Research report advises South Africans to prepare for grey-listing

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There is an 85% probability that South Africa will be grey-listed by the Financial Action Task Force (FATF) in February next year, mainly because institutions in the criminal justice system were undermined during “the era” of state capture, according to a research report released yesterday by Intellidex.

The report, which was commissioned by Business Leadership South Africa, recommends that private sector companies and individuals prepare for the enhanced due diligence that will accompany grey-listing. They should engage foreign service providers to establish how their risk rating will be affected by grey-listing and what enhanced due diligence measures will have to be undertaken.

According to Intellidex, the economic impact of grey-listing will depend substantially on the seriousness with which South Africa is perceived to be acting to address FATF’s concerns.

“A serious government-wide effort to fully implement FATF’s recommended actions to comply with all FATF’s requirements urgently will assure counterparts that grey-listing will be short-lived. In contrast, if South Africa is perceived as being inactive in addressing FATF’s concerns, the costs will be high.”

Intellidex outlines two scenarios South Africa can expect if it exits grey-listing in the short term (18 to 24 months) or if grey-listing lasts longer (five years or more). Optimistically, grey-listing could cost less than 1% of GDP a year because of higher international transaction costs. In a pessimistic scenario, grey-listing could reduce GDP by two to three percentage points a year, recovering gradually once grey-listing is lifted.

Enhanced due diligence for SA clients

The report says the first-order effects of grey-listing will be an immediate increase in the risk category for all South African clients at many international financial institutions, particularly those in the European Union and the United Kingdom.

South African clients will become subject to enhanced due diligence, which will mean more frequent (usually annually instead of every three years) and invasive assessments (requiring senior management to report directly to offshore counterparts) of clients for money laundering and terrorism financing risks. This will mean an increase in costs for South African businesses and individuals who trade internationally and have bank accounts or investment accounts abroad.

Higher compliance costs

Costs will increase particularly for South African banks in managing correspondent banking relationships and relationships with global infrastructure providers, such as payment systems, Intellidex says.

If South Africa is not perceived to be acting swiftly to deal with FATF’s requirements, foreign counterparts may opt to reduce their compliance costs by terminating relationships with South African clients and not entering new relationships.

Funding and capital markets

Grey-listing will complicate official and multilateral development assistance, including funding of South Africa’s energy transition investment needs. Multilateral funders may introduce conditions relating to anti-money laundering and counter-financing of terrorism (AML/CTF) compliance and conduct more detailed due diligence to satisfy themselves on South African risks.

According to the report, the impact on the country’s capital markets will be relatively minor in the short run – bond and equity investors have no automatic response to grey-listing and are already well aware of the risks. However, there will be some down-weighting of South African exposure by ESG funds that use grey-listing as a proxy for governance.

The second-order effects will be through negative publicity and reputation associated with grey-listing. This will affect South Africa’s international relationships in many ways, ultimately resulting in a reduced appetite for business relationships with South African associates, Intellidex says.

A bridge too far

The FATF’s Mutual Evaluation report, adopted in October last year, set 12 “priority actions” for South Africa to address the deficiencies outlined in the report. South Africa needs to demonstrate substantial progress on the priority actions.

According to Intellidex’s analysis, South Africa has fully implemented only two of these recommendations. The other 10 are being addressed, but Intellidex believes there has “not been any notable progress” on three of these.

It expects the following to be the most problematic among the priority actions for South Africa to undertake:

Supervision of designated non-financial businesses and professions

The report says “little to no progress” has been made in implementing AML/CTF supervision of designated non-financial businesses and professions (DNFBPs) such as estate agents, Krugerrand dealers and attorneys. Draft legislation envisages enabling the Financial Intelligence Centre (FIC) to supervise the AML/CTF obligations of DNFBPs, but the FIC will require significant additional budget and resources to do so effectively.

Intellidex expects it will take two to three years for the FIC to build capacity and develop the market to achieve effective supervision.

Beneficial ownership regime

The beneficial ownership regime will take time to become effective. Draft legislation will enable the Companies and Intellectual Property Commission (CIPC) and the Masters’ offices to access information about beneficial owners of companies and beneficiaries of trusts, respectively. However, it will take some time for the CIPC and particularly the Masters’ offices to capture this information and make it available for use.

Lack of capacity at the Hawks

The Directorate for Priority Crimes Investigations (the Hawks) has been slow to implement the recommendation to take on more staff, particularly financial investigators and forensic accountants, so that it can better use financial intelligence and place more emphasis on proactively identifying and investigating money laundering cases. A handful of investigators have been appointed, but there need to be considerably more.

Intellidex says there are other areas where South Africa will be able to demonstrate good progress since the mutual evaluation, which was undertaken in 2019, particularly progress in prosecutions, arrests and asset forfeiture related to state capture.

“This will be a positive in South Africa’s case to the FATF, which must amount to a credible plan. However, we believe the issues above will be very difficult to progress in time for the February FATF plenary and that South Africa will therefore be grey-listed.”

Leadership needed

Considering that South Africa is unlikely to avoid grey-listing, Intellidex says the focus must be on minimising its impact. This will be achieved by:

  • Mounting a comprehensive and credible effort to address the FATF’s concerns and exit the grey list as soon as possible; and
  • Preparation by the private sector to engage with foreign counterparts to minimise the impact of enhanced due diligence.

To deliver such a programme, leadership will have to be provided from the top, the report says.

The most difficult challenges in meeting FATF’s expectations are to build institutional capacity, processes and systems in key parts of the supervisory, investigation and prosecution services, as well as departments such as Home Affairs and Social Development, which will require co-ordinated action across government.

Intellidex recommends that the Presidency sets up an internal task team to lead the government’s response to grey-listing.