UAE Investment Funds Regulation implemented beginning of the end for the tolerated practice? 1 Briefing note August 2012 UAE Investment Funds Regulation implemented The UAE Securities and Commodities Authority (SCA) has implemented its eagerly awaited Investment Funds Regulation. The Investment Funds Regulation transfers regulatory responsibility for the licensing and marketing of investment funds and for a number of related activities from the UAE Central Bank to the applies to all matters relating to domestic investment funds and to the promotion and offering of foreign funds in the UAE. prohibits an entity from establishing a domestic investment fund without first obtaining approval from the With respect to the promotion of foreign funds in the UAE, this may only be done through a locally licensed placement agent with the approval of the SCA (or in some cases, through the local representative office of the fund manager). Non-fund structured products, insurance products, private investment portfolios managed by UAE banks and investment companies, and employee benefits schemes are not subject to the provisions of the Investment Funds Regulation. Background In January 2011, the SCA published a draft decision on investment funds (the "Investment Funds Regulation") for consultation. A little over 18 months later, the Investment Funds Regulation has finally been passed into law. The current incarnation of the law varies in the details from the version put out to consultation; however, it is clear that the Investment Funds Regulation acts to transfer regulatory responsibility for the licensing and marketing of investment funds and a number of related activities from the UAE Central Bank to the The SCA has confirmed that the UAE is considering implementing a "twin peaks" model of financial services regulation and supervision and the Investment Funds Regulation represents the first move in this direction. Under a twin peaks model, the UAE Central Bank would be responsible for both systemic stability and prudential oversight, while the SCA would be responsible for conduct of business matters (including markets oversight and consumer protection). Marketing of foreign funds makes clear that all foreign funds made available to investors in the UAE will need to be approved by the However, it is still possible to market funds to discretionary portfolio managers running a portfolio for a UAE client outside of the UAE (e.g., a Swiss money manager) without triggering the provisions of the Investment Funds Regulation.
2 UAE Investment Funds Regulation implemented beginning of the end for the tolerated practice? Public offering of foreign funds In order to obtain approval from the SCA to undertake an offering of foreign funds to the public in the UAE, a foreign investment fund must: (i) in its home country be subject to the supervision of an authority which is equivalent to the SCA; and (ii) meet the requirements of, and be authorised to make, a public offering of its units in its home jurisdiction. Even where a foreign fund meets these equivalence criteria, the SCA reserves the right to impose conditions on any public offering in the UAE and request additional information and documentation. Once approved, the relevant foreign fund may be offered to the public, through various modes of promotion, in the UAE. Private placement of "nonpublic" foreign funds Where the foreign fund is not a licensed public fund in its home jurisdiction, the Investment Funds Regulation provides for what is termed a "private placement" of foreign fund units; however, such a private placement will still require the approval of the This is a potentially significant feature for the universe of investment funds that are domiciled in offshore financial centres and are not locally licensed for public offering. A private placement foreign fund offering is limited to direct offers to pre-identified prospective investors. Furthermore, minimum subscription amounts of AED 500,000 (in respect of foreign funds) and AED 1 million (in respect of foreign funds incorporated in free zones outside of the UAE) apply. There is no further guidance as to what constitutes a "free zone" for the purposes of the Investment Funds Regulation. Though we understand that this is likely to include many offshore financial centres. Exceptions apply, including where subscription is made pursuant to a savings and investment plan meeting prescribed criteria and where an SCA authorised investment manager subscribes on behalf of a client for whom he undertakes discretionary portfolio management. Private placement considerations are therefore dependent solely on the amount invested and do not factor in investment experience, net worth or other factors. Locally licensed placement agent Irrespective of whether the units of foreign funds are offered publicly or by way of private placement, all offerings must be made through a locally licensed placement agent. Placement agents can be banks and investment companies regulated by the UAE Central Bank or companies licensed by the SCA to undertake such offerings. Presently, the SCA has not issued regulations providing for the licensing and supervision of such companies. Where foreign funds are offered by way of private placement, the offer can be made through a locally established (unregulated) representative office of the fund company, provided (i) the offer is limited to institutional investors; and (ii) a minimum subscription amount of AED 10 million is applied. There is no definition of what constitutes an institutional investor but, in practice, we would expect any non-natural person able to make a minimum investment of AED 10 million into a foreign fund to qualify. places certain obligations on the local placement agent, including an obligation to take all necessary care in selecting foreign funds to be promoted within the UAE in a manner which guarantees the protection of subscription monies paid by investors. We interpret this as a requirement on the placement agent to undertake sufficient due diligence on the funds that it promotes and distributes in an effort to keep "Madoff" type risk to a minimum. However, this does not seem to go as far as the SCA's original proposal, which would have required local distributors to indemnify UAE investors against all noncommercial risk. The local promoter is also responsible for ensuring each UAE investor receives, and countersigns, specified disclosure language required by the Domestic funds regime provides for the establishment, management and distribution of domestic funds in the UAE. Establishment of domestic Investment Funds A domestic investment fund is an investment fund established in the UAE and licensed by the Only UAE joint stock companies or UAE branches of foreign companies may establish investment funds (the "Company"). The Company must hold a minimum capital of AED10 million. The Company is required to contribute a minimum of 3% of the fund's capital in each domestic investment fund it establishes (giving it "skin in the game" as per post-crisis regulatory thinking in other countries, though such thinking has not necessarily extended to investment
UAE Investment Funds Regulation implemented beginning of the end for the tolerated practice? 3 funds). However, the Company (together with its affiliates) may not invest in excess of 49% of the fund's capital, unless the fund is a closeended fund that does not permit public trading of its units. How best to ensure continuing compliance with these percentage thresholds will need to be considered carefully, given the likelihood that open-ended funds will fluctuate in terms of overall size. Entities licensed by the UAE Central Bank (such as banks and financial investment companies) are exempted from the capital requirements as long as they provide to the SCA an unconditional bank guarantee of the same amount. In order to incorporate the investment fund, the Company must submit a "fund licence application" to the The SCA may then grant a "preliminary approval" effective as and until the incorporation and subscription process of the investment fund is complete. Offer Document and Investment Policy contains detailed content requirements for the investment fund's offer document and investment policy. The offer document of the investment fund must be prepared in a form set by the SCA and must be in Arabic. The offer document may also be produced in English; however in cases of discrepancy, the Arabic prevails. The offer document must include, for instance, the investment fund's name, duration and purpose; its investment policy; subscription and redemption methods; names of the investment manager, safe custodian and management services company; limits of borrowing; names of the members in the fund's Board of Directors and the method of their appointment, removal and remuneration; and the limits and mechanism of amending the offer document. Any amendment to the offer document must be approved by fund unit owners in a General Assembly of the investment fund (unless the amendment concerns a nonsubstantive technical issue). In all cases, amendment may only be made with the approval of the The investment policy of the fund is required to correspond to the nature, type, duration and purpose of the fund. The investment policy must include, amongst other things, specifications as to the type of investment instrument the fund intends to invest in and their related risks, and policies and limits concerning borrowing or obtaining finance. also contains certain investment restrictions, including a prohibition on investing in any legal entity where the liability of the shareholders is not specified. Unless otherwise provided for in the fund's investment policy which has been approved by the SCA, the following investment ratios apply: the investment fund may invest up to 15% of its total money in securities of a single issuer and no more than 20% of its total money in securities issued by an associate of that issuer. In all cases, the fund cannot invest more than 10% of its money in any single class of securities or invest in 15% or more of the total securities issued by an issuer; the investment fund may invest up to 20% of its money in other similar funds, so long as no investment in a single fund is in excess of 10% of the investment fund's money. Furthermore, the fund's investment in a single fund should not represent more than 15% of that fund's total money. The investment fund may not invest in other funds managed by the same investment manager; and the investment fund's investment in foreign markets is limited to 20% of its total money, unless otherwise approved by the Where prior approval is obtained, the investment fund must submit monthly reports to the SCA with details pertaining to the foreign investments and the financial status of the fund. Subscription for