The second quarter of 2011 has seen the announcement of significant proposals to enhance securities and capital markets legislation and regulation in the Dubai International Financial Centre (the DIFC). On 20 April, the DIFC’s regulator, the Dubai Financial Services Authority (the DFSA), published Consultation Paper No. 75 (the CP), which proposes a number of changes to the DIFC’s “Markets Law Regime” — a term used to refer to both the Markets Law of 2004 of the DIFC (the Markets Law) and the Offered Securities Rules module of the DFSA Rulebook (the OSRs).
The proposals outlined in the CP represent the DFSA’s stated aim of more closely aligning the DIFC’s Markets Law Regime with the requirements of the EU Prospectus Directive (2003/71/EC) (the PD) and EU Market Abuse Directive (2003/6/EC) (MAD). At the same time, the proposals seek to retain features and flexibility deemed necessary to accommodate the needs and circumstances of the regional markets in the UAE and the wider GCC. The CP, which relates to the capital markets regulatory framework in the DIFC, follows other recent initiatives aimed at harmonising the DIFC’s regulations with those of leading benchmark jurisdictions, such as the introduction of the DFSA’s new regime for Collective Investment Funds, which came into effect on 11 July 2010 (see our Client Alert No. 1078 dated 31 August 2010). The CP also comes at a time of significant ongoing reform to the capital markets regulations in both Kuwait and Saudi Arabia, and in a general climate that is becoming increasingly hot on the topic of corporate governance across the GCC region (see our Client Alert No. 1015 dated 19 April 2010 which discusses ongoing developments in IPO regulation and practice in the Middle East).
The proposals contained in the CP concentrate on the following key areas:
- The Offering of Securities to the Public in or from the DIFC and the requirement for a Prospectus
- Governance of Reporting Entities
- Market disclosure of information
- The regime governing listed Funds in the DIFC
- Periodic financial reporting requirements
This Client Alert provides an overview of the proposed changes.
It should be noted that, in terms of structure, the CP proposes that the existing Markets Law and OSRs be replaced in their entirety with a new Markets Law 2011 and Market Rules module of the DFSA Rulebook (MKT).
Capitalised terms used in this Client Alert and not defined herein have the meanings given to them in the Glossary (GLO) module of the DFSA Rulebook.
Offers of Securities to the Public
Circumstances triggering the requirement for a Prospectus. The current Markets Law Regime employs a three-way classification of all offers of securities in or from the DIFC as being either “Public Offers”, “Exempt Offers” or “Unregulated Offers”. The CP proposes to replace these categories with a structure that is more closely aligned with the PD regime and focuses on two types of activities, each of which will trigger the requirement for a Prospectus. These are (i) an Offer of Securities to the Public in or from the DIFC; and (ii) an application to have securities admitted to trading on an “Authorised Market Institution” (an AMI), which is broadly equivalent to the concept of a “regulated market” as that term is used in the Listing Rules issued by the Financial Services Authority in the United Kingdom (the FSA and the UK, respectively).
Definition of “Offer of Securities to the Public”. The CP proposes a new definition of “Offer of Securities to the Public”. The OSRs currently define an “Offer of Securities” in terms of “offers” and “invitations” which directly or indirectly target investors. Where those investors are “Retail Clients” located in the DIFC, the offer or invitation is a Public Offer triggering the requirement for a Prospectus. The CP proposes to broaden this definition to include any “communication to any person in any form or by any means, presenting information on the terms of the offer and the Securities offered, so as to enable an investor to decide to buy or subscribe for those Securities…”. This definition is closely based on the EU model. Because it is broader than the existing definition, the CP proposes that, in line with the PD, those communications made in connection with the trading of Securities on an AMI or Regulated Exchange be excluded from the definition of “Offer of Securities to the Public”.
Exemptions from the requirement to publish a Prospectus. The CP proposes two specific exemptions from the requirement to publish a Prospectus, namely (i) in the case of an Offer of Securities to the Public which is an “Exempt Offer” under Rule 2.3.1 of MKT; and (ii) in the case of “Exempt Securities”. Rule 2.3.1 refers to Exempt Offers as being offers which, inter alia, (a) are made to or directed at only Professional Clients other than natural Persons; (b) are directed at fewer than 50 Persons (in addition to Professional Clients who are not natural Persons) in any 12-month period or (c) are denominated in amounts of at least US$100,000 or equivalent. The CP also proposes to follow the PD approach with regard to exempting offers made to “qualified investors” (which is broadly analogous to the DFSA concept of a “Professional Client”), but with one exception. The one divergence is that the DFSA proposes not to apply the exemption in respect of an Offer of Securities made to a Professional Client who is a natural Person.
