The following article provides a useful guide to the various types of funds within the UAE.
I. FREE ZONE FUNDS
Foreign investors interested in creating an investment fund in the UAE can choose between two free zones the Dubai International Financial Centre (the “DIFC”) located in the Emirate of Dubai and regulated by the Dubai Financial Services Authority (the “DFSA”), or the Abu Dhabi Global Market (the “ADGM”) located in the Emirate of Abu Dhabi and regulated by the Financial Services Regulatory Authority (the “FSRA”).
A. Dubai International Financial Market ("DIFC")
Dubai has established itself on the global investment funds industry through the DIFC which is Dubai’s most developed zone to set up investment funds.
The Collective Investment Fund Regime as introduced by the DFSA is the main regulation providing for the creation of a fund in the DIFC (the “Regulation”). The Regulation provides for a business-friendly regulatory framework and is compliant with the International Organisation of Securities Commission’s (the “IOSCO”) principles governing collective investments. Therefore, the Regulation meets the international standards in respect of the investors’ protection.
Types of funds in the DIFC
The DFSA provides for two types of funds, the domestic funds and the foreign funds.
1. THE DOMESTIC FUNDS are the investment funds established or domiciled in the DIFC. The domestic funds are divided into three categories: (a) the public funds, (b) the exempt funds and (c) the qualified investor funds. These three categories of funds can in turn, be subdivided into a series of specialist funds as highlighted below.
a) Public funds (“PF”) are subject to a detailed regulation in line with IOSCO standards. PF shall either have/intend to have more than 100 unitholders who can be retail clients, or offer all or some of their units to investors through a public offer. Investors in PF benefit from a high level of protection as a result of a series of requirements including a detailed disclosure in a prospectus.
b) Exempt funds (“EF”) are subject to lesser regulatory requirements than the PF. Only professional clients are eligible to invest in EF’s units. EF shall offer their units only through a private placement and shall have 100 or fewer unit holders. The minimum subscription in respect of EF shall be equivalent to USD 50,000. The fund manager of an EF is not required to entrust the EF’s property to an eligible custodian. Instead, the fund manager shall appoint an investment committee to the EF. The fund manager shall further make a series of disclosures in its prospectus relating to how the EF’s assets are held. EF further benefit from a fast-track notification process: the DFSA aims to complete the process within a period of five business days as from the receipt of the requested application/documents.
c) Qualified Investors Funds (“QIF”) are subject to a regime which provides for a regulation significantly less stringent than the regime applicable to EF and which allows flexibility for QIF’s managers. Indeed, the regulation applicable to QIF requires self-certification regarding the adequacy of systems and controls. As with EF, only professional clients are eligible to invest in QIF’s units. QIF shall offer their units only through a private placement and shall have 50 or fewer unit holders. The minimum subscription in respect of EF shall be equivalent to USD 500,000. QIF benefit from a fast-track notification process as the DFSA aims to complete the process within a period of two business days as from the receipt of the requested application/documents.
d) Specialist funds include:
Hedge funds (the “HF”) whose risks shall be adequately managed by the fund manager. For these purposes, the fund manager shall ensure a segregation of duties between the investment function and the fund valuation process and observe best practice standards issued by the DFSA including the DFSA hedge fund code of practice.
Vehicles used to create a domestic fund
Three types of vehicles may be used to create a domestic fund in the DIFC. These vehicles are (i) investment companies, (ii) investment trusts, and (iii) investment partnerships. To date, the investment companies are the most preferred model. Investment companies shall be incorporated in the DIFC with the fund director appointed as the corporate director in the investment company. Trust structures are employed for property funds. An investment trust shall be authorised upon the creation of a trust deed between the fund manager and a trustee who may be a DFSA licensed company or an authorised individual from an approved jurisdiction. Partnerships are employed for hedge and private equity funds. An investment partnership is a limited partnership registered with the DIFC and has a general partner and limited partners. The general partner shall be the individual authorised by the DFSA to be the fund’s manager.
2. THE FOREIGN FUNDS which are investment funds domiciled or established outside of the DIFC. Foreign funds are either funds located in jurisdictions outside the UAE, or funds located in the UAE but not in the DIFC. Foreign funds which in their home jurisdiction cannot be marketed to retail investors cannot be marketed to retail investors in, or from, The DIFC.
