The Financial Action Task Force (FATF) was established in 1989 to coordinate an international effort to combat money laundering. As South Africa’s economy is deeply integrated with the global financial system, the threat that it may be greylisted by the FATF at its annual meeting in February 2023 for failing to comply with its norms must be taken seriously. Sandy McGregor discusses this threat.
The past 40 years have seen a widespread improvement in living standards as a consequence of economic globalisation. However, globalisation has its negative aspects, one of which is that it facilitates crime by making it easier for criminals to hide the proceeds of their activities. Money leaves one jurisdiction and turns up in another, hidden by a seemingly legitimate façade. While money laundering to hide illegally acquired money is largely a domestic activity, major criminal syndicates increasingly operate internationally. In most countries, the fastest-growing and most profitable criminal enterprise is the sale of illegal drugs. The pernicious impact of drug abuse is one of the greatest social problems of our times, which governments struggle to combat.
What is the Financial Action Task Force?
As part of the war against drugs, at a meeting of the G7 government leaders in 1989 it was agreed to establish a Financial Action Task Force (FATF) based in Paris to combat money laundering internationally. The FATF now has 37 member countries, including South Africa, which joined in 2003. All the G20 nations, except Indonesia, are members. The 37 members account for over 90% of global GDP.
The FATF implements the requirements of the United Nations Conference for the Adoption of a Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances, which became operable in 1990. This Convention criminalises money laundering and allows the confiscation of the proceeds of money laundering. The FATF set up a framework of 40 recommendations, which constitute the best practice to combat money laundering and promote international cooperation to achieve this objective.
In 2001, the FATF’s mandate was expanded to include money laundering to finance terrorism and later to finance the development of weapons of mass destruction. While this expansion of the mandate reflected US concerns, it was supported by other nations which shared these concerns. Seven additional recommendations were added to the FATF framework for this purpose.
Perhaps the greatest danger of greylisting for South Africa is that it will erode our existing international relationships … This is why a national commitment to remain off the greylist … or to get off the list if we are on it, is so important.
The mutual evaluation of South Africa
The FATF conducts regular peer reviews of each member to assess their implementation of its recommendations. South Africa was assessed in 2009 and found to be acceptably compliant. The next review was conducted in November 2019. The publication of the report on this review was delayed by the pandemic until October 2021. South Africa’s technical compliance was very low. It failed to meet 20 of the 40 FATF recommendations. More important, since the 2009 report, greater emphasis is now placed on the effectiveness of the implementation of FATF recommendations. South Africa failed in all 11 effectiveness measures. While some regulatory and legislation changes are required, the big problem is an implementation failure. South Africa has good laws but fails to enforce them.
In its guidance on best practice the FATF states it “attaches great importance to the fight against corruption: corruption has the potential to bring catastrophic harm to economic development, the fight against organised crime and respect for the law and effective governance”. It goes on to say that “corruption and money laundering are intrinsically linked. Corruption offences such as bribery or theft of public funds are generally committed for the purpose of obtaining private gain.”
This is an accurate description of the consequences of the blatant corruption which became so manifest in South Africa in the Zuma years and remains among the greatest impediments to effective government. South Africa is trapped in economic stagnation by a service delivery crisis in all institutions of government, with the notable exceptions of the Treasury, the Reserve Bank and local and provincial government in the Western Cape. At the heart of the problem is a severe shortage of skills as well as the level of corruption.
In February 2018 President Jacob Zuma was forced to resign and was replaced by President Cyril Ramaphosa. An administration which was actively supporting the blatant state capture project was replaced by one committed to fighting corruption. Tom Moyane, who had done so much to cripple the effectiveness of the South African Revenue Service (SARS), was removed, as were some of the more active supporters in government of the Gupta family. New appointments were made to the National Prosecuting Authority and the lengthy process of prosecuting those guilty of theft from the state commenced. These were important steps in the right direction – but not enough.
