Greylisting
In October 2021, the Financial Action Task Force (FATF), an intergovernmental policymaking body combatting all forms of money laundering and terrorism financing, published an evaluation of SA’s anti-money laundering measures. Through a peer review process facilitated by the FATF, SA was evaluated for a period in 2019 on its anti-money laundering and combatting the finance of terrorism systems. It is a two-fold assessment of the adequacy of SA’s legal framework and the efficiency with which legislation is implemented. The review did not go well. The published report outlined serious shortcomings in SA’s policies and efforts to combat money laundering and terrorist financing, despite the country’s financial system already being highly vulnerable to crimes of this nature.
The FATF report found that SA has “a solid legal framework to fight money laundering and terrorist financing” but has “significant shortcomings implementing an effective system, including a failure to pursue serious cases”. Out of 40 ratings on legislation adequacy, half of SA’s ratings scored as partially compliant or non-compliant. Out of 11 ratings on the efficiency of implementing the legislation, SA was scored critically weak on all ratings. As such, SA now runs the serious risk of being placed on the FATF’s greylist – the FATF has worryingly raised more serious concerns about SA than it did about the United Arab Emirates (UAE), which was greylisted earlier this year.
To be greylisted by the FATF means a country’s shortcomings threaten the international financial system and is a serious blow to a country’s reputation. Such a country is subjected to increased monitoring and has to deal with adverse economic consequences for trade and transactions with other countries. Regulators in the US, the UK and the EU may also restrict their banks from transacting with greylisted countries’ banks. In addition to the UAE, the FATF’s current greylisted countries include the likes of Cambodia, the Cayman Islands, Burkina Faso, Albania, Yemen, Pakistan, and Syria. Blacklisted countries — at this stage, only North Korea and Iran — are officially considered high-risk jurisdictions. The list essentially warns of the significant danger of money laundering and terrorism financing that a particular nation holds in global dealings. As identified by the FATF, SA’s three most-critical weaknesses are:
- Customer due diligence;
- terrorist financing offences; and
- targeted financial sanctions for terrorism and terrorist financing.
In a scorecard on the work of the Directorate for Priority Crime Investigation (DPCI or Hawks), police, intelligence agencies and the National Prosecuting Authority (NPA), the FATF report stated that SA principally struggles to detect and prosecute terrorist-financing offences. In this regard, key findings in the FATF mutual evaluation report, for example, include that authorities’ understanding of terrorist-financing risks is “underdeveloped and uneven”. The report further states that law enforcement “lacks the skills and resources to proactively investigate money laundering and terror financing.” SA has until October 2022 to show the Paris-based FATF that it has made sufficient progress in remedying the identified deficiencies.
Suppose it fails to convince FATF at the October meetings. In that case, SA could become the second G20 nation after Turkey to be added to the watchlist of what the FATF calls “jurisdictions under increased monitoring” – the one step before being formally placed on the greylist in a follow-up review. FATF is due to make its final decision on the composition of the formal greylist in February 2023.
What are the implications for the financial sector and the greater SA economy?
The results of global empirical studies of the impact of greylisting or blacklisting by FATF are mixed. A recent IMF study estimates that capital inflows typically decline by 7.6% of GDP at the time of a greylisting (with a typical range of 4.5% to 10.5%). In contrast, two empirical studies found that blacklisting had no significant and enduring impact on banking flows and tax havens. Falling in between these results is a Latin American study that found a small (0.3%-0.4% of GDP) impact on foreign direct investment (FDI) but no consistent impact on other flows. Two further studies found a 10% and 15% decline in cross-border receipts and growth in bank inflows, respectively.
Essentially, these divergent empirical findings demonstrate the difficulty in accurately estimating the economic impact of the FATF’s greylisting and/or blacklisting. This is arguably at least partly because, unlike the specific event of an adverse listing, the fundamentals that inform such listing typically deteriorate or become greater over time. Thus, investors would typically react to these fundamentals independently and not only to the listing status itself. For example, global investors would already have been more cautious about their transactions with SA during the state capture era rather than waiting for an adverse listing of the country by the FATF. Plainly speaking, many international investors would have already priced in the risk of transacting with and within the SA financial system. This mirrors the same dynamic as that of a sovereign credit rating downgrade which does not necessarily cause a material and persistent economic and/or market reaction because the relevant, weak fundamentals are typically discounted well in advance.
