In 2014, a speech by the Securities and Exchange Commissionâs (SEC) Office of Compliance Inspections and Examinations focused predominantly on transparency and fees in private funds, an issue that was thrust into the limelight over subsequent years by several infamous SEC cases against private equity firms for misallocation of expenses and fees. This pressure has added to a wider trend for fund fees to be scrutinised, and the Middle East is no exception.
The Middle East funds market as a domicile is in its infancy compared with developed markets in the West. Over the last decade, the Middle East has made progress in establishing itself as a comparative and legitimate fund regime, and this growth has been solidified over the last few years through the Dubai International Financial Centre (DIFC) and the introduction of the Qualified Investor Fund regime by the Dubai Financial Services Authority.
The interest in and launch of DIFC-based funds over the last few years is fledging. It is fair to say however that in the past, due to the relative smaller size of private investment funds and the general lack of sophisticated investors (compared with the West), managers in Middle East funds have had a run of very favourable fund terms and scope to charge a varying manner of fees.
The growth of Middle East-domiciled and geographically focused funds and establishment of Middle East fund managers has resulted in a natural incline in the interest and investment from foreign investors. With this increased investment, together with Middle East managers increasingly seeking diversification of their investor base, managers have been forced to re-evaluate the structure of their fee arrangements. One of the most scrutinised areas of the fund documentation which we see heavily negotiated is the ability of managers to retain ‘other fees’, such as monitoring fees, transaction and arrangement fees, and corporate finance fees. This wind of change has recently made it very difficult to retain these types of fees, which would previously go without comment.
In the Middle East, it has not necessarily been the case of concern over hidden fees, in fact, there has generally always been transparency over such fees. The sophistication of investors and legal representation of investors (or lack thereof) has simply meant these fees were never questioned and were deemed acceptable. However, with managers struggling to rationalise such fees in light of diversified investors and Western practices, we have seen a significant move to more accurately reflect markets in Europe and the US.
Thus, it is fair to say that although Middle East fund managers have arguably managed to ride the train longer than others, the heyday of the plethora of fees, payments and preferred terms received by managers of Middle East funds is realistically over. A by-product of this is perhaps the rise in scrutiny over indirect fees for Middle East managers, such as fees charged by incubators and accelerators operated by managers, due to previous past practices and such preferential structures.
Managers of Middle Eastern funds have an incentive to adopt heightened levels of disclosure and reflect practices that are equivalent to Western best practice. With the continued promotion and popularity of Middle East funds, this can only be a good thing and it will hopefully serve to propel the Middle East into the more mainstream of fund markets.
Philip Dowsett ia a partner at Morgan Lewis (Dubai office)
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