South Africa has been grey listed, what now?

2 March 2023 | Market Forces

On Friday, 24 February 2023, the Financial Action Task Force (FATF) added South Africa (SA) and Nigeria to the grey list. Countries on this list have deficiencies in their money laundering and terror financing practices. We find ourselves in the company of Albania, Barbados, Burkina Faso, Cayman Islands, Democratic Republic of Congo, Gibraltar, Haiti, Jamaica, Jordan, Mali, Mozambique, Nigeria, Panama, Philippines, Senegal, South Sudan, Syria, Tanzania, Turkey, Uganda, United Arab Emirates and Yemen. Countries on this list are at risk of being placed on the black list, which can have significant economic consequences. At the moment, the Democratic People’s Republic of Korea, Iran and Myanmar are on the FATF’s black list.

The FATF stated that SA has made progress in terms of the 67 recommended actions that were identified in 2021. In their most recent assessment in January 2023, the strategic deficiencies were reduced to eight. It seems like we are clear from a regulatory point of view, but lacking from an effective implementation stand point. The expectation is that SA needs to address these deficiencies by no later than the end of January 2025.

What has the impact been so far?

When looking at currency, bond and equity markets, the impact felt was muted since the grey listing decision was made. In figure 1 below, the rand has been weak this year, depreciating by 7.83% against the US dollar. On the day of the announcement, the rand depreciated by 1.12% against the US dollar on the back of dollar strength.

Greylisting South Africa

Source: IRESS

From a SA bond perspective, as seen in figure 2 below, bond yields have been volatile over the respective period. Bond yields pushed higher (implying a capital loss in the short term) in the back end of last year, which could be attributed to the Phala Phala saga, but yields have gradually pushed up leading up to the announcement. On the day of the grey listing announcement, the shorter end (5-year yield) spiked, while the 10- and 30-year bond yields moved lower. One could argue that it has largely been priced in, but global themes such as the direction of global interest rates, sticky global inflation and the possibility of a recession have had a greater impact leading up to the decision.

Has South Africa been grey listed Source: IRESS

The grey listing of SA should not be seen as a non-event, because if this is not addressed, long-term consequences can be significant. Being on the grey list can negatively impact a country’s capital flow, increase compliance costs, hamper access to international finance and create a further disincentive for offshore companies to deal with SA.

Where to from here?

One would hope that this serves as a wake-up call, leading to action that builds stronger, more effective anti-money laundering and counter-terrorism practices. Unfortunately, hope is not a strategy, but political will is required to get us off the grey list. We have been given a clear set of recommendations to address the deficiencies identified by the FATF, which is important to avoid being placed on the black list.

We reached out to a few of our fixed income managers to get their immediate reaction on the grey listing, to find out if it would impact portfolio allocation/strategy and to gauge their view of the short- to medium-term consequences.

The FATF’s decision did not come as a surprise to the responding managers and none of them made any strategic changes to their portfolios on the back of the announcement. Please refer to the table below for their summarised views.

Asset Manager	View
Coronation Fund Managers	Our base case was that we were going to be grey listed. The minister of Finance also advised of this possibility in his budget speech, therefore, it was well flagged and understood by market participants. We did not make any portfolio changes subsequent to the announcement. The most likely lasting impact of grey listing is the transactional and administrative cost implications imposed on banks and other financial institutions. If we are not removed from the list, it will undermine the competitiveness of the SA economy. However, the Government has responded to address most of SA’s deficiencies and have announced their intention to get off the list as soon as possible. The Government has also asked the FATF to formerly reassess compliance during its next plenary in June 2023, which indicates that there is some commitment to provide evidence of better enforcement activity in the near future.
Matrix Fund Managers	The grey listing was expected hence there were no portfolio adjustments. Our core view was that this is not a financial market and portfolio flow risk. While there was a modest reaction in the rand over the course of Friday, this was more a function of dollar strength on the day. The cost of doing business in SA will increase and this could limit new domestic and inward direct investment, adding to the pressure on growth and hindering job creation. As a result, SA assets should reflect a discount to account for the weaker growth outlook, risks for inflation persistence, and potential for tighter macro policy. Going forward, global factors should dominate domestic factors now that some of the event risk (SA budget and FATF) is out of the way. Based on various analysis, it seems unlikely that we will move off the grey list within the next 24 months. Even so, the potential upside is an acceleration of implementation to adhere to the FATF requirements and while this may not quickly lead to a removal from the grey list, this would assist to reverse the negative impact on business confidence.
Ninety One Asset Management	Our expectation was that SA would be grey listed. From a portfolio perspective, we hold downside bond protection in the form of bond put options, which shields the portfolio’s bond position during significant idiosyncratic events. Recently, we increased our foreign exchange (FX) exposure to 6.5% and added swap hedges to the portfolio due to our view that global rates markets were complacent regarding inflation risks. This provided protection over the volatility experienced throughout February, which also coincided with the announcement of SA’s inclusion on the grey list. In the short term, the rand has been underperforming compared to emerging markets in anticipation of the decision. The market reaction following the announcement suggests that the decision did not come as a surprise. However, in the medium term, the transfer of flows out of the country is expected to encounter increased frictional costs.
Prescient Investment Management	It was reasonable to expect that SA would be grey listed. This was formally announced on 24 February 2023 and was met with very little market reaction. It is arguable that perhaps the market made this inference directly (i.e. the inevitability of grey listing) in October of last year. We don’t respond to ‘market catalysts’ directly, but this risk would have been picked up and responded to as it feeds into our overall bond score. It is important to note that out of the 67 areas of concern, all but eight were addressed and resolved, meaning there remains only eight developmental areas to improve before SA can migrate off the grey list. National Treasury has noted that none of these eight areas relate to the prudential monitoring of the financial sector, meaning none of them pertain to banks or insurers or the regulation thereof. This materially limits the risks to financial stability and also limits the extent to which the grey listing could influence the cost of doing business with SA and by extension, long-term risk premia. As far as our understanding goes, there is nothing to indicate that we are in a position which will jeopardise the long-term economic prospects for SA.
Terebinth Capital	The grey listing was expected, as is evident from the FX and bond market sell-off in the preceding weeks with minimal movement post the announcement. It is well understood that once a country is added to the FATF grey list, it is also added to the European Union (EU) high-risk third countries list by the EU and to the United Kingdom’s high-risk jurisdictions list, and that the IMF has found that when a country is grey listed there is a large, significant negative effect on capital inflows. But these capital flows predominantly speak to foreign direct investment and not foreign portfolio investment. National Treasury has made significant efforts to address deficiencies in the financial system and ensure technical compliance with all regulatory requirements. However, effective implementation is the focus of the FATF, and more work needs to be done in this regard. Given the current investment climate, a highly tactical approach is necessary. As the rand continues to weaken, FX positions may be removed, and eventually, FX risk may be hedged back as the rand is starts to screen cheaper. Going forward, it raises the hurdle for doing business in SA, underscoring the need for a more effective government.