South Africa probably won’t avoid the gray list: experts


Despite the South African government’s efforts to accelerate reforms and make urgent changes to the country’s financial regulations, the sheer magnitude of the shortcomings when it comes to Financial Action Task Force (FATF) statistics means which is most likely a gray list.

This is the view of experts at financial services firm KPMG, who say the sooner companies and the financial sector get the hang of this, the sooner the country can start tackling what needs to be done to get off the list.

“In order to avoid the gray list, several actions have been taken to rectify the findings,” KPMG said.

“Since December 2021, many South African supervisory authorities have submitted notices asking responsible institutions to take corrective action in accordance with FATF requirements, and to strengthen the scope of their oversight of responsible institutions.”

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

In addition, such amendments must be submitted to the FATF at least six months before the plenary session, which is scheduled for mid-February 2023. At this stage, with less than two months to re-evaluate the FATF, many deficiencies have not yet been addressed or are still in the planning or approval process,” the group said.

These deficiencies therefore cannot be considered for reassessment by the FATF – based on this, it is very likely that South Africa will be placed on the gray list of the FATF, according to KPMG.

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The financial group accepted this as the base case and said the question needs to shift from how the gray list can be avoided, to how the gray list will affect South Africa from a regulatory and economic perspective and what can be done to prevent the removal of speed up the list.

How will the gray list affect us?

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

KPMG said that for a more practical look at the impact, companies should look at what happened in other markets on the gray list.

In Botswana, asset managers were unable to transact directly with pension funds with an offshore portfolio – and foreign direct investment in the diamond sector was impacted by influencing the repatriation of profits from Botswana to origin.

Pakistan’s FATF Gray List, which began in 2008 and ended in 2019, is estimated to have resulted in cumulative real GDP losses of about $38 billion. Findings from market research and analysis group Intellidex found that Pakistan’s graylist status led to a decline in economic growth of between 1% and 2% between 2012 and 2015.

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

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

According to Momentum Investment, South Africa could escape the worst of the consequences, given the country’s clearer plan to deal with the penalty. The impact on credit ratings is also likely to be muted, it said.

“Sovereign rating agencies are more likely to follow South Africa’s macro fundamentals than a possible greylisting event being the sole determinant of the rating outcome,” it said.

But even with a smaller impact, a gray list would nonetheless further erode the economy’s ties to the global financial system, increase the country’s cost of capital and create an additional disincentive for offshore companies to do business with South Africa.

This would be on top of clunky network industries, inflexible labor markets, energy shortages and policy uncertainty, Momentum said.

For KPMG, the outcome could fall into a number of scenarios, ranging from simple reputational damage to foreign investors leaving the country. Broadly speaking, the group highlighted six consequences:

  1. South African entities may not be recognized as equivalent regulated entities;
  2. Risk reduction and divestment in South African entities and investment vehicles;
  3. Imposing audits, according to national and international standards;
  4. Delays in payment arrangements;
  5. Reluctance to enter into relationships with politically exposed persons;
  6. Comprehensive Know Your Customer performance reviews.
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In the end, KPMG said there is still uncertainty about whether South Africa will be added to the FATF’s gray list. But even this uncertainty is harmful.

“The magnitude of capital inflows and outflows is expected to decline due to reduced investment and activity. Interestingly, many graylisted jurisdictions noted that prior to the graylist announcement, there was a sharp increase in capital outflows, taking advantage of information asymmetry,” it said.

In the event that South Africa is included in the FATF’s gray list, in addition to the extensive follow-up assessments by the FATF, South Africa may also face restrictions imposed by other jurisdictions, which may lead to barriers for doing business or investing in the country.

The international economic consequences can be:

  • An increase in regulatory burden for both South African entities and their foreign counterparts;
  • Economic restrictions from international financiers such as the IMF or the World Bank;
  • Restrictions imposed by individual banks and companies when doing business with South African entities.

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

According to National Treasury, it will be several years before South Africa is removed from the FATF gray list, which could mean that the international economic impact could have long-lasting consequences for the South African economy.

Read: Cabinet takes ‘grey list’ threat seriously: minister



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