South Africa is known for being at the top of all the wrong lists and looks all set to join a new list – countries on the grey list for its financial systems.
South Africa’s economy is indeed in knee-deep trouble right now. Some of the trouble is self-inflicted – for instance the drastic decline in the performance of state-owned enterprises – but the country is also impacted by global issues like rising inflation and higher interest rates. The new risk on the horizon is that South Africa will join countries like South Sudan, Uganda and Syria on the global grey list.
What is the grey list, and who enforces it?
The Financial Action Task Force (FATF), which is an intergovernmental organisation, is the enforcer of any grey listings on countries not abiding by the laws of good and transparent management of finances. Currently, there are 39 member countries of the FATF, of which South Africa is one.
The FATF acts as a global ‘watchdog’ to monitor any corrupt financial actions as well as keep an eye on terrorist financing and money laundering. In short, the FATF is promoting and encourages good corporate governance in general.
The decision to be a member country of the FATF is voluntary. Considering what was uncovered by the Zondo commission it seems almost peculiar that SA decided to be a member of the FATF.
What gives reason for a country/member of the FATF to be grey listed?
The purpose and objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. Again, in view of the findings of the Zondo commission, it is not a surprise that we find ourselves here.
When the FATF identifies any strategic deficiencies in a country’s systems to counter financial crimes, you face the risk of being greylisted. Two of South Africa’s better global rankings are for its banking and legal systems. At the moment, however, it seems like the legal system is failing, in view of the many politicians and their associates implicated in state capture who have not been charged and are still in office.
A legal system can only be judged by the application of rule and law, and the consequences faced by any transgressors.
South African Bonds have long been very attractive as an investment alternative for global investors (given good governance on local fronts). Very often, I get the question as to why foreign investors do not buy more and more of our local bonds, and the reason is simple – governance! (Or rather, lack thereof).
Foreign investors are truly wary of South Africa and the state of our political and economic landscape. Philip Bradford (Portfolio Metrix) recently indicated that global investors have a lack of confidence in the SA local government and the way the country is governed. This is an indication that the rest of the world is watching and taking note of the state of local affairs.
South Africa’s inability to effectively prosecute guilty parties for various financial crimes, is one of the biggest reasons for the possible grey listing.
What are the odds of SA being grey listed and how will it impact capital flows to and from SA?
Although there is no definite indication, the answer is high – very high! There is also no exact timeline of when this might happen, but there is a strong indication that the outcome will be made public in February 2023. See below an interesting timeline from Intellidex:
SA currently falls short of about half of the total recommendations by the FATF.
The answer you are looking for:
SA received 12 immediate priority reaction points from the FATF to avoid the grey list. Based on research done by Intellidex, here is how we fare:
- Two have been satisfactorily achieved;
- Three are far from being achieved; and
- Seven have made some progress.
The actual probability of SA being grey listed is calculated at 85%. The biggest contributing factor to this result is the undermining of the criminal justice system during the state capture era.
Capital flows in and out of SA? – The grey can get dark, really dark!
This is a daily conversation with investors. The most important factor to keep in mind is this – with regards to the greylisting, it is much more important where your money comes from, from a global point of view, than where this money is going.
That means, it will make it an extremely difficult, close to impossible task, for South African investors to take capital offshore.
SA will be flagged as a high-risk jurisdiction by foreign countries and institutions. The issues will be mostly with capital being externalised out of SA, and not with capital flowing back into the country.
It will have a dire impact on South African asset managers, as well as individual retail investors in SA looking to take their capital abroad. In a recent meeting with one of the top asset managers in the country, a clear message (or rather warning) was shared – prepare yourself to be inundated with documentation and admin from all fronts when investing capital offshore if SA makes the list.
The finest detail of the capital and source of funds will have to be proved by the investor, which will make offshore investments an onerous and nearly impossible task for South Africans. Sufficient proof will have to be provided that the capital is not corruptly gained or the proceeds of criminal activities.