It should be noted that the question of whether an offer is an “Exempt Offer” for the purposes of Rule 2.3.1 of MKT is only relevant in respect of the first of the two “triggers” for the requirement to publish a Prospectus (i.e. the making of an Offer of Securities to the Public in or from the DIFC). Where the second limb (having Securities admitted to trading on an AMI) is triggered, the fact that the offer is an Exempt Offer will not exempt the issuer from publishing a Prospectus. In practice, this means that the range of offerings that can be made without a Prospectus in the DIFC is narrower than would be the case in the UK. This is because there is only one securities exchange in the DIFC (NASDAQ Dubai) and it is an AMI for the purposes of the Markets Law Regime (the Dubai Mercantile Exchange is also an AMI in the DIFC but it is an energy futures and commodities exchange). By contrast, in the UK, there are alternative exchanges available (such as AIM and PLUS Markets) which are not “regulated markets” and therefore the admission of securities to trading on those markets by means of an exempt offer under the UK regime would not trigger the requirement to publish a prospectus.
Secondary sales. The current OSRs provide that, where Securities have previously been offered by way of a Prospectus, a secondary offer of those Securities is not treated as a new offer requiring a new Prospectus. The CP proposes to further develop this rule in line with the PD. It is proposed that, where the original offer was made without a Prospectus in reliance upon an exemption, the subsequent offer will be treated as a new Offer of Securities to the Public requiring a Prospectus unless that secondary offer itself qualifies as an “Exempt Offer” in its own right. It remains to be seen how significant this somewhat subtle tweak to the existing rule will be in practice. Clearly, this addresses the issue whereby the original offer is made to professional investors who require less regulatory protection but then potentially on-sell on the same basis to retail investors who require greater protection.
Approval and Validity of a Prospectus. A notable feature of the existing Markets Law Regime in the DIFC is that, although the DFSA reviews the content of a Prospectus, it is unlike many other regulators in that it does not formally approve the publication of a Prospectus. In line with the PD (and several other recognised jurisdictions), the CP proposes that, going forward, the DFSA’s formal approval of a Prospectus will be required before it can be published in the DIFC. In addition, whereas the existing OSRs are silent on the validity period for a Prospectus, the CP proposes that, in line with the PD, a Prospectus will have a validity period of 12 months from the date of approval.
Authorised Market Institutions. At present, the OSRs do not require that Securities admitted to an Official List of Securities be also admitted to trading on an AMI. This contrasts with the position in the UK where securities admitted to the Official List of the FSA must also be admitted to trading on a regulated market (and vice versa). The CP proposes to include in the draft Markets Law 2011 a requirement that Securities admitted to an Official List of Securities are also admitted to trading on an AMI. This also means that, as a result, a Prospectus is required for any listing or offer of securities on an AMI even if it is an Exempt Offer.
Obligations of Reporting Entities
A “Reporting Entity” for the purposes of the Markets Law Regime is generally the person who makes an Offer of Securities to the Public or has Securities admitted to trading on an AMI. An exception to this is in the case of a listed Fund, where it is typically the Fund Manager who constitutes the Reporting Entity. The CP contains a number of significant proposals in relation to Reporting Entities, their governance and their disclosure obligations. The general theme running through the proposed changes is one of fostering a culture of enhanced corporate governance, market disclosure and reporting, and is in line with similar developments in more established markets.
Definition of Reporting Entity. The CP proposes an enhanced definition of “Reporting Entity” for the purposes of the new Markets Law Regime. The enhancement of the definition is aimed at identifying with greater clarity the specific entity within an offer structure that is the Reporting Entity for the purposes of the regime, and ensuring that, as a result, the governance, disclosure and reporting obligations incumbent on a Reporting Entity are applied to the most appropriate entity within the structure. In the majority of situations, the issuer itself will be the Reporting Entity and there will be little need to focus on the definition. However, there are scenarios — such as in the case of a special purpose vehicle (SPV) issuer or a listed Fund, where another entity (e.g. the Fund Manager) will be the more appropriate person to serve as the Reporting Entity for regulatory purposes. The enhanced definition seeks to address such cases.
Governance of Reporting Entities. The CP proposes a number of changes to the DFSA’s corporate governance requirements for listed companies to reflect recent amendments, effective from June 2010, to the UK Corporate Governance Code published by the Financial Reporting Council in the UK (the UK Code). In particular, in line with the approach taken in the revised UK Code, the CP proposes to include an “overarching governance requirement”, requiring a Reporting Entity to have “a corporate governance framework which is adequate to promote prudent and sound management of the Reporting Entity in the long-term interests of the Reporting Entity and its shareholders”. This overarching requirement will be supported by seven corporate governance principles which, despite their name, will be effective as rules.
