INTRODUCTION
The United Arab Emirates ("UAE") is one of the preferred jurisdictions globally for establishing collective investment funds. Within the UAE, the financial free zones - Abu Dhabi Global Market ("ADGM") and Dubai International Financial Centre ("DIFC") have emerged as financial centres for funds and fund management activities. There are various contributing factors that enabled ADGM and DIFC (collectively, "Financial Free Zones") to become hubs for collective investment funds, as detailed below:
- Comprehensive regulatory framework;
- Beneficial tax regime;
- Availability of various types of investment vehicles;
- Fast-track notification process;
- Flexibility for licensed fund managers to set up funds within and outside the Financial Free Zones;
- Availability of various third-party service providers including asset managers, fund administrators, and custodians.
- Simplified regulatory framework for start-up and boutique funds;
- Regime for various types of specialist funds such as property funds, feeder funds, credit funds, and sustainability focused funds; and
- Funds passporting framework between various regulators in the UAE that enables the distribution of fund units across the country.
The Financial Free Zones are keen on fostering innovation while building adequate regulatory guardrails to ensure investor protection. As a result, both the Financial Free Zones have been successful in developing a balanced and nuanced regulatory framework that has contributed to a thriving funds ecosystem.
In this article, we look at certain emerging trends in the funds regime of the Financial Free Zones.
NEW CLASSES OF SPECIALIST FUNDS
A. Sustainability Oriented Funds:
In July 2023, ADGM implemented a comprehensive regulatory framework for sustainable finance, including a regulatory framework for sustainability-focused funds and discretionary portfolio management. Amidst growing concerns around greenwashing and credentials of assets held by green investment funds, ADGM recognised the need to implement a regulatory framework that requires funds to invest in verifiable green assets or greening assets.
FSRA amended its Funds Rules to include two new classes of specialist funds: (i) ADGM Green Fund ("ADGM GF"); and (ii) ADGM Climate Transition Fund ("ADGM CTF") (collectively, "Sustainable Funds").
For both classes of funds, ADGM has stipulated specific eligibility criteria for investable assets. An ADGM GF must invest in Eligible Green Fund Property which comprises assets (i) that align with any one of the Acceptable Green Taxonomies (such as the EU Green Taxonomy or the ASEAN Taxonomy for Sustainable Finance); or (ii) that are included in or otherwise track a Paris-Aligned Benchmark ("PAB") (for e.g., Fund may track or include securities from multiple EU Paris Aligned Benchmarks). ADGM CTF on the other hand must invest in 'greening' assets i.e., assets that are not currently green, but have the potential to become so over time.
The Sustainable Funds may be set up as public funds that are open to retail investors or Exempt or Qualified Investment Funds ("QIFs") that are only open to professional investors. Exempt Funds or QIFs are subject to less stringent regulatory requirements as compared to a public fund.
Sustainable Funds can use specific designations and logos in their marketing and communication material, to evidence that the fund adheres to applicable sustainability criteria. As UAE prepares to host COP 28, these initiatives are expected to boost the sustainability finance ecosystem in the UAE, while cementing ADGM's position as a hub for sustainable finance activities.
B. Private Credit Funds
Credit funds are permitted to use fund property to lend loans to borrowers, participate in syndicated lending/ co-lending, purchase existing loans from other lenders or invest in debt instruments. Both DFSA and ADGM have introduced regulations governing credit funds, while recognising a credit fund as a specialist class of fund. There are certain commonalities under both the regulatory regimes, as detailed below:
A credit fund must:
- only be set up as an exempt fund or a QIF, both of which are not permitted to target retail investors;
- be closed-ended;
- prohibit lending to certain types of borrowers including natural persons, other funds, financial institutions and related parties and persons intending to use the credit for speculative investment purposes;
- limit exposure to a single borrower (or group of connected borrowers) to 25% of the net assets of the fund.
Apart from the general requirements that apply to fund managers, managers of credit funds are required to comply with additional specialist fund requirements such as:
- ongoing monitoring of granted credit;
- sound assessment and pricing methodology;
- adequate risk management;
- application of stress testing methodologies; and (iv) management of collateral.
DFSA has clarified that a credit fund would be permitted to undertake financial leasing, along with discounting and factoring but it may not issue letters of credit or undertake trade finance.
The tightening of lending by traditional lenders following the 2008 global financial crisis paved the way for the emergence of private credit funds. For investors, credit funds offer several advantages including focused investment strategies that may offer higher yields than traditional investment-grade debt securities.
C. Crypto Funds
In November 2022, DFSA issued a comprehensive regulatory framework governing virtual assets activities which entailed amendment of its Collective Investment Rules ("CIR") to, inter alia, recognise a crypto token fund as a specialist class of fund ("Crypto Token Fund").
Under CIR, a Crypto Token Fund means a fund whose main purpose is to invest in crypto tokens. A fund will be considered as investing in crypto tokens if:
- any of the fund property consists of crypto tokens;
- the fund has a derivative exposure to crypto tokens;
- the fund tracks an index that includes crypto tokens;
- the fund invests in another fund or entity which satisfies the criteria specified in (a) to (c) above.
It must be noted that under DIFC's regime, a Crypto Token Fund is only permitted to invest in a Recognised Crypto Token. Consequently, a DFSA-licensed fund manager is prohibited from managing, offering or promoting a fund that invests in unrecognized crypto tokens. DFSA has clarified that the above-stated prohibition also extends to funds seeking to have derivatives exposure or funds that track an index which includes unrecognized crypto tokens. It also applies to indirect investment in unrecognised crypto tokens including by use of Feeder Funds or Exchange Traded Funds ("ETFs").
Recognised Crypto Token: A Recognised Crypto Token is a virtual asset (a) that is listed in the Initial List of Recognised Crypto Tokens released by DFSA; or (ii) that is specifically recognised by DFSA as such on a case-to-case basis. So far, the Initial List contains three Recognized Crypto Tokens: Bitcoin, Ethereum and Litecoin.
With respect to ADGM, it is noteworthy that a virtual assets focused fund has not been recognized as a specialist class of fund under FSRA's Funds Rules.
D. Tokenisation Of Fund Units
With an increased focus on asset tokenisation, usage of fund structures for tokenisation of real-world assets has been on the rise. Tokenisation of fund units involves creating a digital cryptographic token on a distributed ledger or blockchain, which represent units in a collective investment fund. Tokenisation offers a range of benefits for fund managers such as access to a wider range of investors, simplification of the investment process (for example, through investment rules being embedded into smart contracts), and efficiency in transactions through faster settlement and clearing.
In the Financial Free Zones, a unit in a fund is treated as a traditional security. Consequently, tokenised units of funds are also deemed to be a security.
As such, the practical instances of tokenisation of fund units within the Financial Free Zones are few and far between. One such practical instance is of an ADGM established feeder fund (investing into another crypto-currency trading fund) that was tokenised. However, the Financial Free Zones are taking into consideration tokenisation business models and are issuing licenses to companies focused on developing asset tokenization technologies.
CONCLUSION
The Financial Free Zones continue to foster a robust landscape for the funds ecosystem. At the UAE mainland level (i.e., UAE outside of Financial Free Zones), the Securities and Commodities Authority ("SCA"), the federal financial regulator in the UAE, recently overhauled its regulatory framework for investment funds including promotion and marketing of foreign funds in the UAE. Further, discussions are currently underway between the GCC countries to develop a GCC fund passporting regime.
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.