local investment funds Subscription for the fund's units must be in accordance with the relevant fund's offer document. The fund must within 15 days from the subscription closing date issue units with a nominal value of not less than AED1 and not more than AED500,000, or its equivalent in other currencies. Listing and trading of funds Where provided by the fund's offer document and investment policy, fund units may be listed and traded on one of the UAE securities markets. Units of closed-ended investment funds directed to public subscription should be listed, whereas units of unlisted closed-ended investment funds must be traded in accordance with the offer document. Unlisted open-ended investment funds must only be sold and redeemed through banks, brokerage companies or other entities authorised by the Redemptions
4 UAE Investment Funds Regulation implemented beginning of the end for the tolerated practice? Redemptions must also be conducted in accordance with the offer document. permits a fund to temporarily suspend redemptions for a period of no more than ten days. In circumstances where the investment manager cannot meet redemption requests, or is experiencing liquidity issues for reasons beyond its control, or there is an abrupt and severe reduction in the value of the fund's assets, then this period of suspension may be extended with the approval and supervision of the The investment manager may borrow money in order to meet redemption requests; however, any such borrowing cannot exceed 10% of the net asset value of the fund and must be approved by the Service providers sets out the roles and obligations of a fund's service providers, in particular outlining the specific duties of the fund's investment manager, management services company and custodian. A fund must enter into written contracts with each of its service providers which detail the rights and obligations of each party. Importantly, in order to facilitate business continuity and minimise any damage to fund unit owners, the contract must contain provisions in respect of termination or rescission and the steps to be taken to transfer operations to a new service provider. Obligations imposed upon service providers under the Investment Funds Regulation include, amongst others: cooperating and coordinating with the fund's board of directors and the fund's other service providers; providing reports and other data to the SCA on a periodic basis or upon request; and disclosing to the SCA any violations of the fund of which it is aware as well as any steps implemented to rectify any such violation. Service providers therefore play an important oversight role and are a source of information for the Clifford Chance comment Finally, a domestic regime The UAE holds market opportunity as the vast increase in private and institutional wealth in the region has created a substantial demand for specialist financial services. To date, the focus for providing these specialist financial services has been on the financial free zones, such as the Dubai International Financial Centre (DIFC). The development of "onshore" regulation has tended to lag behind. The implementation of the Investment Funds Regulation is a step in the right direction and a more extensive legislative and regulatory framework for establishing and distributing domestic investment funds will be welcomed. An end to the tolerated practice? Pursuant to the Investment Funds Regulation, all foreign funds made available to investors in the UAE would need to be approved by the SCA and offered through a locally licensed placement agent or, in limited circumstances, a locally established representative office. The absence of a full exemption (including an exemption from the SCA's equivalence and approval requirements) for foreign non-retail funds marketed on a cross-border basis, is likely to cause many DIFC and foreign firms offering funds in the UAE to change their business model and practices. Currently foreign firms engage in a limited amount of crossborder business with non-retail investors in the UAE consistent with practice to date tolerated by the UAE Central Bank. The DIFC markets itself as "an ideal platform for raising, deploying and managing capital across the region". Indeed, many foreign firms have chosen the DIFC as their base for accessing the Middle East market. Often this has been on the premise that their activities would be subject to civil and commercial regulations akin to that found in the UK and other Commonwealth jurisdictions combined with the flexibility of being able to deal with sophisticated investors in the UAE and elsewhere without having to establish an entity in those jurisdictions. These firms may find that the DIFC no longer provides a gateway to the UAE market the way it once did. The DIFC has dedicated time and resources to creating a legislative and regulatory regime designed to support and establish a secure environment for the growth of the funds industry. In compliance with IOSCO Principles, the DIFC's funds regime allows for the domiciliation, management and distribution of funds from the DIFC. The classification by the SCA of funds established in the DIFC as "foreign funds" for the purposes of the Investment Funds Regulation may detrimentally affect the growth of the DIFC as a funds centre and inadvertently give competitive advantage to similar free zones, such as the Qatar Financial Centre situated in Doha.