Funds are managed by a fund manager (the “FM”) who is responsible for the management of the investment fund and for providing administrative services. The FM can be either a DFSA licensed FM, or an external FM. To obtain a DFSA license, the fund manager shall demonstrate to the DFSA that (i) it has adequate systems and controls to manage the type of fund to be established; and (ii) the individuals performing certain functions within the FM’s company such as the board members, the senior management and the persons in charge of key control functions meet the relevant suitability and integrity criteria. DFSA licensed FM are able to establish and manage funds in the DIFC and in jurisdictions outside the DIFC as well. External FM from an acceptable jurisdiction may establish and manage a Domestic Fund without the obligation to obtain a DFSA license provided that the external FM:
a) is a corporate body;
b) manages the Domestic Fund from a jurisdiction which is either included in the DFSA’s recognised jurisdiction list, or assessed by the DFSA as capable of providing an adequate threshold of regulation;
c) willingly subjects itself to the DIFC laws and courts in respect of its activities relating to the Domestic Fund; and
d) appoints a DFSA licensed fund administrator or trustee who will act as the local agent of the external FM to deal with the DFSA in respect of all regulatory processes and to handle some investor-related functions (e.g. to maintain the unitholders’ register, to make the fund’s prospectus available to investors and the like).
The FM shall comply with the requirements of DIFC and DFSA. The DFSA also regulates the key players in the fund management service sector such as fund administrators, custody providers and trustees for the purposes of ensuring an adequate investor protection by promoting high industry standards which meet international best practice.
Marketing of funds in the DIFC
The marketing of domestic funds is subject to a series of disclosures to be set out in a prospectus. The level of the disclosures required for public funds i.e. funds which are open to 100 or more investors and/or to retail clients is significantly higher that the level of disclosures applicable to exempt funds which are open only to professional investors. A copy of the prospectus shall be filed with the DFSA.
Foreign funds can only be marketed by DFSA licensed firms which hold advisory or arranging authorisations (the “Authorised Firms”). Additional conditions shall further be met in order for Authorised Firms to advertise foreign funds’ units. These conditions are as follows:
a) the foreign fund shall be a designated, regulated fund in a jurisdiction included in the DFSA’s recognised jurisdictions;
b) the Authorised Firm shall have a reasonable basis to recommend the investment in the foreign fund’s units; or
c) the foreign fund shall be open to 100 or fewer investors who meet a professional client test and whose minimum subscription is USD 50,000 and is not offered to investors by way of a public offering.
Foreign funds which cannot be marketed to retail investors in the foreign fund’s home jurisdiction cannot be marketed to retail investors in the DIFC.
Documents required for an investment fund in the DIFC
A series of documents are required to set up a domestic fund vehicle including a private placement memorandum (“PPM”), a subscription agreement for investors and an investment management agreement. The PPM is the key document and sets out among other things, the terms of the offering, the investment’s objectives, strategies and methodologies, the structure of the investment, the profile of the fund manager and the service provider and statutory and commercial disclosures, the risk factors, the calculation methods and the like.
B. Abu Dhabi - Abi Dhabi Global Market (“ADGM”)
The ADGM is an award-winning international financial centre, strategically located in the capital of the UAE. ADGM’s jurisdiction extends across Al Maryah Island and offers various options for funds setup.
The rules and regulations applicable to the setup of a fund are set out in the Financial Services Regulatory Authority legislation (the “FSRA”), which is considerably similar to the rules set out in the DIFC Regulation, save for some differences outlined below.
Types of funds in the ADGM
The ADGM has adopted the same classification of funds as the DIFC. As such, the ADGM differentiates between:
- Domestic Funds, which include Public Funds, Exempt Funds and QIFs. These three types of Domestic Funds can include various specialist funds, including but not limited to the specialist funds outlined in Section 1 (d) above, umbrella funds where a single fund may have more than one sub-fund where each has its own investment objective and policy, feeder funds where all investments are made into one other fund – the master fund; and
- Foreign Funds, i.e., funds domiciled outside the ADGM which wish to market/sell units in/from the ADGM.
In addition to investment companies, investment partnerships, and investment trusts, Domestic Funds may be structured in the ADGM using Protected cell Companies (“PCC”) and Incorporated Cell Companies (“ICC”). PCCs and ICCs allow fund managers to legally segregate the assets and liabilities of each cell whilst operating under common management.
The provisions applied by the ADGM in relation to the licensing of Fund Managers, whether local or foreign, correspond, to a large extent, to the provisions/requirements applicable within the DIFC.
Marketing of funds
The rules applicable to the marketing of domestic and foreign funds in the ADGM are consistent with those applicable in the DIFC.
