Asset managers operating in the United Arab Emirates are digesting new rules for the countryâs funds industry, which some see as a blow to the Dubai International Financial Centre. George Mitton reports.
At the centre of the Dubai International Financial Centre (DIFC) stands The Gate, a giant square arch surrounded by carefully watered lawns. Its shape is symbolic. Launched in 2004, the centre is an entry point to the United Arab Emirates (UAE), a free zone with its own civil and commercial laws in English and no restrictions on foreign corporate ownership. With the minimum of fuss, global investment firms can set up there and begin serving clients in the Gulf.
Many asset managers have distributed Cayman Islands or Luxembourg-domiciled funds to the local population from their base in the centre, abiding by “tolerated practices”, which means not marketing on TV or radio and selling discreetly to a limited number of investors.
TOLERANT APPROACH
But the UAE’s Investment Funds Regulation, published in August, threatens to upset this balance. The rules say foreign funds can only be marketed through a locally licensed placement agent with the approval of the Securities and Commodities Authority (SCA). The placement agent must be based onshore in the UAE itself, which means outside the DIFC.
In some cases, an asset manager may be able to market funds through a local representative office, but this too must be on the ground in the UAE.
Some in Dubai are worried that the new rules deal a blow to the DIFC. It seems having an office around The Gate is no longer enough to distribute funds in the country.
“Before, when a fund manager complied with DIFC regulations and the UAE-tolerated practices approach, you were fine to market interests in foreign funds in the UAE,” says Kai Schneider, a partner at law firm Latham & Watkins, which has an office in the centre.
“Now, you have to hire an appropriately licensed placement agent across the street and obtain SCA approval. As a result, why would a foreign fund manager seeking to market foreign funds in the UAE ever set up in the DIFC?”
Schneider says the rules, which seem designed to protect retail investors, risk cutting off the sale of sophisticated products such as private equity funds or hedge funds, which are targeted at institutions and high-net-worth individuals.
“If you’re selling foreign funds on a retail basis to moms and pops all over the UAE, that’s fine,” he says.
“But to require a private fund offered on a private placement basis to institutional and sophisticated investors to obtain approval from the SCA and appoint a local placement agent, that is going too far and is overly restrictive.”
If the regulations are inflexible, he says, it will drive the sale of private funds offshore, leaving regulators with no sense of fund flows.
The regulator of the DIFC, the Dubai Financial Services Authority, declined an offer to discuss the effects of the new regulation. The SCA had not responded to a request for comment at the time of publication.
FOREIGN PLAYERS
When Funds Global visited Dubai recently, the newly released legislation was a popular talking point.
For Asif Raza, head of Middle East and North Africa treasury and securities services at JP Morgan, it had been his lawyer’s top priority that week. “It’s a question mark,” he says.
If the rules are tightly enforced, companies such as JP Morgan may have to rearrange their business structure. It seems that large international companies will not struggle to find a way to distribute legally under the new regulations.
JP Morgan, for example, has a representative office in Abu Dhabi which could perhaps be used for fund distribution. Another option would be to sign a deal with a local bank, which would act as a placement agent.
The players that could lose out would be the mid-sized and small companies, which might baulk at the expense of taking on a placement agent. If these players choose not to establish themselves in the DIFC, that could be a blow to the financial centre.
It would not be good for the asset management industry in the Gulf to squeeze out foreign players, as the local industry is still small. Not counting sovereign wealth funds, there are just 11 locally based asset managers in the Gulf Cooperation Council (GCC) with more than $1 billion under management, according to Tony Hallside, regional director at investment consultancy Investit.
Although the DIFC is seen as one of the more successful of Dubai’s free zones, with some 1,700 funds managed by companies based there, more than 99% of these funds are domiciled offshore, says Hallside. There are fewer than ten funds domiciled in the DIFC itself and about twice that number domiciled onshore in the UAE.
The publication of the UAE Investment Fund Regulation might have been a chance to increase the number of onshore funds. Rules for domestic funds are included. However, there are a number of restrictions, notably a 20% limit on investments in foreign markets, unless the SCA gives approval. One source said this limit is likely to deter asset managers that aren’t linked to domestic banks from launching domestic funds.
Meanwhile, Hallside is concerned about the operational problems presented by the new regulations, notably the “mountain of paperwork” it will produce.
The background to the new regulations is a move towards a “twin peaks” model of financial regulation in the UAE, which will split regulatory oversight between the UAE Central Bank and the SCA.
There is also increasing competition to be a Gulf fund domicile. Qatar is trying to set itself up as a regional jurisdiction with its own financial free zone, the Qatar Financial Centre. Meanwhile, in the UAE itself, a second financial centre is in development on Al Maryah Island (formerly Sowwah Island) in Abu Dhabi. If the Sowwah Island centre is not designated as an offshore zone, it could have an advantage over the DIFC, which is considered offshore by SCA’s rules.
FRUSTRATION
Some workers in the DIFC express frustration that the SCA rules appear to have been drawn up from scratch rather than being based on existing, successful regimes.
Luxembourg could have provided a template, or regulators could have looked closer to home, to Bahrain, where the process of fund registration is seen as fairly efficient. Bahrain has fallen from favour as a domicile recently, but this is due to political unrest.
That said, it is possible to exaggerate the effects of the new rules.
Nick Angio, managing director for Apex Fund Services, says the laws are likely to allow room for manoeuvre. “Until it’s tested, the law doesn’t define boundaries,” he says.
Asset managers may be able to find ways to work within the rules. The regulations say foreign funds cannot be marketed in the UAE without SCA approval, but, he asks, what about inviting a potential high-net-worth customer to have coffee inside the centre and discussing a foreign fund there? Asset managers will have to wait and see whether such arrangements will be allowed.
FLY-BY-NIGHTS
The rules may be a deterrent to one-man hedge funds, which don’t have the funds or resources to spend on placement agents and regulatory compliance. But, says Angio, the DIFC has never attracted asset managers of this type.
Perhaps that is no bad thing. One aim of the DIFC was to create a zone in the UAE where real financial work was done, creating jobs and boosting the economy. The UAE authorities have no interest in attracting “suitcase asset management”, in which salesmen fly in to the country, promote their funds, and fly out again.
The risk is that, in discouraging these fly-by-nights, the new regime also cramps the growth of those larger players that could play a more meaningful role in developing the financial markets.
©2012 funds global