South Africa unlikely to avoid the grey list: experts

Despite the South African government’s best efforts to fast-track reforms and make urgent changes to the country’s financial regulations, the sheer scale of its deficiencies when it comes to the Financial Action Task Force’s (FATF’s) metrics means a greylisting is highly likely.

This is the view of experts at financial services group KPMG, who say that the sooner businesses and the finance industry get to grips with this, the sooner the country can start tackling what needs to be done to get off the list.

“In order to avoid the grey-listing, various actions have been taken to remediate the findings,” KPMG said.

“Since December 2021, many South African supervisory authorities have submitted notifications asking accountable institutions to proceed with remedial actions according to the FATF requirements, and strengthened the extent of their supervision on said accountable institutions.”

However, the group noted that requests for technical compliance re-ratings will not be considered where the FATF determines that the legal, institutional, or operational framework has not changed since the country’s assessment.

“Additionally, such changes need to be presented to the FATF at least six months before the plenary, which is scheduled to take place mid-February 2023. At this stage, with less than two months left before the FATF reassessment, many deficiencies have not yet been addressed or are still in the planning or approval process,” the group said.

These deficiencies can therefore not be considered for re-assessment by the FATF – based on this, it is highly probable that South Africa will enter the FATF grey list, KPMG said.

Accepting this as the baseline scenario, the finance group said the question needs to move on from how to avoid the greylisting, to how the greylisting will impact South Africa from a regulatory and economic perspective and what can be done to hasten the move off the list.

How will the greylisting hit us?

The impact of the greylisting has been broadly mentioned but not clearly explained. CEOs and other analysts have stated that it will make doing business in international markets more difficult, and local companies will have to have due diligence ready to deal with the additional administrative burden.

KPMG said for a more practical view of the impact, businesses need to look at what happened in other greylisted markets.

In Botswana, asset managers were not able to transact directly with pension funds containing an offshore portfolio – and foreign direct investment in the diamond sector was affected as the repatriation of profits from Botswana to the origin was impacted.

The FATF greylisting of Pakistan, which began in 2008 and ended in 2019, is estimated to have led to cumulative real GDP losses of approximately $38 billion. Findings from market research and analytics group Intellidex showed that Pakistan’s greylisted status between 2012 and 2015 triggered a cut in economic growth of between 1% and 2%.

Turkey, meanwhile, saw a steep decline in foreign investment and saw a ripple effect on its other economic woes.

According to the International Monetary Fund (IMF), a greylisted country can expect an average decline in capital inflow of 7.6% of gross domestic product (GDP), a decrease in foreign direct investment (FDI) of 3% of GDP, and a decrease in portfolio inflow of 2.9% of GDP.

According to Momentum Investment, South Africa might escape the harshest outcomes, given the country’s clearer plan to deal with the penalty. The impact on credit ratings will also likely be muted, it said.

“Sovereign rating agencies are more likely to move on South Africa’s macro fundamentals rather than allowing for a potential greylisting event to act as the sole determinant of the rating outcome,” it said.

However, even with a lesser impact, being greylisted would nevertheless further impair the economy’s links to the global financial system, raise the country’s cost of capital and create an additional disincentive for offshore companies to deal with South Africa.

This would come on top of inept network industries, inflexible labour markets, energy shortages and policy uncertainty, Momentum said.

For KPMG, the outcome could fall into any number of scenarios – ranging from simple reputational damage to foreign investors pulling out of the country. Broadly, the group highlighted six consequences:

1. South African entities might not be recognised as equivalent regulated entities;
2. De-risking and disinvestment in South African entities and investment vehicles;
3. Imposition of audits, following national and international standards;
4. Delays in payment settlements;
5. Reluctancy to establish relationships related to politically exposed persons;
6. Extensive Know Your Customer performance assessments.

Ultimately, KPMG said that there is still uncertainty as to whether South Africa will be grey-listed by the FATF. But even this uncertainty is damaging.

“The extent of capital inflow and outflow is expected to decline as a result of reduced investments and business activity. Interestingly, in many greylisted jurisdictions, it was observed that ahead of the greylisting announcement, a surge in capital outflow took place where advantage was taken of the information asymmetry,” it said.

In the event that South Africa is included in the FATF grey list, in addition to the enhanced follow-up reviews by the FATF, South Africa may also face restrictions imposed by other jurisdictions, leading to barriers to doing business or investing in the country.

The international economic impacts may include:

• An increase in the regulatory burden imposed on both South African entities and their foreign counterparties;
• Economic restrictions from international funders such as the IMF or World Bank;
• Restrictions imposed by individual banks and businesses in doing business with South African entities.

This would lead to a loss of trading and business partners as well as loss of financial flows, it said.

According to National Treasury, it will take a number of years for South Africa to fall off the FATF grey list which may mean that the international economic impact may have long-lasting effects on the South African economy.

Read: Government taking ‘grey list’ threat seriously: minister