Nonetheless, it is safe to assume that landing on the grey list will be detrimental to the integrity of the SA banking system and jeopardise the country’s relationships with overseas banks. Regulators from some of SA’s main trading partners, such as the US, the UK, China and Japan, may restrict their banks from transacting with SA banks. Of those able to transact, the associated costs will be raised significantly. This, in turn, may have a material adverse impact on capital flows and subsequent growth, as well as on the currency and bond markets. Furthermore, it will become increasingly difficult to invest offshore, even for the wealthiest investors. Whilst one cannot rule out an adverse impact on SA’s economy, bonds, and currency should the country be greylisted, at this stage, it would be premature to adjust our macroeconomic forecasts on the assumption that at least some of SA’s deficiencies are already being discounted by high idiosyncratic risk premia and, if placed on the grey list, the reasonable probability of authorities making adequate progress in addressing these deficiencies to be removed off said list.
How do we get out of this mess?
Significant progress would need to be made in a very short period to avoid such an adverse outcome of the FATF process currently underway. Positively, the FATF assessments lend substantial weight to any demonstrable effort by policymakers (such as interventions by the SARB and Treasury) to address SA’s shortcomings. However, aside from the typical uncertainty surrounding the timeframes to complete specific actions (such as regulatory changes), the FATF assessments also embody inherent subjectivity, which clouds estimating any probability that SA can make enough progress timeously to avoid being greylisted. Nonetheless, an adverse outcome is not inevitable, but at this point, recent assessments by the Treasury and the SARB of a “high” probability of such an outcome appear pertinent.
Regardless, in an urgent move to help prevent SA from being greylisted, cabinet approved a raft of new amendment bills in late August. The omnibus of bills amends the Financial Intelligence Centre Act, the Non-profit Organisations Act, Trust Property Control Act, the Companies Act and the Financial Sector Regulations Act. The amendments included in the bill aim to respond to the deficiencies identified during the peer review of the country conducted by the FATF and address around 14 of the 20 areas in which the FATF found SA deficient. The Protection of Constitutional Democracy against Terrorist and Related Activities Amendment Bill, currently before Parliament, will address two other deficiencies. The remaining technical deficiencies will be addressed through various regulatory changes.
Whilst it is indeed plausible (even if unlikely) that Parliament will be able to process these legislative reforms by the end of this year, other aspects of the FATF review will require a broader political response to correct. In particular, SA authorities will need to fully assure the FATF that collectively, SA is more capable of giving effect to this legal framework than it has been in the past and governance institutions can hold to account those responsible for past and inevitable future transgressions. With regards to the upcoming review, above all, authorities will need to restore confidence in SA’s capacity to deliver accountability for state capture crimes and its ability to recoup the funds looted from state institutions by those implicated in high-level state capture offences.
Could this be the wake-up call that SA needs?
While no country would ever want to wind up on the FATF’s greylist, doing so could kick-start and accelerate much-needed reforms to counter fraud, corruption, and terrorism financing in SA. Such was the case for Mauritius – the country was able to get off the greylist in under two years, much to its longer-term economic benefit. Mauritius was initially greylisted in February 2020 for several reasons, including a lack of effective risk-based supervision, limited access to beneficial ownership information, and insufficient oversight of non-profit organisations that may be subject to terrorist financing. There was also a general ineffectiveness in conducting money laundering investigations. After quickly and proactively implementing the necessary reforms, the country’s financial sector is beginning to stand out for all the right reasons – attracting significant international growth and development opportunities.
SA might not be as lucky as Mauritius was to get off the grey list so quickly – as countries tend to spend several years on the list tackling the various identified deficiencies – but it is possible. Mauritius took a concerted effort to exit the greylist, but it is now fully compliant with 39 of the 40 FATF recommendations. Mauritius has its FATF-approved objectives set out across core strategies such as:
- Strengthening anti-money laundering/counter financing terrorism (AML/CFT) legal and regulatory frameworks to meet international standards, effectively mitigating risks.
- Implementing a comprehensive, risk-based supervision framework to monitor financial institutions and designated non-financial businesses, such as real estate brokers, banking and securities, and jewellery stores.
- Improving the process of detecting fraud threats, prosecuting criminals, and confiscating illegal proceeds.
- Enhancing the transparency of legal persons and enlisted national coordination, as well as regional and international cooperation
- Increasing training and capacity and raising awareness to ensure all stakeholders are working in accordance with AML/CFT obligations.
- Implementing an AML/CFT data collection system to continuously improve risk detection.
These are all solid, sound steps that have gone a long way for Mauritius, not only in removing itself from the greylist but also in setting up the country’s financial sector (and thus the greater economy) for better, long-term development and growth opportunities. SA could do well to take note.
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