On 22 July 2012, the Securities and Commodities Authority of the United Arab Emirates issued the long-awaited rules concerning domestic and foreign investment funds. The new regulations will enter into force the day after their publication in the Official Gazette, which is expected in late August or early September. The private equity industry has been eagerly awaiting these regulations ever since a first draft was issued for public review in January 2011, resulting in an extraordinary level of interest and commentary.
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.
Missing from the SCA's public announcement is the fact that the new regulations mark a dramatic shift in the way funds are marketed or "promoted" in the UAE. In a surprisingly direct challenge to the Dubai International Financial Centre, the regulations treat funds established in one of the UAE's "free zones" as foreign funds. Despite having the most sophisticated financial regulations in the Middle East and having marketed itself as a gateway to investors throughout the region, the DIFC has been relegated to the same status as any other foreign jurisdiction by the federal securities regulator.
The regulations also continue a trend of lumping all investment funds together with very little attention to the specificities of closed-ended funds or vehicles that are reserved for sophisticated institutional investors. Finally, there is little evidence of reciprocity being granted to funds established and regulated in other "friendly" jurisdictions.
All this matters to the private equity industry because UAE investors (both sovereign and private) are important suppliers of capital to private funds worldwide. The UAE is also perceived as a bellwether 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; (ii) the regulation of service providers; (iii) the promotion of "foreign" funds; and (iv) 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 unpalatable 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 really big news for private equity is found in the new rules on "foreign" funds (including DIFC funds). In a welcome departure from previous drafts, the new rules introduce a concept of "private offering" within the UAE. Unfortunately, this "private offering" regime is subject to so many restrictions that it may be of limited interest in practice.
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: a local bank or investment company licenced 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 increases to AED 10 million per 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.
In summary, although the new SCA fund rules provide welcome clarity in some areas, they are likely to hinder access to the UAE market and make it more difficult and expensive to raise private equity funds here in the future. In an effort to avoid regulation altogether, fund managers may be tempted to foreswear any promotion whatsoever in the UAE and instead seek to market their funds outside the country or through some form of "reverse solicitation" or "passive marketing".
This can hardly be the objective pursued by the SCA in its first major regulatory foray into this area. Regrettably, the history of securities regulation is littered with rules that had such unintended consequences. It remains to be seen whether the SCA will try to use its new regulatory powers to curtail such passive marketing activity.
Benjamin Aller is managing partner of SJ Berwin's Middle East practice and head of its Investment Funds Group across the MENA region. He currently advises a number of private equity fund managers operating in the Middle East and has more than 15 years experience advising European private equity fund managers.
Bilkis Ismail is employed as counsel by SJ Berwin (MENA) LLP and is part of the international funds team. She advises on the structuring and formation of private funds including Shariah-compliant funds and co-investment schemes.
The article was part of Zawya's Private Equity Monthly Insight, August 2012 issue.
Zawya 2012
