Since the first Quarterly Report of 2013, there have been several interesting developments relevant to the establishment, marketing and distribution of funds and related services in the Middle East. These include:
- amendments to the UAE Investment Funds Regulations (“UAE IFR”) allowing for limited exemptions from the registration and local promoter requirements when promoting foreign fund products in the UAE;
- the announcement of a new financial free zone in Abu Dhabi; and
- the publication by the Saudi Capital Markets Authority (“CMA”) of a new draft of the Saudi Investment Fund Regulations, for comment by industry participants.
Amendments to the IFR
The UAE IFR, enacted on August 26, 2012 to regulate the marketing and distribution of foreign funds in onshore UAE,1 required mandatory registration of all foreign fund products (open-ended, close-ended, public and private) with the Emirates Securities and Commodities Authority (“ESCA”) and required a UAE-licensed bank or investment manager as a promoter to distribute such products locally.
The UAE IFR has since been amended at the end of May, 2013,2 to completely exempt the application of the fund regulations in the UAE in respect of:
- federal and local governments and authorities;
- institutions that have “investment in securities” as one of the objects in their constitutive documents; and
- ESCA-licensed investment managers (who have the authority to make investment decisions on behalf of their clients).
Previously, the UAE IFR only exempted products from having a local promoter in the case of representative offices of foreign fund managers, which are permitted to solicit investments into foreign funds (from institutional investors only) where the minimum investment amount is in excess of AED 10 million (approximately US$ 2,740,000).
Dechert attorneys, on behalf of the firm’s clients, had meetings with ESCA’s Supervision and Enforcement Department, in which the firm requested clarification regarding the UAE IFR amendments – the following is resulting general guidance:
- When dealing with federal or local governments and authorities, it is the duty of the foreign fund manager to request proof of status – a mere contractual warranty or representation to this effect will not be sufficient.
- The exemption for federal or local governments and authorities does not extend to commercial entities owned by federal or local governments or authorities. Given the extensive role of federal and local governments in commercial enterprises in the UAE, this is a very important distinction. In this regard, a government or authority will have been created by decree, whereas commercial entities owned by governments or authorities will be set up in accordance with normal commercial, legal, registration, and/or licensing procedures.
When dealing with institutions that have “investment in securities” as an object in their constitutive documents, the following should be considered:
- The term “institution” is not defined in the IFR, but ESCA presently interprets this to mean any legal person other than a private individual.
- When confirming whether an institution qualifies under the “investment in securities” object requirement, ESCA currently follows a strict interpretation on the required wording – a passing reference in a company’s Memorandum and Articles of Association generally permitting investment of all sorts is likely not to be sufficient.
- A contractual warranty or representation to this effect by the institution concerned will not be regarded as sufficient by ESCA. Copies of the actual constitutive documents proving the object is specifically stated should be requested by the foreign fund manager and kept on file.
The exemption to allow the promotion of foreign funds to local investment managers:
- applies only to investment managers licensed by ESCA and not to investment managers previously licensed under the old Central Bank regime; and
- foreign fund managers relying on this exemption must obtain proof from the local investment manager that the local investment manager has the discretion/authority to make investment decisions on behalf of the local investment manager’s clients. ESCA is of the view that a contractual warranty or representation to this effect by the local investment manager will not be considered sufficient for the foreign fund manager to rely on this exemption.
Other notable amendments to the UAE IFR that were passed at the end of May 2013 include:
- The original exemption relating to representative offices (in which such offices could register and place products without appointing a local placement agent, provided that they marketed only to institutions and for minimum placement amounts in excess of US$ 10 million) has been expanded to include local branch offices of foreign institutions, and now also allows them to distribute third-party products in the same manner.