When the FATF’s mutual evaluation of South Africa was performed in November 2019, only 21 months had passed since President Zuma’s resignation. It was too soon for those conducting the peer review to come to any other conclusion but that South Africa has a serious corruption problem. Unfortunately, now three years later, progress in the war against corruption remains meagre. Eskom and Transnet are being held hostage by mafia-like organisations who wish to benefit from extortionate procurement agreements. Construction companies are prevented from operating by extortion rackets and the mining industry is under constant attack. The police seem to be visibly absent. Procurement scandals in local government remain endemic.
The mutual evaluation report notes that given South Africa’s role as a financial hub in Africa, it is probable that it is a source of finance for terrorist activities. The United States, which monitors terrorist activities globally, believes South Africa has become a conduit for the financing of terrorism, especially in Africa. The FATF finds it surprising that, in the past decade, South Africa has achieved only one successful antiterrorism prosecution. While South Africa responds positively to requests for assistance in terrorism investigations, it does so with lengthy delays.
This is seen as an example of implementation failure. This failure will be an important consideration when certain FATF members, such as the United States, consider the appropriate response to the mutual evaluation report on South Africa.
The FATF identifies countries which have what it calls “strategic deficiencies” in controlling money laundering. It has a blacklist of countries which are making no effort to comply with its guidelines and whose behaviour is such that it recommends countermeasures to protect the integrity of the international system. There are two countries on this list, North Korea and Iran, and it is possible that Myanmar will join them.
These countries are the exception. Most wish to benefit from participation in the global economic system and therefore need to avoid offending the members of the FATF. Those which are actively cooperating with the FATF to eliminate identified deficiencies constitute the greylist. There is no ban on doing business with members of the greylist. Rather, all jurisdictions are encouraged to apply enhanced diligence in financial transactions with greylisted countries to ensure that the guidelines of the FATF are not breached. However, in practice, given the box-ticking methodologies characteristic of compliance systems, greylisting does impede inward capital flows and imposes increased compliance costs on the financial institutions within the country subject to enhanced diligence.
At present there are 23 countries on the greylist. Notably only one member of the FATF, Turkey, is currently included, mainly due to deficiencies in its control of the financing of terrorism. If South Africa is listed, it will be the second FATF member to be included. Also on the list are the United Arab Emirates, Panama and the Cayman Islands, which are financial centres with lax controls. Nine of the 23 listed countries are in Africa. Membership of the list need not be permanent. Recently Nicaragua, Pakistan and Mauritius have been removed from the greylist after demonstrating a sufficient commitment to compliance.
Will South Africa be greylisted?
Initially the South African government did not treat the peer review published in October 2021 as seriously as it should have. The political leadership failed to appreciate the complexities involved in responding to the report within the given time frame – ahead of the meeting scheduled to review the matter in February 2023. Only after leaders of the banking industry went public with their concerns were the National Treasury and Police ministry given the support needed to introduce appropriate amendments to legislation. These include measures to identify and disclose the beneficial ownership of companies, trusts and non-profit organisations. However, because these had to be rushed through the legislative process, parliament is unhappy about the short time it was given to review the legislation and non-profit organisations believe that the legislation will submit them to burdensome compliance processes. The legislation may be taken on judicial review. Such indignation is not restricted to South Africa; the European Court of Justice has recently overturned similar legislation in the European Union.
… perhaps our biggest vulnerability is the financing of terrorism.
South Africa’s case to avoid greylisting will be that it has made the required changes to legislation and that since the review was performed in November 2019 it has made progress in combating corruption and will continue to do so. President Ramaphosa emphasised the need to fight corruption in his speech following his re-election as president of the ANC at the December party conference. The report was complimentary about our banking system, which has state-of-the-art systems better than those of many developed countries and strong management competent to implement and operate the systems required to prevent money laundering. As the banking system is on the frontline of the battle to combat money laundering, this is of particular importance. The South African delegation meeting the FATF to report on our progress and plans to address the issues it has raised is being led by Ismail Momoniat, the acting director general of the Treasury, who is one of South Africa’s most able public servants. If there is anyone to successfully present the case against greylisting, he is the one.
