As the investment funds industry in the GCC region experiences activity not seen for several years, the UAE Securities & Commodities Authority (SCA) has issued new investment funds regulations dealing with the establishment, management and promotion of local funds and the promotion of foreign funds in the UAE.
The new SCA regulations are expected to be the first in a series of related regulations. A UAE-domiciled fund can be established only with the approval of the SCA. While offshore funds have dominated the GCC funds industry for many years, local funds may offer an attractive alternative when making investments in the GCC region. Foreign funds can be publicly or privately offered in the UAE only by a locally licensed placement agent (or in certain circumstances, by a representative office) that obtains the prior approval of the SCA.
On July 22, 2012, the Board of Directors of the SCA issued Resolution No. 37 of 2012 Concerning Regulations of Investment Funds (SCA Regulations). The SCA Regulations came into force on August 27, 2012, the day following their publication in the Official Gazette.
Prior to the implementation of the SCA Regulations, the key investment funds legislation in the UAE was Resolution No. 164-8-94 Regarding the Regulation for Investment Companies and Banking, Financial and Investment Consultation Establishments or Companies (Central Bank Regulations) issued by the Board of Directors of the Central Bank of the UAE, which had needed updating for some time. The SCA Regulations transfer regulatory responsibility for the licensing and promotion of investment funds from the UAE Central Bank to the SCA. However, the SCA Regulations do not deal with the licensing of fund managers and other service providers. It is therefore currently necessary for fund managers operating in the UAE to be licensed by the Central Bank under the old regime, although the SCA has indicated that it will be issuing further regulations to deal with the licensing of fund managers in due course. The SCA has also indicated that it will be issuing further regulations specifically to deal with certain types of funds, including real estate funds and exchange traded funds.
Establishment of Local Funds
The SCA Regulations provide that a UAE-domiciled fund can be established only with the approval of the SCA, and the applicant must be a UAE joint stock company or a UAE branch of a duly licensed foreign company. Applicants are required to have minimum capital of AED 10,000,000, although banks and investment companies licensed by the Central Bank are exempt from this requirement. In addition, the minimum investment in each local fund by the licensed fund sponsor is 3 percent of the fund’s capital. While this may be an issue for certain smaller firms, this should not be a significant obstacle for most firms in an environment where sponsors are generally expected to make a material commitment to the fund.
Due to restrictions in the UAE companies law, a non-GCC national or entity cannot hold more than 49 percent of the shares in a UAE joint stock company, and therefore any non-GCC entity wishing to be licensed under the SCA Regulations for the establishment of a UAE-domiciled fund will need to enter into a suitable arrangement with a local partner.
The SCA Regulations do not restrict a UAE entity from establishing a foreign fund. This is good news in the UAE, where a vast majority of investment funds established by UAE sponsors and managers are formed in the Cayman Islands and other offshore financial centers.
Importantly, the SCA Regulations are silent on the corporate form of a local fund. We understand that a local fund is an unincorporated vehicle in which investors do not have an equity interest but instead have a contractual right to share in the profits and losses of the underlying investments of the fund. Given that a local fund does not have a corporate personality, the legal title to investments could be held by the fund manager (or a special-purpose vehicle affiliated with the fund manager) rather than the fund itself, which offers interesting structuring possibilities for investment in the GCC region. The investment funds regulations of the Kingdom of Saudi Arabia offer a similar structure and have been extremely popular.
The SCA Regulations include several unusual restrictions for local funds, such as the maximum amount a fund can invest in any single company. Such restrictions would be impracticable in the context of private equity and real estate funds. However, we understand that the SCA intends to take a pragmatic approach in this regard and has the discretion to waive such restrictions under the regulations.
Management of Funds
The new SCA Regulations do not deal with the licensing of fund managers in the UAE. Currently, persons are prohibited from conducting investment business (which includes fund management) or banking, financial and investment consultations business in the UAE unless they hold a Central Bank license. Further legislation is required to set out the regulatory framework for the licensing of fund managers domiciled or operating in the UAE and also to set out the role of the SCA in such licensing process. We are aware that the SCA intends to issue further regulations to deal with these matters, although it is not yet known when such regulations will come into force. It may therefore be possible for local and foreign entities to apply for a fund management license in due course.
Fund managers of UAE-domiciled funds must now comply with certain statutory duties and obligations set out in the SCA Regulations. UAE-domiciled funds must also satisfy certain statutory requirements, including minimum requirements for the fund offering documents (which must be in Arabic) and the filing of audited quarterly and annual financial statements with the SCA.