UAE Investment Funds Regulation implemented beginning of the end for the tolerated practice? 5 The implementation of the Investment Funds Regulation is therefore likely to come with renewed calls for some form of passporting, mutual recognition arrangement or other special treatment for DIFC funds or funds marketed by DIFC firms. In the meantime, firms established in the DIFC may be weighing up the advantages and disadvantages of opening up an additional establishment onshore in the UAE. Indeed, some sector specific firms may relocate permanently from the DIFC. Furthermore, the proposed regime is more stringent than that applied by other regulators in the region (where there is often an informal "tolerated practice" for non-retail business) or in European jurisdictions (where there generally has been an explicit exemption for private placements or exempt offers), and would be most comparable to the position in Saudi Arabia. Saudi Arabia has long been considered a challenging market for foreign fund managers to access and, as a result, wealthy Saudi citizens often travel outside the jurisdiction to obtain access to specialist financial services. The Investment Funds Regulation may, instead of affording UAE investors enhanced protections, cause them to take their chances with foreign regulatory regimes. The provisions of the Investment Funds Regulation are clear; what is less clear is how they will operate in practice. To date, the SCA has not operated any tolerated practice similar to that of the UAE Central Bank. However, where the purpose of the Investment Funds Regulation is purported to be consumer protection, it is not inconceivable that there would be less interest in strictly enforcing fund approval requirements in circumstances where non-retail funds are offered cross-border to a limited number of sophisticated investors on the basis of discreet marketing or even a reverse enquiry basis. It is likely to be a case of wait, see and then choose one's moment to ask the SCA whether there is still scope to rely on these concepts in relation to sophisticated investors at least in the context of a particular fund offering that may be under consideration.. Twin peaks on the horizon A number of additional rules and regulations of the SCA are anticipated by the Investment Funds Regulation, including regulations concerning investment management activity in the UAE as well as a number of standard form documents. As and when these documents are published, we may develop a clearer idea of how the establishment and distribution of funds will work in practice in the UAE. Furthermore, the Investment Funds Regulation is a significant step in transferring regulatory responsibility for licensing and marketing from the UAE Central Bank to the The SCA may have taken considerable time to implement the Investment Funds Regulation; however, this was in many ways a "trial run" for future developments. The legislative timetable may be unclear but one thing we can be sure of is that the Investment Funds Regulation represents the first of many such legislative changes to come. Key contacts Tim Plews tim.plews@cliffordchance.com Tel: +971 56 683 3427 Max-Justus Röhrig maxjustus.rohrig@cliffordchance.com Tel: +971 4362 0665 Jodi Griffiths jodi.griffiths@cliffordchance.com Tel: +971 4362 0687 Per Lindberg per.lindberg@cliffordchance.com Tel: +971 4362 0706 This publication does not necessarily deal with every important topic or cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. www.cliffordchance.com Clifford Chance, Building 6, Level 2, The Gate Precinct, Dubai International Financial Centre, P.O. Box 9380, Dubai, United Arab Emirates Clifford Chance LLP 2011 Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571. Registered office: 10 Upper Bank Street, London, E14 5JJ. We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications. Licensed by the DFSA. Abu Dhabi Amsterdam Bangkok Barcelona Beijing Brussels Bucharest Doha Dubai Düsseldorf Frankfurt Hong Kong Istanbul Kyiv London Luxembourg Madrid Milan Moscow Munich New York Paris Perth Prague Riyadh* Rome São Paulo Shanghai Singapore Sydney Tokyo Warsaw Washington, D.C. *Clifford Chance has a co-operation agreement with Al-Jadaan & Partners Law Firm in Riyadh.