- The obligations of local promoters with respect to what needs to be provided to local investors subsequent to investment have been reduced, essentially paving the way for omnibus subscriptions to be permitted into foreign funds in the name of local promoters acting as a nominee investor on behalf of their clients. This amendment appears to have been necessitated by the sheer magnitude of this practice presently in the UAE at the retail subscription level. However, ESCA’s Supervision and Enforcement Department confirmed, in response to a query from Dechert attorneys, that using a nominee or omnibus structure will not lower the minimum subscription amount applicable to each of the investors investing with a local promoter on this basis. At present, there are no measures in place in the UAE to protect the assets of omnibus investors if the local promoter (holding the units or shares in foreign funds in trust for the omnibus investors) becomes the subject of bankruptcy or creditor proceedings.
Note that the above-mentioned clarifications provided to Dechert attorneys by ESCA were given verbally as general guidance by the head of the relevant department within ESCA and, although indicative of the current thinking within ESCA, cannot in any way be relied upon as definitive or comprehensive statements on the topics under discussion. It should also be understood within the context of the UAE being a civil law jurisdiction where there is no system of binding precedent on which to rely.
A New Financial Free Zone for the UAE
Historically, equity participation by foreigners in commercial companies in the UAE has been restricted to 49%, with an even more restrictive regime for financial services providers wanting to establish themselves locally. The practice of declaring designated areas in the UAE as free zones with their own sets of implementing regulations has certainly helped to overcome some of the challenges of operating onshore in the UAE. Typically, free zones levy no tax on income or capital gains, allow for 100% foreign ownership and 100% repatriation of capital and profits, and, where relevant, provide import and export tax exemptions.
In this regard, one of the success stories for the UAE has been the Dubai International Financial Centre (“DIFC”), which commenced operations in 2004. The DIFC, as a financial free zone, took the concept of trading in a free zone in the UAE further – it introduced its own financial services regulator, the Dubai Financial Services Authority (“DFSA”), implementing a principles-based regulatory model largely emulating the UK FCA, as well as its own independent legal system, comprised of (i) independent civil and commercial laws, which default to English law; and (ii) its own courts, with judges from leading common law jurisdictions including England, Singapore and Hong Kong.3
At the time of its establishment, the DFSA became the fourth financial services regulator in a country that already boasted three other financial services regulators – the UAE Central Bank, ESCA and the Insurance Regulatory Authority. A unique feature of the enabling federal legislation that permitted for the establishment of the DIFC – UAE Federal Law 8 of 2004 – allowed for each emirate to establish its own financial free zone by way of a federal decree, in order to ensure equal treatment for all seven emirates that constitute the federation of the UAE.
Consequently, Abu Dhabi (being the most oil rich and prosperous of the seven emirates) announced plans in May to establish its own financial services free zone later this year pursuant to the provisions of Federal Law 8 of 2004 – to be known as “Global Marketplace”.
Much of the detail still requires clarification, and may be subject to change, but the following is known from the Federal Decree (since supplemented by a Cabinet Decision) and statements from government officials published in newspaper reports:
- 100% foreign ownership will be permitted.
- A variety of corporate structures and branch or representative offices will be permitted.
- A tax holiday of 50 years will apply in respect of personal and corporate income and capital gains as well as an exemption from customs duties.
- The proposed authorities in the Global Marketplace will be: the Financial Services Regulations Bureau (the regulator); the Global Marketplace Courts, divided into a Court of First Instance and a Court of Appeal; and the Global Marketplace Registration Bureau (the registrar of companies).
- Depending on the conditions of their licensing, establishments in the Global Marketplace will be permitted to carry out a full range of financial or ancillary support services from the free zone.
It is not clear what laws and regulations will apply in the free zone and whether it will be modelled on more established jurisdictions globally. Note that officials have stated in a press release that accompanied the announcement that these laws and regulations will “conform with financial markets’ regulations”.
The announcement has raised some questions as to how the Global Marketplace, as a relative latecomer to the party, will compete with other financial centres in the Gulf region, such as Dubai, Qatar, Bahrain and the planned King Abdullah Financial District in Saudi Arabia, and whether some form of incentive will be offered by the cash-rich emirate for global players to participate in the Global Marketplace. It is no secret that some of the world’s largest sovereign wealth funds and several state pension funds are situated in Abu Dhabi, so it will definitely be an interesting space to watch in the future.
