By Marthinus van der Nest
The possible greylisting of South Africa follows several recent strong headwinds, such as downgrades, market volatility amid the pandemic and war in Ukraine, and lack of economic growth.
These kinds of conditions have always created opportunities and challenges for investors and fund managers.
While greylisting is negative for South Africa, the question for investors is to what extent is this already in the price, and what should fund managers be doing to mitigate risk and – where possible – to continue to find investment opportunities.
What will happen
In October 2021, the Financial Action Task Force (FATF) identified deficiencies in South Africa’s policies and systems to combat money laundering and terrorist financing. While government is moving to bring some regulations up to standard, the country’s inability and lack of political purpose to monitor, investigate and prosecute financial crimes could render these efforts insufficient and lead to what many experts think is an inevitable greylisting in February next year.
Greylisting will essentially be a confirmation of the lack of control over crimes that have been evident for several years, and some experts believe it was inevitable. It will result in constraints to investment, higher borrowing costs and restricted access to capital for government, state-owned entities and the private sector.
What it means for the economy and investment
Greylisting requires other countries to apply enhanced due diligence and countermeasures, and the South African Reserve Bank (SARB) has indicated that it is not only concerned with the greylisting, but that jurisdictions such as the European Union (EU) will “step up their actions on South African-based institutions” and that international entities will ask if it is worth it to do business with South Africa and increase the cost of borrowing, or not avail resources, reducing access to capital.
Once greylisted, access to international finance and trade is limited and offshore counterparties are disincentivised to do business.
It is no secret that global asset allocators have cut back on exposure to South Africa for some years, given a series of downgrades and the constant flow of news about the poor economy, corruption and state capture, and widespread power cuts.
As foreigners keep exiting South Africa, the risk premium has been rising and the greylisting is just one more reason to avoid SA or unwind positions due to political concerns, says Erik Nel, who manages two Amplify funds.
As this has been a long-term trend, it may imply that greylisting is already in the price of South African investments, in which case there should be little real impact, although an immediate reaction may follow the announcement.
However, the investment environment at the time of the announcement in February 2023 will frame the investment scenario going forward, says Nel, particularly as the investment environment is currently driven by a number of variables that are difficult to predict, such as the oil price, the war in Ukraine and Russia’s future moves, and the ANC leadership elections.
Nel says greylisting “is quite a small factor in the capital flow story, relative to general global tumult and risk off – but may have been, at the margin, at least somewhat of an explanatory variable for the ongoing disinvesting of foreign portfolio outflows over the past three years”. The net sum is it risks a material slowdown of inbound flows.
Nel says the big effects of greylisting are evident in countries that have other big problems, such as Turkey.
What it means for asset allocation
It is difficult at this stage to predict which asset class, sectors or individual companies will be affected, but Amplify expects the move to affect locally-focused businesses less than sectors or companies that rely heavily on foreign demand and flows. As greylisting will likely affect the rand, companies exposed to imports and foreign exchange flows are clearly more at risk.
What will government do?
Various bills and amendments are before Parliament that should result in amendments to the Financial Intelligence Centre Act, Financial Sector Regulations Act, Companies Act, Trust Property Control Act and Nonprofit Organisations Act.
While these go some way towards addressing the numerous deficiencies identified in the task force’s Mutual Evaluation Report (MER) of South Africa, published in October 2021, South Africa’s biggest problem is implementation and enforcement, and the consensus seems to be that South Africa will not be able to do enough to avoid greylisting, given the enormity of the task.
Changing laws is one thing, but the ability of various state agencies to uncover financial crimes and arrest and prosecute perpetrators is another.
We are following these developments closely and await the October update on government’s progress, when it has to prove to the FATF it has done enough to address its concerns. We view this as one of many challenges we face and can overcome.
Marthinus van der Nest is the head of Amplify Investment Partners.
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