The United Arab Emirates’ New Investment Funds Regulations

On July 22, 2012, the UAE Securities and Commodities Authority (“ESCA”) issued the much anticipated new UAE investment fund regulation (the “Regulation”) pursuant to Resolution No. 37 of 2012. The Regulation was published in the UAE Official Gazette on August 26, 2012, and entered into effect the following day.

Key Changes to UAE Funds Regime

• Transfer of regulatory supervision: In practice, ESCA has for quite some time had responsibility for the day-to-day regulation of investment funds, including licensing and marketing. However, the Regulation formalizes the transfer of responsibility to ESCA from the UAE Central Bank.

• No exemptions for private placements of foreign funds: Previously, a “tolerated practice” was accepted in the United Arab Emirates which informally permitted discreet marketing of foreign funds to sophisticated investors without any requirement to obtain the approval of the UAE Central Bank. The new Regulation does not contain any exemption for such “private placements,” and marketing of a foreign fund in the United Arab Emirates will now require ESCA approval.

• Framework for domestic funds: The Regulation sets out detailed requirements for the establishment and distribution of UAE domestic funds.

• Marketing by local promoter: All foreign funds marketed in the United Arab Emirates will now need to be offered through a licensed agent (or a locally established representative office in certain circumstances).

• Fund service providers: The Regulation sets out the various duties of each service provider, specifically the investment manager, the management services company and the custodian, each of which must enter into a written contract with the fund which clearly specifies termination and transfer provisions. The Regulation highlights the importance of service providers not just in terms of their duties towards the fund itself but also as a source of ongoing information to ESCA.

• Other investment products: Non-fund structured products, investment management activities, insurance products, private investment portfolios managed by UAE banks and investment companies and employee benefits schemes are not subject to the Regulation.

Marketing of Foreign Funds in the United Arab Emirates

ESCA Approval

The Regulation provides that any foreign fund promoted in the United Arab Emirates will need to be approved by ESCA. The fact that a foreign fund may be offered only to institutional investors does not provide an exemption from the requirement to obtain ESCA approval.

This is likely to affect the business of firms in the Dubai International Financial Center (the “DIFC”) offering non-retail funds in the United Arab Emirates, as they will no longer be able to use their physical proximity to the onshore market to discreetly promote such funds without the prior approval of ESCA. ESCA has not yet discussed the possibility of passporting or any other special arrangements for DIFC firms which would enable foreign funds or DIFC funds being marketed by DIFC firms to come under the umbrella of the United Arab Emirates.

Public Offerings of Foreign Funds

The Regulation states that a foreign fund may not be marketed to the public in the United Arab Emirates unless the foreign fund is:

• subject to the supervision of an authority equivalent to ESCA in its jurisdiction of incorporation, and

• authorized to make offers to the public in its jurisdiction of incorporation.

The Regulation also provides ESCA with the power to impose further conditions.

Private Placements of Foreign Funds

If a foreign fund cannot satisfy the criteria set out above to make a public offering, then it will be authorized to promote the fund only by way of a private placement. The Regulation states that the promotion of a foreign fund shall be limited to direct contact with persons who are specified in advance. There was initially some concern that an application would need to list each individual target entity. However, ESCA has confirmed that it does not need to approve the identity of each potential investor, and that it just needs to approve a class of investors.

The minimum subscription amount by an investor in respect of the private placement of a foreign fund shall be not less than AED500,000 (U.S.$136,128) or AED1 million (U.S.$272,257) for a fund incorporated in a free zone outside the United Arab Emirates. No guidance has been provided, but it is assumed that the reference to foreign free zones is intended to catch jurisdictions such as the Qatar Financial Center.

In relation to private placements, only completed copies of ESCA’s standard forms, including the Application for Approval of Promotion and the Undertaking, will need to be in Arabic; everything else can be in English.

Local Promoter

The Regulation requires the appointment of a local promoter in relation to any offering of a foreign fund in the United Arab Emirates. This is intended to prevent the “fly-in, fly-out” practice of fund marketing which has occurred previously. The promoter is responsible for 1) filing the application forms with ESCA, 2) liaising with ESCA on behalf of the foreign fund and 3) conducting all marketing activity in the United Arab Emirates in respect of the foreign fund.

The Regulation provides that a local promoter may be:

• a bank licensed by the UAE Central Bank;

• an investment company licensed by the UAE Central Bank; or

• a company licensed for such purpose by ESCA.

The representative office of a foreign company may also act as a local promoter without an ESCA or a UAE Central Bank license where it is marketing only to institutional investors with a minimum subscription amount of AED10 million (U.S.$2.7 million) per investor. However, the difficulty in setting up such a representative office in practice is that the Department of Economic Development will not issue a trade license permitting the representative office to undertake fund promotion activities unless the proposed representative office has received a license from ESCA or the UAE Central Bank. ESCA is aware of the issue and is coordinating with the relevant government departments to resolve the matter.

