SCA ISSUES REGULATIONS FOR MUTUAL FUNDS
The Securities and Commodities Authority (SCA) of the United Arab Emirates issued rules concerning domestic and foreign investment funds [Board decision no. (37) of 2012 dated 22 July 2012 concerning the Regulations as to Mutual Funds]. The new regulations entered into force the day after their publication in the Official Gazette, which is on 26 August 2012 this year. The private equity industry has been eagerly awaiting these regulations ever since a first draft was issued for public review in January 2011.
In announcing its final regulations, the SCA said they represent a positive step that will help strengthen collective investment in the UAE and enhance stability in financial markets. In particular, the regulations are designed to allow for new investment products and to attract new investments and greater liquidity to local markets.
The new regulations mark a seismic shift in the way funds are marketed or promoted in the UAE. In what can only be viewed as an open challenge to the Dubai International Financial Centre, the regulations potentially treat funds established in one of the UAE’s free zones as foreign funds. Despite having the most sophisticated financial regulations in the region, the DIFC could have been effectively relegated to the same status as any other foreign jurisdiction by the SCA.
It was not elaborated upon whether the DIFC is considered to be outside the UAE (although there is an argument that it is a separate jurisdiction), but this clarification is nonetheless welcome, as otherwise it is very difficult to implement a ‘reverse enquiry’ model of distribution that is not unduly restrictive.
The regulations also continue a trend of categorizing all investment funds together with minimal attention to the specifics of closed-ended funds or vehicles that are reserved for sophisticated institutional investors. Further, there is little evidence of reciprocity being granted to funds established and regulated in other non-hostile jurisdictions.
All this is of grave concern to the private equity industry in the UAE, since UAE investors (both sovereign and private) are important suppliers of capital to private funds worldwide. The UAE is also perceived as a trailblazer for other capital exporting states in the region.
The new SCA funds regulations are split into four chapters covering:
- the incorporation and promotion of domestic UAE funds;
- the regulation of service providers;
- the promotion of ‘foreign’ funds; and
- >miscellaneous provisions on grievances, fees and grandfathering of existing funds.
The rules on domestic funds are of limited interest to private equity investors as they are subject to limitations that will make them inedible to all but the largest domestic institutions. These limitations include the requirement that managers of UAE funds be licensed by the SCA , be established in the UAE (via a subsidiary or a branch) with a minimum capital of AED 10 million and must subscribe at least 3% of each fund’s capital on the same terms as other investors. The domestic fund’s offering document must be drafted in Arabic, and where an English translation is used the Arabic version will prevail in case of discrepancy.
The most important news for private equity is found in the new rules on ‘foreign’ funds. In a welcome departure from previous drafts, the new rules introduce a concept of ‘private offering’ within the UAE. Unfortunately, this regime is subject to numerous restrictions, which limit its practical application in this industry. In addition to requiring the prior written approval of the SCA, a ‘private offering’ of foreign fund units is subject to the following constraints:
1. Promotion (defined as “offering, marketing, distributing or advertising” the fund or the units thereof) is restricted to a list of offerees whose details must be notified to the SCA at the time of seeking approval for the promotion.
2. Offerees must commit at least AED 500,000 per subscriber (increased to AED 1 million per subscriber in the case of investment funds incorporated in a “free zone” outside the UAE).
3. Promotion may only be conducted through: (i)a local bank or investment company licensed by the UAE Central Bank; (ii) a company licensed for such purpose by the SCA ; or (iii) a local representative office of the foreign issuer.
4. Where a local representative office is used, the minimum subscription is AED 10 million per institutional subscriber.
5. In any event, the local promoter owes a professional duty of care to investors when selecting the foreign fund for promotion and in monitoring its performance. The local promoter also acts as distributor of the fund’s units and effectively guarantees investors’ title to such units.
The SCA has also made it clear that marketing activities taking place in the UAE will be covered by the laws and that marketing activities taking place outside the UAE will not be covered (irrespective of whether the target is an UAE national or resident).
In summary, although the new SCA fund rules provide welcome clarity in some areas, they are likely to hinder access to the UAE market for private equity funds in the near future. In an effort to avoid regulation altogether, fund managers may be tempted to abstain from any promotion whatsoever in the UAE and instead seek to market their funds outside the country or through some form of passive marketing strategy.
It remains to be seen whether the SCA will try to use its new regulatory powers to curtail such passive marketing activity or genuinely impact the UAE fund businesses in a positive manner.
(This article is compiled by Mr. Chaitanya Kirtikar, Manager, Offshore & Free Zone Services.)