Directors’ duties. It is proposed that the new regime will set out in one place (Rule 3.3 of MKT) the range of duties of directors of Reporting Entities, including the duty to act in good faith and on an informed basis and to exercise due diligence in discharging their functions. These provisions are currently scattered throughout the Markets Law but will be aggregated in a single section of MKT for ease of reference. Interestingly, as the CP itself points out, these requirements or their equivalents are, in most developed jurisdictions, contained in the relevant companies legislation rather than in a listing regime. For example, the UK recently codified express directors’ duties into the Companies Act 2006. This means that the directors of Reporting Entities will be subject to express duties regardless of the directors’ duties contained in the company law (or not, as the case may be) to which the Reporting Entity is subject.
Conflicts of interest, related parties and dealings by restricted persons. The CP contains a number of proposed requirements relating to conflicts of interest, largely benchmarked against the UK. The proposed new provisions employ three separate definitions: “Related Parties”, “Restricted Persons” and “Connected Persons”, with corresponding provisions relating to transactions between such parties and a Reporting Entity or member of a Reporting Entity’s Group. By the DFSA’s own admission, there is a degree of overlap between these three classes of person, but this is by design as the specific restrictions applicable to each are designed to address different risks, and are modeled on the UK regime. The proposed changes mark a widening of the scope of regulation for Reporting Entities in the DIFC, with the triggers and reach of disclosure and reporting obligations generally being expanded. The increased regulation of related party transactions, a more common feature of the corporate landscape in the Middle East, should be welcomed by all market participants.
In terms of dealings by Restricted Persons, the CP proposes to expand the current “close period” during which dealings are prohibited, so as to ensure that dealings do not occur when information relating to a Reporting Entity is likely to be accessible to Restricted Persons. It also proposes to expand the definition of “Restricted Persons” beyond the Directors to include senior management.
In terms of transactions with Related Parties, the CP proposes to clarify the definition of “Related Party” in line with the UK regime, so as to capture those persons who are likely to be able to obtain more advantageous terms than those available to independent third parties. The proposed rule will require disclosure to the market of transactions with parties who hold 5 per cent or more of the voting rights of the Reporting Entity or its holding companies. This contrasts to 10 per cent in the UK, Australian and Hong Kong regimes, and is a deliberate deviation by the DFSA in view of the more nascent nature of the DIFC as a capital markets jurisdiction and the need to protect investors.
Disclosure by “Connected Persons” is also addressed in the proposals, which include enhancing the definition of Connected Persons and specifying the circumstances in which disclosure is required.
The CP proposes a number of “refinements” to the DIFC’s existing market disclosure regime (known under the current regime as “continuous disclosure”). The changes are largely inspired by MAD and, in particular, the UK regime. Among the proposed changes are a replacement of the dual concepts of “Material Information” and “Price Sensitive Information” with a single concept of “Inside Information” and the replacement of the current requirement for market disclosure of Inside Information to be made “without delay” with the requirement for such disclosure to be made “as soon as possible”, to accommodate short delays which may be justified in certain unexpected situations.
The CP proposes that all provisions applicable to Reporting Entities of listed Funds (which will usually be the Fund Manager) be brought together in a discrete chapter of MKT (chapter 6), with the exception of provisions relating to sponsors and systems and controls, which will be dealt with in chapters 7 and 8 of MKT, respectively.
The CP also proposes some minor enhancements to the periodic financial reporting requirements applicable to Reporting Entities, including changes in terminology and the inclusion of provisions relating to the content of semi-annual financial reports. Moreover, in line with MAD (and in particular as implemented in the UK), the CP contains a number of proposals in relation to market abuse. These include the insertion of a prohibition on the use of fictitious devices and other forms of deception, a catch-all provision relating to the “misuse of information”, broadening the scope of insider dealing and empowering the DFSA to issue a code of market conduct.
It should be noted that new proposed listing rules of the current sole securities exchange regulated as an AMI in the DIFC, NASDAQ Dubai, were recently closed for consultation and so we hope that the proposed new Markets Law Regime and the listing rules, being the two key facets of the securities law and regulatory architecture of the DIFC, will be sufficiently dovetailed throughout. Key areas of overlap include the requirements for a prospectus and the sponsor regime and a clear demarcation that the DFSA approves the prospectus (effectively the offer) and the AMI approves the listing.
The CP, together with a copy of the proposed new Markets Law 2011 and MKT module, can be obtained from the DFSA’s website at http://www.dfsa.ae/WhatsNew/DispForm.aspx?Id=174. The deadline for providing comments on the CP is 18 July 2011. Latham & Watkins LLP will be reviewing the CP and the proposed changes in their entirety and will be making a submission to the DFSA within the allotted timeframe for responses. If you have views or comments we would be happy to incorporate them as part of our response. We will be sending out an additional Client Alert once the proposed changes have been finalised and implemented.