The local promoter of a fund shall be required to, among other things, take all necessary care when selecting a foreign fund to be promoted in the United Arab Emirates and perform its duties in a manner that “guarantees the protection of the money paid by investors.” This places a significant obligation on the promoter, but is less onerous than the earlier draft of the Regulation which required a promoter to indemnify UAE investors against all non-commercial risk.

Local promoters are required to distribute dividend and redemption proceeds to unitholders if not otherwise undertaken by an entity related to the fund in the United Arab Emirates. Given that most foreign funds will have offshore administrators tasked with this role, this payment function will be difficult for the local promoter to undertake practically, and is not an ongoing role that many would typically perform.

Reverse Solicitation

Certain market participants are exploring ways in which to structure their activities outside the scope of the Regulation, and have made enquiries regarding reverse solicitation, which occurs where a sophisticated investor independently approaches a foreign promoter of funds on an unsolicited basis.

ESCA has confirmed that it has received several requests for clarification on whether the sale of units in a fund following reverse solicitation is permitted, and that it will issue a decision on the matter in the near future. In the meantime, ESCA will assume that a foreign promoter has initiated contact with an investor, unless it has evidence to suggest otherwise, meaning that the onus is on the foreign promoter to prove that the investor contacted it prior to any further dealings.

Establishing and Marketing Domestic Funds in the United Arab Emirates

Fund Sponsor

The Regulation provides that an entity establishing a local fund must be a UAE joint stock company or a UAE branch of a foreign company.

Capital Requirements

The capital of the company or branch must not be less than AED10 million (U.S.$2.7 million). However, entities licensed by the UAE Central Bank can instead provide an unconditional bank guarantee to ESCA for the amount of AED10 million (U.S.$2.7 million).

The company or branch shall invest not less than 3 percent of its own capital into the fund so that it has financial exposure to the fund which it is sponsoring.

Fund Offer Document

The Regulation sets out a detailed list of information which an offer document shall contain, and also provides that the offer document shall be prepared in accordance with a form provided by ESCA. The offer document must be in Arabic, and, while an English version may also be provided, the Arabic version shall prevail in the event of any discrepancy.

Investment Policy

The investment policy of the fund must specify, among other things, proposed investment instruments, investment risks relevant to the proposed investment instruments, restrictions on types of investments and borrowing controls.

The Regulation also prescribes ratio restrictions on investing in traded securities, including the following:

• no more than 15 percent of a fund’s capital may be invested in the securities of any one issuer and no more than 20 percent may be invested in the securities of an “interconnected group”;

• no more than 10 percent of the fund’s capital may be invested in any category of security (e.g., shares or bonds) of any one issuer;

• no more than 20 percent of a fund’s capital may be invested in other similar funds and no more than 10 percent may be invested in any single fund. In addition, an investment in another fund should not constitute more than 15 percent of that other fund’s capital; and

• no more than 20 percent of a fund’s capital may be invested in foreign markets.

The final restriction makes it clear that domestic funds in the United Arab Emirates will need to be primarily focused on investing in local markets such as the Dubai Financial Market and the Abu Dhabi Securities Exchange. As a result, the regime is likely to be a disincentive to foreign funds with an international focus looking to establish in the United Arab Emirates.

Other Notable Points

Investment Management

ESCA issued a draft investment management regulation at the same time as the draft of the Regulation was circulated. However, the investment management regulation was not enacted with the Regulation.

Therefore, the position should technically remain the same, in that providing investment management services without a license is not permitted, but that the authorities will tolerate the marketing of investment management services to pre-selected clients in practice. However, there is a perception in the marketplace that ESCA will monitor other areas more strictly as a result of the new Regulation.

Fund Application and Timing

ESCA is required to approve or refuse an application on the prescribed forms within 30 days of the date on which the required documents and information are submitted.

Grace Period for Compliance

The Regulation provides that entities currently engaged in investment fund activities in the United Arab Emirates shall have one year to comply with the terms of the Regulation.

Many market participants had assumed or hoped that this grace period was designed to allow promoters to conclude existing campaigns, i.e., to execute the sale of fund units to certain investors following the marketing of such funds to those investors in accordance with the previous tolerated practice regime.

However, ESCA has confirmed that the grace period is intended only to allow funds which have already been registered with the UAE Central Bank time to re-register with ESCA, and that the marketing and selling of all other funds must cease immediately.

Penalties for Violations

Following a violation of the Regulation, ESCA may issue warnings, impose fines and suspend or cancel a license.

Fees

The Regulation provides that ESCA shall issue a resolution on the fee structures relating to licensing of a fund, annual renewal of a license, approval for the promotion of a foreign fund and any other fees payable in connection with the administration of the Regulation. However, in the meantime, no fees are payable in connection with the registration of a fund by ESCA.

Restrictions on Using Fund Assets as Security

The Regulation provides that the monies of a local fund may not be pledged or seized for the satisfaction of any obligations of the fund entity.

Natalie Boyd and Andrew Johnston are Partners and Simon Mabin is Counsel with K&L Gates LLP, Dubai. They may be contacted at natalie.boyd@klgates.com, andrew.johnston@klgates.com, and simon.mabin@klgates.com.