The Collective Investment Rules (the "CIR") of the Dubai Financial Services Authority (the "DFSA") Rulebook were amended on 1 February 2016, following the issue of the DFSA consultation paper No. 102 on Property Funds and Money Market Funds on 29 June 2015.
The changes aim to: (i) improve the regime of Property Funds set up in the Dubai International Financial Centre (the "DIFC"); and (ii) introduce rules on Money Market Funds.
The purpose of this briefing is to outline the main changes made to the CIR and the reasons behind these amendments.
Unless otherwise defined herein, capitalised terms will have the meaning attributed to them in the Glossary Module of the DFSA Rulebook.
1. Property Funds
DIFC Property Funds are closed-ended Funds dedicated to investment in Real Property (i.e., land or buildings, whether freehold or leasehold, where the unexpired term of any lease exceeds 20 years) and in Securities issued by Bodies Corporate whose main activities are to invest in, deal in, develop or redevelop Real Property.
Real Estate Investment Trusts ("REITs") are a sub-category of Property Funds. REITs can only be set up as Public Funds. As REITs are a subset of Public Property Funds, the changes made to the CIR in relation to Public Property Funds will also be relevant to REITs.
The CIR rules relating to Property Funds have been amended to offer greater flexibility and also take into consideration the specificities of the UAE real estate market.
The CIR rules have been amended in the following five areas:
- borrowing limits;
- Affected Person transactions;
- valuation; and
- listing requirements for Property Related Assets.
Before 1 February 2016, the custody of Fund Property had, in principle, to be delegated to an Eligible Custodian who was a separate legal entity from the Fund Manager.
Since the entry into force of the new CIR provisions, the Fund Manager of a Public or Exempt Property Fund is now permitted to act itself as custodian of the Real Property provided that effective arrangements are in place, which ensure that the Real Property is not available to creditors in case of insolvency of the Fund Manager. In addition, the Fund Manager of a Public Property Fund must make appropriate disclosures in the Prospectus and must put in place adequate systems and controls to ensure the proper segregation and protection of the Real Property. This last requirement aims to prevent the Fund Manager from having unfettered control over the Fund's assets, by addressing the risks of theft or fraud by the Fund Manager and the risks of the Fund Manager commingling its assets with the assets of the Fund or assets of other funds it manages.
The self-custody arrangement is only available for the custody of the Real Property. It does not apply to the other types of assets held by the Property Fund, such as Units in another Property Fund. These assets must be held by an Eligible Custodian appointed by the Fund Manager in accordance with the CIR.
Also, the list of criteria for who can be appointed as an Eligible Custodian has been amended to extend the choice of custodians available to the Fund Managers.
The borrowing limits applicable to Property Funds have been amended. Originally measured against the total Net Asset Value ("NAV"), the limit for Public Property Funds (including REITs) is now set at 50% of the gross asset value ("GAV").
This change brings the borrowing restrictions in line with other jurisdictions such as Hong Kong, Singapore and Malaysia, without compromising on the protection of investors (high borrowing limits are not without risk).
Affected Person transactions
The CIR contain requirements that Fund Managers must comply with before entering into transactions with Affected Persons. An Affected Person in relation to a Fund is: (a) its Fund Manager; (b) its Governing Body; (c) its Custodian; (d) its Trustee or other Persons providing oversight; (e) any Advisor; (f) a holder of 5% or more of the Units of the Fund; or (g) any Associate of any person in (a) to (f).
The key changes in relation to Affected Person transactions are the following:
- Voting: before entering into an Affected Person transaction, the Fund Manager had to obtain Unitholders' prior approval by way of Special Resolution if the total consideration or value of the transaction was 5% or more of the most recent NAV as disclosed in the latest published audited accounts of the Fund. This requirement has been changed to an Ordinary Resolution for Public Property Funds (requiring consent of more than 50% of the Unitholders voting) and has been repealed for Exempt Funds. Also, a Unitholder who is the Affected Person proposing to enter into the transaction, and a Unitholder who is an Associate of that Affected Person will not be entitled to vote on the resolution.
- Acquisition or sale of Real Property in the UAE by Public Property Funds: in order to take into account the unique nature of the UAE real estate market and its ownership structure, the requirements to (i) issue to Unitholders a circular containing the details of the proposed transaction; (ii) obtain Unitholders' prior approval in the respect of a proposed transaction if the total consideration or value is 5% or more of the most recent NAV; and (iii) issue a notice to Unitholders providing details of the results of the Unitholders' voting; do not apply in relation to the acquisition or sale of Real Property in the UAE, provided that:
- the Fund Manager has received general authorisation by an Ordinary Resolution passed at the previous annual general meeting of Unitholders to enter into Affected Person transactions without obtaining prior Unitholder approval in each case during the period for which the resolution is valid. This authorisation must be disclosed in the Prospectus;
- the oversight provider of the Fund has confirmed in writing, before the transaction is entered into, that such transaction complies with all applicable CIR requirements, including being on terms at least as favourable to the Fund as any comparable arrangement on normal commercial terms negotiated at arm's length with an independent third party (CIR 8.3.2(2));
- the investment committee of the Fund has confirmed in writing, before the transaction is entered into, that the transaction is on terms that comply with CIR 8.3.2(2) and it has no objection to the transaction; and
- after entering into the transaction, the Fund Manager has notified the Unitholders in writing, as soon as practicable, of the details of the transaction.
This modification is welcome, especially where a number of shareholders in a Property Fund are themselves Unitholders in UAE real estate companies who could seek to acquire the same UAE-based properties as the Property Fund proposes to acquire.
