that there will be no going back and any resemblance of trust would be shattered. Such a situation will resemble more a dead end than anything else. Dead end scenarios are particularly worrisome as usually only crisis ensues.

Additionally, the long history of tension and competition between many of the protagonists (US, Iran, Saudi, Israel), and the geographical proximity of some of them distinguishes this from the North Korean scenario where China as an immediate neighbor has had a moderating role and is the de facto regional hegemon with whom no one competes. This adds another layer of complexity and can act as a catalyst for crisis.

As we write these lines the UK Foreign Secretary is visiting the US to lobby in favor of the Iran deal, following in the foot steps of President Macron and Chancellor Merkel. While we hope their efforts pay, we remain very sceptical and hope that the situation resulting from a US exit remains contained and dissipate. Though, realistically it’s consequences are unlikely to be a non-event in the medium term and could foster new crisis in a tense region. It should not be taken lightly by anyone, investors included, and must be given particular attention in light of the very high level of unpredictability.

#geopolitics #JCPOA #irandeal #Iran #saudi #sanction