Also, the creation of a fifth financial services regulator in the UAE, with the possibility of even more coming as other emirates also exercise their above-mentioned right to establish financial free zones, begs the question as to whether a super-regulator overseeing the entire financial services industry in the UAE should at some stage be considered by the authorities to ensure overall quality and consistency of regulatory oversight.
A New Draft of the Investment Funds Regulations in Saudi Arabia
The Saudi Arabian CMA published a new draft of the Saudi Arabian Investment Funds Regulations (“Saudi IFR”) on April 24, 2013, for interested parties to provide comments by no later than August 19, 2013. It is not clear when the CMA plans to issue the final regulations in the above regard, but the draft represents a substantial rewrite of the existing regulations that have been in force since December 2006.
Among key changes, the draft Saudi IFR would (if enacted generally in its proposed form):
- Add to the duties and obligations of Saudi fund managers in relation to (i) fiduciary duties and (ii) liability for losses incurred as a result of their own errors or on account of matters where the fund manager may be the ultimate responsible party (e.g., fund administration).
- Potentially reduce the duties of Saudi fund managers in respect of managing conflicts of interest (by not cross-referencing fund managers’ duties under the Saudi IFR to the much wider wording of Article 41 of the Authorised Persons Regulations, as is the case with the current regulations).
- Require Saudi fund managers to themselves keep a register of unitholders (rather than expressly permitting them to outsource this function, as is the case with the current regulations).
- Restrict the ability of Saudi fund managers to make proprietary investments in the funds they manage, by prohibiting them from: investing on more favourable terms than other investors; voting their shares at any meetings of investors; and holding more than 25% of the units in issue of any fund managed by them.
- Potentially expand upon permissible soft dollar arrangements (e.g., cash payments as part of soft dollar arrangements are currently expressly prohibited but the new draft is silent on this issue).
- Add to the powers of the CMA in removing and replacing fund managers, custodians and distributors in Saudi Arabia.
- Replace the present custodian regime (where fund managers have the primary responsibility) with a completely new regime whereby Saudi-regulated custodians may undertake greater responsibilities).
- Make a much-needed distinction between public and private fund regimes and expand the requirements on the part of public funds in areas such as: fund board requirements; overall governance; reporting and transparency; general investment rules and restrictions; valuation methodology; and audit requirements.
- Apply investment limitations and diversification rules only to public funds, and also suggest a material liberalisation of the restrictions set out in the current Saudi IFR.
- Add new rules in respect of investments by money market funds, feeder funds, funds of funds and capital-protected funds (none of which are addressed under the existing regulations).
Change the oversight and regulatory requirements in relation to private funds – for example, to:
- require that private funds provide a notification to the CMA (as opposed to the authorisation requirement for public funds), with greatly reduced requirements as to the information to be submitted;
- place a SAR 1 million (approximately US$ 267,000) limit on minimum investment amounts;
- limit subscriptions to sophisticated investors (currently a clearly defined concept that includes institutions, professional investors and portfolio managers who make investment decisions on behalf of individual clients); and
- expand the permitted organisational structure for private funds (now generally limited to a statutory trust-type arrangement between the fund manager and investors).
Set forth the requirements for placing foreign funds in Saudi Arabia in a single set of definitive rules, which would include the following:
- Foreign funds may only be placed in Saudi Arabia through the intermediation of a local distributor;
- Foreign funds may only be distributed by way of private placement;
- Foreign funds must be regulated in a jurisdiction that has regulatory standards and oversight equal to that of the CMA; and
- The minimum subscription amount shall not be less than SAR 1 million (approximately US$ 267,000).
These developments are all indicative of increasing growth, maturity and sophistication of the financial services and regulatory regimes in the Middle East, especially in the Gulf region. The changes in the legal and regulatory landscape that have taken place over the past few years in places like the UAE, Saudi Arabia, Qatar and Kuwait illustrate the need for market participants and financial services providers who operate in these markets, or plan to do so in the future, to be aware of current and proposed legal and regulatory developments in this regard.