Prohibition on Affected Persons acting as property agents (Public Property Funds): the prohibition for the Fund Manager to engage Affected Persons as property agents for rendering services to the Fund, including advisory or agency services in property transactions, has been repealed. Instead, the Fund Manager will need to obtain prior approval of the oversight function if the value of the transaction is 5% or more of the most recent NAV of the Fund as disclosed in the latest published audited accounts. This requirement is in addition to the other requirements of the CIR (for example, the requirements to ensure that the transaction is on normal commercial terms and is subject to Unitholders approval if it is 5% or more of the NAV of the Fund).
This change is also welcome in consideration of the specificities of the UAE market. Many local property agents have key UAE institutions or nationals as shareholders or beneficial owners, who - given the ownership arrangements and interconnectivity in the UAE - will generally be connected to Unitholders of the Fund or other Affected Persons. The previous rule rendered it almost impossible for some Fund Managers to find a suitable property agent in the UAE to serve the Fund.
- Prior approval for services provided in the ordinary course of estate management of Real Property of a Public Property Fund: Affected Person transactions that involve services provided in the ordinary and usual course of estate management of the Real Property of the Fund, including renovation and maintenance work, only need to be approved by the oversight function if the transaction is 5% or more of the most recent NAV. Transactions below 5% that are carried out on commercial terms no less favourable than those of an arm's length transaction carried out with an unrelated party can be exempt from the requirement to gain approval by the oversight provider.
- Exempt Property Funds: given the professional nature of investors in Exempt Funds, the DFSA has decreased the scale of regulation applicable to Affected Party transactions by Exempt Property Funds. The DFSA has removed some of the requirements applicable to Affected Party transactions, including the requirements to obtain Unitholders' approval for transactions whose value is 5% or more of the recent NAV. Requirements to ensure that the transaction is on normal commercial terms and to disclose the transactions in the annual reports have been maintained.
- Change in terminology: The references to "Affected Persons" have been changed to "Related Party". This brings the terms used in the CIR in line with the terms used in the Market Rules of the DFSA Rulebook.
Under the CIR, the Fund Manager must appoint an independent valuer which will value each Real Property prior to its acquisition or disposal.
The requirement for the independent valuer to automatically retire after five consecutive years and not to be reappointed for a period of at least two years has been amended. Under the CIR, the re-appointment of the valuer after five consecutive years is now permissible, provided that before the end of that period the valuer position has been put out to tender and the same valuer has been reappointed in accordance with that process. The Fund Manager will have to provide the Unitholders with the specific reasons for the re-appointment and the evidence supporting those reasons will have to be published in the next interim or annual report.
Such change aims to address the concerns expressed by the stakeholders over the limited number of UAE market participants who can carry out independent valuation.
The inconsistencies regarding the date of the valuation report (six or three months) have now been removed. The valuation report prepared by the independent valuer should be no more than six months old for the purposes of any acquisition or disposal of the relevant Real Property.
Listing requirements for Property Related Assets
The list of Real Estate Related Assets in which the Property Funds can invest has been extended. Non-traded and non-listed Property Related Assets are included, provided that, for Public Property Funds, these assets are approved and reviewed regularly by the investment committee of the Fund to ensure that they are sufficiently liquid and can be accurately valued.
Disclosure in the Exempt Fund's Constitution
Exempt Property Funds are now required to disclose their investment objectives, including the type of assets in which they may invest, as well as any borrowing restrictions, in their Constitution.
2. Money Market Funds
A new category of Fund has been introduced in the CIR: the Money Market Fund.
Money Market Funds are defined as Funds whose investment objectives are to preserve the capital of the Fund and provide daily liquidity, while achieving returns that are in line with money market rates. These Funds must be established as variable NAV Funds rather than stable NAV ("SNVA") Funds, due to the additional systemic risks and risks to investors that an SNAV Fund can present.
The DFSA has introduced a number of investment restrictions and risk diversification rules that a Money Market Fund has to comply with. The aim is to limit investments to investments in high quality deposits and debt instruments in order to minimise liquidity risks and enable a Fund Manager to deal with redemption requests at any time. At least 90% of the NAV of the Fund Property must be invested in high quality Deposits or Debentures. In determining the quality of such Deposits or Debentures, the Fund Manager will have to take into account the following factors: (a) the credit quality of the Issuer, and any guarantor, of the Investment; (b) the nature and quality of the asset class represented by the Investment; (c) the liquidity of the Investment; and (d) any other risks associated with the Investment or the market in which it is traded. Derivatives can only be used for the purposes of hedging against foreign exchange rate risk.
Although the DFSA's objective in introducing the Money Market Funds rules is to avoid systemic risk, the new regime is rather restrictive. For example, it does not take into account the fact that in practice there are different types of Money Market Funds, with different strategies, some being more speculative or aggressive than others, depending on the needs and risk appetite of the investors. Instead of imposing extensive investment restrictions that would apply to all Money Market Funds, a risk management based approach could have been used. Under such an approach, the rules would concentrate on the relevant Fund's risk management process by adequately addressing, controlling and managing all relevant risks such as liquidity, credit, operational and counterparty risks. Appropriate disclosures in the Fund's documents could have been added to this risk management based approach in order to enhance investors' protection.
Amendments to the Property Fund regime is an excellent example of the DFSA listening to the concerns of the stakeholders while ensuring compliance with international market standards, such as IOSCO Principles for Securities Regulation.
The introduction of the Money Market Funds regime to address systemic risks associated with such types of Fund as outlined by the FSB/IOSCO is welcome. However, the rules are very conservative and may act as a deterrent for Fund Managers to establish Money Market Funds in the DIFC.