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The grey list – what does it mean, and what is its potential impact?

By Dean de Nysschen, Portfolio Manager, Glacier Invest, 8 September 2022

It seems as if local markets, as well as policymakers, have only recently woken up to a risk event which has been waiting for some time. South Africa is currently under review by international watchdog, the Financial Action Task Force (FATF).

In October 2021, the FATF published an evaluation of South Africa’s anti-money laundering measures, which found exceptions in the country’s policies and efforts to combat money laundering and terrorist financing, highlighting areas where the financial system is highly susceptible to these crimes.

How did SA get to the point of potentially being grey listed?

When a country is put on the grey list, it means that it is under increased monitoring by the FATF. A country on the grey list is an indication that the FATF has identified strategic deficiencies in its systems to counter financial crimes.

The outcome of the FATF’s SA evaluation was poor, with our country scoring particularly low on the prevention, monitoring and prosecution of terrorism finance, as well as transparency around politically exposed persons and the beneficial ownership of companies and trusts. This means that our country is on the verge of being placed under increased monitoring by the body i.e., being grey-listed.

The consequences could be material, as it raises the risk profile of the country abroad – increasing the cost of doing business in SA and potentially severing business relationships with offshore stakeholders.

What is the probability of SA being grey listed?

Whether this development is a done deal depends on several factors. The review period ends this October, and the FATF expects a concrete plan to address the 20 areas in which SA was judged to be lacking. Currently, this seems unlikely to materialise, as the process would require legislation to be passed through parliament.

On a positive note, cabinet has already recently announced that it approved the submission of new amendment bills for anti-money laundering and combatting terrorism financing. Furthermore, the FATF plenary only convenes in February 2023 for the final decision, providing some hope that the technical compliance aspect of the recommendations could be satisfied in time.

The largest challenge, however, will likely be the effectiveness measures aspect of the recommendations. Satisfying this is dependent on SA’s prosecutorial capacity, meaning SA will have to drastically step-up policing, prosecuting and asset forfeiture. Although strides are being made in this regard (i.e., the National Prosecuting Authority state capture clean-up), it seems unlikely that SA will timeously satisfy the FATF. A middle-road outcome could also include SA being placed on enhanced follow-up – both Treasury and the SARB have expressed their doubts. With this said, the crucial consideration becomes the impact on capital markets, and how long this could take to remedy.

If we land on the list, when and how can we come off it?

In terms of having the decision reversed, it all depends on how seriously the recommendations are taken by the jurisdiction in question, and how effectively policy is instituted to address them. On average, it takes countries on the grey list five to 10 years to get themselves removed from it. Importantly, however, it is very possible to reverse the decision in a shorter time. Mauritius is a good example, having been removed after less than two years on the grey list.

How have other countries fared once grey-listed?

The financial impact of the grey listing seems to be inconclusive when considering historical case studies. The challenge is that studies typically use different measures of financial flows. A series of studies conducted between 2009 and 20161 indicated that countries that were grey-listed experienced no significant impact on cross-border flows and that there was a negligible impact on the ability to attract foreign direct investment. Conversely, studies conducted post-2016 reported a decline of up to 16% in cross-border payments.

A recent International Monetary Fund (IMF) study (Kida and Paetzold, 2021)2 is perhaps the most relevant, having examined the impact across all financial flow measures, using more recent data and the most exhaustive list of grey listed countries. The findings of this study were an average decline in capital flows of 7.6% of gross domestic product (GDP).

Should investors be worried?

Local investors should be aware that there is a high risk of SA being grey listed, which may well have a negative impact on capital flows. This could in turn impact the currency and local bond and equity markets over time. More importantly, investors should know that much of this impact has likely been priced into our markets already, when considering current valuations.

Similar to the impact of a credit rating downgrade, the market and broader economic impact does not occur upon the actual event announcement, but steadily over time when not remedied. It, therefore, stands to reason that SA’s deep capital markets, well-developed financial system, and rational monetary policy could potentially reduce the impact of a grey listing, especially in comparison to the economically and institutionally wayward jurisdictions that have been evaluated previously.

Along with efforts currently underway to prevent this event, the above robust characteristics of our local economy mean that the longer-term market impact is not yet a foregone conclusion. The longer-term outlook and appropriate positioning towards local markets should continue to be driven by fundamental valuations and economic factors, including the prudence of monetary and fiscal policy, and political willingness to implement economic growth-friendly reforms.

About the author

dean-de-nysschen dean-de-nysschen

Dean joined Sanlam Investments Multi-Manager in August 2022 as a portfolio manager in the Retail and Implemented Consulting (RIC) team. Prior to joining the Multi-Manager, he was a member of the Glacier Research team, where he performed the role of Senior Research and Investment Analyst.

Dean joined Sanlam Investments Multi-Manager in August 2022 as a portfolio manager in the Retail and Implemented Consulting (RIC) team. Prior to joining the Multi-Manager, he was a member of the Glacier Research team, where he performed the role of Senior Research and Investment Analyst.

Dean holds a Bachelor of Commerce degree in Investment and Financial Management from the University of Stellenbosch and is a CFA® charter holder.

1 “Did blacklisting hurt the tax havens & quest”, Robert Kurdle, January 2009; “The Impact of Grey Listing on Flows, “Does Saying “Yes” to Capital Inflows Necessarily Mean Good Business? The Effect of Anti-money Laundering Regulations in the Latin American and the Caribbean Economies”, Farias, Maria Elisa and Monica Arruda de Almeida. 2014; “Bank Secrecy in Offshore Centres and Capital Flows: Does Blacklisting Matter?” Working Paper 2016-20, Balakina, Olga, Angelo D’Andrea, and Donato Masciandaro. 2016.

2 “The Impact of Gray-Listing on Capital Flows: An Analysis Using Machine Learning”, IMF Working Paper, Mizuho Kida and Simon Paetzold, 2021.

Glacier Financial Solutions (Pty) Ltd is a licensed discretionary financial services provider, trading as Glacier Invest FSP 770.

Sanlam Multi-Manager International (Pty) Ltd FSP 845 is a licensed discretionary financial services provider, acting as Juristic Representative under Glacier Financial Solutions (Pty) Ltd. As Juristic Representative of Glacier Invest, Sanlam Multi-Manager International (Pty) Ltd manages the retail investment solutions.