South Africa is unlikely to avoid the gray list: experts

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

This is the view of experts from the financial services group KPMG, who say that the sooner businesses and the financial sector get to grips with it, the sooner the country can begin to tackle what needs to be done to get off the list.

“In order to avoid the gray list, various actions were taken to remedy the results,” said KPMG.

“Since December 2021, many South African supervisory authorities have sent notifications asking responsible institutions to proceed with corrective actions according to FATF requirements and have strengthened the scope of their oversight of those responsible institutions.”

However, the group noted that requests for reclassification of technical compliance will not be considered where the FATF determines that the legal, institutional or operational framework has not changed from the country assessment.

“Furthermore, these changes must be submitted to the FATF at least six months before the plenary, which will be held in mid-February 2023. At this stage, with less than two months remaining before the FATF re-evaluation, many shortcomings have not yet been addressed or they are still in the planning or approval stage, ”the group said.

These shortcomings cannot therefore be taken into account for a reassessment by the FATF – based on that, South Africa is highly likely to enter the FATF gray list, KPMG said.

Taking this as a baseline scenario, the financial group said the question must move from how to avoid greylisting, to how greylisting will impact South Africa from a regulatory and economic perspective, and what can be done to accelerate the move from the list.

How will greylisting affect us?

The impact of greylisting has been widely mentioned but not clearly explained. CEOs and other analysts have said it will make it more difficult to do business in international markets and that local companies will need to have due diligence in place to cope with the additional administrative burden.

KPMG said that for a more practical view of impact, companies need to look at what happened in other greylist markets.

In Botswana, wealth managers were unable 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 affected.

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

Turkey, meanwhile, has seen a sharp decline in foreign investment and has seen a ripple effect on its other economic woes.

According to the International Monetary Fund (IMF), a country in the greylist can expect an average decline in capital inflows 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 could escape the toughest outcomes given the country’s clearest plan to deal with the sanction. The impact on credit ratings is also likely to be mitigated, she said.

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

However, even with a minor impact, being greylisted would further undermine the economy’s ties 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 add to inept network industries, tight labor markets, energy shortages and political uncertainty, Momentum said.

For KPMG, the outcome could fall into any number of scenarios, ranging from mere reputational damage to foreign investors withdrawing from the country. Overall, the group highlighted six consequences:

  1. South African entities may not be recognized as equivalent regulated entities;
  2. De-risking and divestment in South African entities and investment vehicles;
  3. Audit imposition, according to national and international standards;
  4. late payments;
  5. reluctance to establish relationships related to politically exposed persons;
  6. Extensive Know Your Customer performance ratings.

Ultimately, KPMG said there is still uncertainty as to whether South Africa will be placed on the gray list by the FATF. But even this uncertainty is harmful.

“The magnitude of the inflow and outflow of capital is expected to decrease due to reduced investment and commercial activity. Interestingly, in many greylisting jurisdictions, it was observed that prior to the announcement of greylisting, there was an increase in capital outflows where information asymmetry was exploited, “he said.

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

International economic impacts can include:

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

This would result in a loss of trading and trading partners, as well as a loss of cash flows, he said.

According to the National Treasury, it will take several years for South Africa to come off the FATF gray list, which could mean that the international economic impact could have long-term effects on the South African economy.

Read: Government takes “gray list” threat seriously: minister