SCA And The Central Bank – The Memorandum Of Understanding Moves Forward And The Focus Is On Funds

In brief:

• SCA has issued two draft Directors' Decisions, the first concerning the regulation of investment funds (Fund Decision), the second covering the activity investment managers (Manager Decision).
• The Fund Decision sets out a new regulatory framework for the establishment, licensing, operation and promotion of investment funds in the UAE.
• Funds that are based in the DIFC are carved out of the SCA licensing regime for the establishment of funds. However, they would appear to be included for the purposes of the promotion rules that cover foreign funds.
• The consultation for the draft Fund Decision has just ended and representations have been made to SCA with respect to various elements of it.

In 2009, the Securities & Commodities Authority (SCA) and the UAE Central Bank entered into a memorandum of understanding to pave the way for amendments to the Federal framework for the regulation of securities and commodities in the UAE, and in particular, for more supervisory responsibilities to pass to SCA from the Central Bank.

There are now more concrete indications of how this process might manifest itself in practice.

At the recent GCC Regulators' Summit in Abu Dhabi, HE Sultan Bin Saeed Al Mansouri, the UAE Minister of Economy announced that there were to be new regulations covering custody, delivery-versus-payment, margin trading, collective investments, broker dealing, customer account handling and short selling. HE Ebrahim Al Zaabi, ESCA Deputy Chief Executive for Licensing, Supervision and Enforcement echoed the Minister's words.

Note the reference to 'collective investment'; in other words, funds. The UAE is an important centre from which the international financial community attracts significant investment into their funds whether specialist or general, open or closed ended.

Recent events may have a significant effect on the way foreign funds go about accessing a UAE investor base, even if those investors are either institutional or 'professional'.

SCA has issued two draft Directors' Decisions, the first concerning the regulation of investment funds (Fund Decision), the second covering the activity investment managers (Manager Decision). This article focuses, at a very high level basis, on the contents and possible implications of the Fund Decision for local and, especially, foreign funds. As for the Manager Decision, this proposes to transfer the licensing and conduct of business responsibilities of investment companies and investment managers from the Central Bank to SCA. The draft Manager Decision may have an impact on the provision by foreigners of unlicensed cross-border management services. We will address the Manager Decision in a future issue of Hadef Highlights. For now, we focus on the Fund Decision.

What does the draft Fund Decision say?

In very broad terms, the Fund Decision sets out a new regulatory framework for the establishment, licensing, operation and promotion of investment funds in the UAE.

For local funds:

• It requires that companies wishing to establish a fund in the UAE must meet certain minimum requirements as to, among other things, paid up capital, capital adequacy, their scope of activity and their own investment in a fund. Entities which are already licensed by the Central Bank are exempted from some of these requirements although even they must provide ESCA with an unconditional guarantee of AED10 million.
• Assuming that a company meets the relevant criteria then it may submit an application for an investment fund to be licensed by SCA.
• The draft Fund Decision then sets out the basic requirements for a fund if it is to be granted a license, and covers areas such as: articles of association, investment policy, special rules for investing in traded securities, the subscription process, listing, valuations, distributions/redemptions. The draft also addresses the prospectus for a fund and corporate governance matters in terms of unit holders' meetings, the powers/functions/responsibilities of the board, conflicts of interest and financial reporting.
• The draft additionally sets out the powers, functions and responsibilities of those who are engaged in the management and administration of a fund, in particular the investment manager, the fund administrator and the custodian.
• It is evident that there may be further regulations that address certain specialist funds, eg REITS and ETFs.

The overall architecture of the framework for local funds is broadly what one might envisage from the tenor of the original Memorandum of Understanding, namely i) that SCA governs who may set up a fund if they are not already licensed by the Central Bank, ii) SCA oversees the licensing of individual funds and acts as the supervisory authority for the manner in which they are operated, whilst iii) the Central Bank retains responsibility for the supervision (with inspection powers) of the financial stability of investment funds (ie the prudential role).

For foreign funds:

An entire part of the draft Directors' Decision (Part IV) is devoted to the promotion of foreign fund units within the UAE. This represents the most concentrated attention paid to foreign securities in the financial services laws and regulations of the UAE.

Currently, the relevant law is to be found in various decisions and resolutions of both the Central Bank and SCA. In the context of those who wish to sell foreign securities (including funds) to potential investors in the UAE, the focus has been primarily upon the Central Bank resolutions and, in the specific case of funds, Central Bank Resolution No 164/8/94 which contains express provisions about the licensing requirement for both the establishment of funds (in the UAE) and the 'advertising' of any funds (ie including a foreign fund).

It is fair to say that the ambit of the current law is subject to uncertainty and wide interpretation and, as a very general statement, foreign securities (including funds) have been sold in the UAE, but mitigating steps have been taken by those who are concerned about regulatory risk so that the activity might reasonably be regarded as a sale pursuant to a limited private placement addressed to a limited number of institutional/professional investors.

There are a number of guidelines as to how the risk mitigation might be achieved, but these are beyond the scope of this article. Notwithstanding the mitigating steps, however, it remains the case that they have not been the subject of any formal or informal approval of the Central Bank and therefore their effectiveness cannot be assured.

The draft SCA Directors' Decision is, on the face of it, rather more clear in its intentions.

Here is an overview of the key elements to Part IV of the draft:

• Any promotion of a foreign fund in the UAE requires the approval of SCA.
• Additionally, Central Bank approval is also required.
• The fund and those responsible for it must be subject to the 'supervision of a control authority similar to [SCA]'. No further detail is provided on this point as to which jurisdictions and authorities qualify for this purpose.
• Certain tasks must be performed by entities licensed in the UAE, but the most important of these is that the promoter and distributor must be licensed by SCA to conduct promotion and underwriting subscriptions. In other words, a local intermediary is necessary for the sale process. The local distributor is subject to various requirements relating to disclosures, record keeping, provision of pricing information, provision of financial information both to investors and SCA (there are also requirements as to the auditing of such information).
• There are also restrictions relating to the trading of funds (both listed and unlisted).

No distinctions are drawn between whether the fund might reasonably be regarded as aimed only at a limited number of institutional/professional investors.

What about funds in the Dubai International Financial Centre (DIFC)?

Funds that are based in the DIFC are carved out of the SCA licensing regime for the establishment of funds. However, they would appear to be included for the purposes of the promotion rules that cover foreign funds (indeed the definition of 'foreign fund' expressly includes free zone funds), the implication being that someone who wishes to promote a fund out of the DIFC (even if it was established in the DIFC) must obtain approval of SCA (and Central Bank) and must use an intermediary. We do not know if this was the intention of the drafting, but its surface meaning might suggest that this is the case.

What next?

The consultation for the draft Fund Decision has just ended and representations have been made to SCA with respect to various elements of it. It remains to be seen whether the legislation when ultimately enacted will reflect revisions, eg some kind of 'safe harbour' for private placements to professionals, or perhaps clarification on how onerous (or otherwise) the approval process for promotion will be, or specific provisions relating to DIFC based funds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.