Similarly to the DIFC and with a view to advertising foreign funds’ units in the ADGM, an authorised fund manager shall comply with a series of requirements, including:
- disclosing the jurisdiction of the foreign fund and the name of its regulator;
- describing the regulatory status of the foreign fund by its home regulator;
- include a series of warnings in the prospectus; and
- disclosing the investment policy and strategy as well as the associated risks.
II. ON SHORE FUNDS
Since the 28th February, the on shore funds, historically regulated by the UAE Central Bank (the “Central Bank”), are licensed by the Securities and Commodities Authority (the “SCA”/“ESCA”), a financially and administratively independent UAE entity whose main purposes are to supervise and monitor the UAE financial markets, including the Dubai financial market (the “DFM”), the Abu Dhabi securities exchange (the “ADX”) and the Dubai gold and commodities exchange (the “DGCX”). The Central Bank continues however to have a role in the funds’ industry; indeed, the Central Bank supervises the financial status of the investment funds established and licensed in accordance with the provisions of the SCA regulations concerning investment funds and investment management activity (the “Regulation”) and sends reports to the SCA. The SCA shall take the necessary measures to address any issue provided for in the Central Bank’s report. The Central Bank and the SCA have therefore complementary roles in controlling investment funds’ activities.
Prior to the introduction of the Regulation, the local fund management industry was limited and was mainly carried out in house by banks and investment companies. As from the 28th February 2015, all entities whose activities relate to investment funds and investment management activities became eligible to carry out the local fund management activities provided that they are licensed by the SCA. Indeed, the Regulation provides that subject to the provisions pertaining to the competence of the Central Bank, it is prohibited to establish a local investment fund or promote any foreign investment fund within the UAE before obtaining an establishment license or an approval for the promoting process from the SCA.
The Regulation applies to all issues in respect of (i) local investment funds, and (ii) the promotion of foreign funds in the UAE. For the purposes of the Regulation, a local investment fund is an investment fund established in the UAE and licensed by the SCA. Funds incorporated in the DIFC and the ADGM are considered as foreign funds.
The main effects of the Regulation can be summarised as follows:
• create a more regulated regime for the investment and fund management market in the UAE (the “Market”);
• widen the scope of the Market; instead of being restricted to banks and investment companies, the Regulation opens the Market to DIFC domiciled and DFSA regulated asset fund managers; and
• provide security for clients and investors over assets; indeed, the Regulation provides that (i) the fund’s monies guarantee the unit holders’ rights and cannot be pledged or seized to secure/in settlement of, the fund’s founding party; (ii) the fund’s assets are the fund’s property and cannot be mortgaged, loaned or disposed of in any manners other than those provided for in the OM; and (iii) the fund’s securities shall be kept with a “keeper of securities” i.e. a custodian.
In light of the above, the Regulation provides for a series of tools whose purposes are to provide a security to the fund units’ holders. The Regulation should however be further clarified in order to address a series of relevant issues including the nature of the “separate fund” where the fund’s assets are to be segregated and the nature of/regime applicable to, the custodian of the fund’s assets. With respect to the segregation of the fund’s assets, the conditions of the trust/fiduciary regime are implicitly provided for in the Regulation. However, in the absence of such concepts in the laws of the UAE, the Regulation should further clarify how the assets are to be segregated. As for the custodian, additional details/clarification should be provided for in order to fully assess the security provided through the custody of the fund’s assets referred to in the Regulation as “securities”.
Types of funds
The Regulation provides for two types of funds, the local funds and the foreign funds.
1. LOCAL FUNDS shall meet a series of requirements set out in the Regulation.
The requirements which apply to the company which intends to set up a fund are as follows:
a) the company shall be a joint stock company or a branch of a foreign company licensed by the competent authorities;
b) the company’s purposes as set out in its bylaws shall be the establishment of investment funds. Banks, financial investment companies, foreign companies’ branches licensed by the Central Bank are exempted from this requirement;
c) the capital of the company or the branch of the foreign company shall be equivalent to AED 10 million, at least. Banks, financial investment companies, foreign companies’ branches and any party licensed by the Central Bank are exempted from this capital requirement provided that they provide an unconditional bank guarantee amounting to AED 10 million to the benefit of the SCA;
d) the company shall invest in each investment fund it sets up at least 3% of the fund’s capital. The company’s investment with its affiliated companies shall not exceed 49% of the capital of the fund the company sets up to the extent that the fund is not a close-end fund and does not allow public placements or the trading of its units; and
e) the company shall be enough solvent to practice its activities in accordance with the SCA’s standards.