Despite this progress, many of those close to the process believe South Africa will be greylisted. The weakness of our law enforcement institutions is a serious problem. However, perhaps our biggest vulnerability is the financing of terrorism. This is what got Turkey into trouble. Furthermore, the cosmetics of South Africa’s behaviour are poor. Since 1994 it has a history of siding in international forums with nations which have a poor human rights record. Russia is playing an increasing role in African civil wars through its proxy, the Wagner Group, a paramilitary organisation closely linked to the Kremlin. Despite specious explanations of South Africa’s stance regarding the invasion of Ukraine, it is difficult to come to any other conclusion but that South Africa is supporting Russia. When a Russian ship subject to US sanctions is welcomed at the Simonstown naval base and allowed to unload a mysterious cargo of what can only be presumed to be armaments, but about which the Minister of Defence claims ignorance, member countries of the FATF have strong grounds to be concerned.
The consequences of greylisting
Greylisting should not seriously impede foreign investment in South Africa. Private sector companies in South Africa are well regarded and have long-established financial links, which will continue to operate. Trade between South Africa and the rest of the world will continue, especially as the world needs South African raw materials. Legitimate investment abroad by South Africans will continue.
However, capital flows will be subject to more complex due diligence procedures, which could have a cost. Also, domestic interest rates could be somewhat higher because capital from certain foreign institutional investors will no longer be available. The cost of funding government debt will increase and accessing green finance for the energy transition will become more complicated. The total impact of these costs is difficult to quantify but should be manageable.
Anything which reduces inward capital flows has an adverse impact on the rand exchange rate. However, the market does not depend on rating agencies or FATF greylisting to decide whether a country is investable; it makes its own judgement long before these institutions make their pronouncements. For example, the market downgraded South Africa to sub-investment grade prior to the rating agencies. The impact of greylisting arises because certain institutional investors are precluded by internal rules or by rules imposed by regulators from investing in greylisted institutions. However, this will be of less importance than the principal determinants of the exchange rate, such as trade flows, international monetary policy and the behaviour of the South African government.
The key to reducing the adverse impact of greylisting is a convincing commitment by government to continue to work with the FATF to address the issues that have been raised. An improving situation will be condoned. Mauritius got off the greylist within 18 months by displaying the necessary commitment.
Greylisting in a polarised world
The FATF was founded in 1989 just when the communist regimes in Eastern Europe and Russia were imploding and China was at the start of its journey to becoming an economic superpower. Following the collapse of European communism, the global economy became centred in the Western financial system. To take advantage of the opportunities of globalisation, China and Russia had to conform with the rules governing the operation of this system. One of these requirements was compliance with the guidelines of the FATF, of which both became members. However, in recent years this global consensus has started to break down. China and Russia have become increasingly hostile to what they regard as the imposition of an American hegemony and the world is again dividing into two hostile camps, led respectively by the United States and China. As the ANC is instinctively anti-Western, South Africa is drifting into the latter. The danger is that if South Africa is greylisted, it may regard this as a Western interference in its political independence and may not sustain the current political commitment to get off the list.
This is no time to weaken our links with the West.
Accordingly, it is possible that, given its incapacitated state and the ruling party’s hostility to the West, South Africa could remain permanently on the greylist. While we have major trade links with China, our economy remains firmly integrated with the Western economic system. Companies and financial institutions domiciled in Europe, the US and Japan account for almost all foreign investment in our economy and the majority of our trade. This will be the case for a long time yet. China faces serious economic problems and is becoming obsessed with self-sufficiency. Russia has become an international pariah.
This is no time to weaken our links with the West. Perhaps the greatest danger of greylisting for South Africa is that it will erode our existing international relationships at a time when alternative opportunities are becoming less rewarding. It could become yet another contributor to our economic stagnation. This is why a national commitment to remain off the greylist, if we are not on it, or to get off the list if we are on it, is so important.