Promotion of Foreign Funds
Notwithstanding the Central Bank Regulations, which prohibit funds from being publicized in the UAE without a license from the Central Bank, in practice, foreign funds have been (at least until the implementation of the SCA Regulations) marketed cross border on an informal, private-placement basis (i.e., in a discreet manner to a limited number of sophisticated and professional investors). Although such placements are technically in breach of the Central Bank Regulations, the Central Bank appears to have historically tolerated such practice.
The new SCA Regulations provide that foreign funds may be offered, marketed, distributed and advertised (promoted) in a public or private offering in the UAE only with the approval of the SCA and that any such promotion may be carried out only by banks or investment companies licensed by the Central Bank, companies licensed by the SCA (although we understand that the SCA is not in a position to grant such licenses until it issues further regulations) or representative offices of foreign companies (provided that any promotion by a representative office shall be on a private-placement basis only to institutional investors with a minimum subscription of AED 10,000,000 per investor).
The minimum subscription amount per investor in a foreign fund approved by the SCA to be promoted in a private offering in the UAE is AED 500,000; it is AED 1,000,000 for funds established in a free zone outside the UAE. The SCA Regulations do not define “free zone,” although we understand that in the coming months the SCA will be issuing a list of free zones that is likely to include certain offshore financial centers such as the Cayman Islands.
The SCA Regulations state that the SCA will issue its decision approving or rejecting an application regarding the promotion of a foreign fund within 30 business days. However, we understand that the SCA aims to issue its decision well within this period and has recently granted approvals within five days. The SCA has indicated that it will accept applications (and accompanying fund documents) in English.
The SCA Regulations do not appear to prohibit the promotion of fund interests to UAE investors where such promotion occurs entirely outside the UAE, such that offering documents are received by the investor outside the UAE (although it may be permissible for a UAE investor to receive offering documents by email or through a secure website), any meetings regarding the foreign fund with the investor are held outside the UAE and any subscription agreements are executed outside the UAE. Road shows and other marketing presentations in the UAE are strictly prohibited unless conducted by a duly licensed placement agent. Furthermore, the SCA Regulations do not expressly prohibit reverse solicitation of fund interests.
Given that the SCA Regulations have been implemented only recently, it remains to be seen whether the SCA will strictly enforce the placement restrictions contained therein, and it will be interesting to see whether a new tolerated practice for cross-border marketing of investment funds will develop.
Local Placement Agents
The new SCA Regulations give an opportunity for locally licensed firms to capitalize on their ability to promote foreign funds to UAE investors in an environment where global and regional managers are lining up to raise capital. However, it is important to note that the SCA Regulations impose certain obligations on local promoters of foreign funds, including an obligation to exercise care in the selection of foreign funds to be promoted in the UAE and an obligation to follow up on the performance of the fund to ensure protection of the investors’ funds. Such strict obligations may affect the desire of certain local firms to promote foreign funds and may affect placement fees.
One of the main criticisms of the new SCA Regulations is that they do not provide any licensing exemptions for investment funds being offered on a private-placement basis to sophisticated investors such as financial institutions and high-net-worth individuals. While UAE investors ought to be protected by appropriate securities legislation, most sophisticated jurisdictions provide certain safe harbors for investment funds offered on a private-placement basis to certain types of investors. If foreign fund managers and promoters must now engage a local promoter to promote their funds in the UAE, this may increase the cost of placing such funds in the UAE, and such costs may be passed on to investors through subscription or similar fees.
A large number of global, regional and local fund sponsors and managers are based in the Dubai International Financial Centre (DIFC). The new restrictions on the private placement of foreign funds in the UAE (which capture DIFC funds and other foreign funds managed by DIFC managers) are likely to inconvenience certain DIFC firms that target UAE investors. There is likely to be some pressure on the SCA to develop some form of passport or mutual recognition for funds that are either domiciled in the DIFC or promoted by DIFC-licensed entities. We are also aware that the SCA intends to issue further regulations in the coming months that will allow it to grant fund promotion licenses. It may therefore be possible for local and foreign entities (including DIFC firms) to apply for a fund promotion license in due course.
The introduction of the SCA Regulations is a step in the right direction, although further regulation is required to deal with certain licensing matters. The SCA Regulations will help promote the growth of the UAE funds industry and will bolster consumer protection by providing a more certain legal and regulatory framework, which has been needed for some time. Having said this, the ultimate success of the SCA Regulations will depend largely on how the SCA implements and enforces such regulations. One thing is for certain: The SCA Regulations will dramatically change how investment funds are established and promoted in the UAE.