Not only will there be dire consequences for local investors looking to invest capital abroad, but it may also place additional limitations and administrative burdens on local businesses and individuals doing international transactions, which includes sourcing and buying stock/resources from abroad, doing simple online transactions or to purchase personal items from abroad.
South Africa will likely also experience a loss of an investment-grade credit rating, which poses a very big reputational risk for South Africa as an investment destination. And just as you think it can’t get worse, there’s more –
often, countries being placed on the FATF’s grey list are followed by a blacklisting by the EU shortly after. SA will likely also follow this route, as this was the case with Mauritius (removed from the grey list in February 2022).
Further implications for SA
Over and above the additional burden on SA investors looking to externalise assets under a grey-listed jurisdiction, the wider economy will also feel the brunt.
International banks will be required to place even more emphasis on bureaucracy when dealing with South African clients, whilst global funders such as the World Bank will also apply further restrictions in terms of financial support for SA.
And yes, this is bad. Certain countries simply refuse to deal with investors/parties from jurisdictions on the grey list, meaning that SA will lose access to those markets, products, services, funding, etc. This can cut the artery of many businesses and investors in South Africa.
The biggest implications of the greylisting are:
- Lowered credit/investment ratings for SA.
- Additional complexity, bureaucracy, and administrative burdens in doing simple offshore transactions. These foreign transactions will also be more expensive to execute.
- Up to (and likely even more) than 3% of the GDP of SA can be down the drain if grey listed, depending on the seriousness with which SA is perceived to be acting to address the concerns of the FATF.
- The exchange rate can easily be flushed to around R20/$ and likely even worse.
- Foreign investors may cut strings with SA.
See below with whom we will be rubbing shoulders and the size of the countries (GDP and domestic equity market cap) that have been grey-listed before. Not the company you would like to be in….
The economic impact of greylisting
The rocky road ahead, and the tantrums of the ZAR
South Africa has been on the watchlist of the FATF since October 2021 and has until February 2023 to show improvements on various fronts regarding financial crime, the way corruption is dealt with, the list goes on.
Should SA not be able to show improvements in this regard, it will not escape the grey list and a tough time will follow. In the case of the greylisting of Mauritius, that country was cleared within two years of being named on this list as its government made it a priority to get this done.
Our view going forward is that firstly, we will most likely not make the required improvements in time which will lead to us being added to the grey list, and secondly, once we are grey-listed, we will be spending a significant amount of time there. It normally takes countries several years to get their house in order to be merely considered to be removed from the grey list. Considering the slow response of the SA government to a range of issues, this may take a while.
One of the biggest fears of a possible grey listing is the impact on the rand/dollar exchange rate. Various models already indicated that there is a strong possibility that the rand can plunge to even R25/$ should SA be grey listed in February 2023. According to Codera Analytics, the options market expects the rand to trade at current levels (R18/$) over the next 12 months but the market is pricing in a higher risk of depreciation than appreciation. In other words, all rand-related risks point to the downside. This is not a pretty picture.
Together with the above, is the net flow of SA assets, primarily bonds and equities. 2021 saw a record level of net outflow of assets from SA, to a value of almost R350 billion. In simple terms, this means that foreign investors took their money, and ran! And there is only one reason why investors pull the plug – the risk is too high for the possible upside (or even lack of any upside in general).
Going from bad to worse, 2022 is on track to break this record yet again. At the start of October, SA already surpassed the R250 billion mark.
Limit the effect of a possible grey listing on your investments
If ever, now might be an opportune time to reconsider taking some of your liquid investments offshore to avoid being trapped and getting hammered by a shock in the currency markets. The expectation is that the final ruling will be made public in February 2023, but it is widely expected that a greylisting is on the cards.
The effect of the possible grey listing is not limited to financial markets only but will have a much deeper effect on the structural strength of the economy and local businesses that contribute to the GDP, creating jobs, and making fixed investments in SA. These will all be given a heavy blow.
Enjoy South Africa for the good it has to offer – rugby, scenery and more, but safeguard your hard-earned assets against the ramifications caused by mismanagement and lack of governance, law, and order from our own government. The grey clouds can become very dark, very quickly.