A company which complies with the above requirements shall apply for an SCA license. For these purposes, the company shall provide a series of documents and information among which the fund’s offering memorandum to be prepared in accordance with the SCA’s model (the “OM”). The OM shall include, among other things, the fund’s name and capital, the fund’s investment policy and applicable method to evaluate the fund’s assets and units, the conditions governing the subscription to the fund’s units and the units’ redemption, the fund’s policy for the profits distribution, the names of the fund’s board members, the director of the investments, the auditors and other similar information with the fee calculation scale of each of these parties’ fees. If the considered fund is an Islamic fund, the OM shall clearly indicate that the fund complies with the Shari’a and list the names of the fund’s Shari’a board. The OM shall further determine the specifications of the fund’s available investment instruments, their related risks, their anticipated returns as well as their expected impact on the achievement of the fund’s objectives, the limitations applicable to the fund’s investments, the limitations of the fund’s borrowings or lending, the mechanism governing the amendment of the fund’s policy (if applicable), the obligation to prepare financial reports in accordance with the Regulation, and the like. The OM shall also provide for the disclosures necessary to make available to the investors all kind of information allowing them to properly assess their investment in the fund’s units.
Upon the issuing of the SCA’s license granting the fund a license to carry out its activities, the fund shall issue nominal units with an equal nominal value which ranges between AED 1 and AED 500,000 (or their equivalent in other currencies). The fund’s units shall grant their holders equal rights to participate to the profits and losses linked to the fund’s activity pro rata the number of units they hold.
Investments - service providers
A local investment fund which invests in securities shall, unless otherwise approved by the SCA, comply with a series of ratios provided by the Regulation in order to limit the risks associated with the fund’s investments. This investment policy aims to optimise the unit holders’ security in the event that an investment fails to achieve the anticipated returns.
Investment funds’ service providers shall comply with a series of requirements set out in the Regulation, the OM, the applicable laws and any instructions given to them by the SCA. They shall provide the SCA with all data/documents the SCA may request and disclose any violations with the suggested remedy to address them.
Termination of the fund
The fund is terminated at the term of its duration as set out in the OM if it is not renewed, or if at the time the fund’s purposes are achieved. The fund is further terminated in the event of the occurrence of events which prevent it to exercise its activities, or if the unit holders of a close-end fund decide to liquidate the fund in accordance with the terms and conditions as set out in the OM. The commercial companies’ law provisions governing the liquidation of joint stock companies apply to the funds’ liquidation unless otherwise provided for in the OM.
2. FOREIGN FUNDS
Foreign investments funds may be promoted in the UAE through a bank licensed by the Central Bank, an investment company licensed by a local promoter i.e. the Central Bank or a company licensed for this purpose by the SCA, provided that the foreign investment funds first obtain the SCA’s approval. The Regulation sets out the requirements for promoting foreign funds’ units in the UAE. The foreign fund shall be registered with the SCA prior to any marketing to UAE based investors. The SCA’s approval is subject to the foreign fund being (i) established in a foreign state and subject to the supervision of an authority which is similar to the SCA; and (ii) licensed in its home jurisdiction for promoting units for a public offering.
The Regulation provides for exceptions where foreign investment funds are exempted from the registration with the SCA:
a) If the foreign fund is to be marketed exclusively to federal or local government agencies or to their wholly owned subsidiaries;
b) If the investor initiates the transaction (reverse solicitation) and there is no promotion in the UAE by the fund manager or any of its agents. An evidence would be required to prove that the investor approached the fund manager without any promotional activity conducted by the fund manager in the UAE.
The Regulation sets out the obligations of a foreign fund’s local promoter, the promotion methods and the investors for whom the promotion may be made.
Conclusion: A clear intention to further develop the UAE funds market
On the 11th March 2019, the SCA, the DFSA and the FSRA announced the introduction of rules, based on common regulatory framework, to facilitate the marketing and sale of units in domestic UAE funds across the UAE (the “Passporting Arrangement”). The Passporting Arrangement does not apply to the promotion of foreign funds’ units in the UAE. The Passporting Arrangement allows the UAE licensed firms to promote units in the relevant UAE fund to certain investors in one or both of the other jurisdictions in the UAE. The Passporting Arrangement should stimulate the development of the domestic UAE funds market and witnesses the intention of the local authorities to further develop the financial markets and play a leader role in the funds’ industry.
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