By Simon Gray – The financial crisis has slowed but not stalled efforts to build up a regional fund industry that contains substance on the ground in the Middle East rather than focused on outside financial services jurisdictions such as London, Luxembourg and Ireland. In Dubai, where efforts to build a broad-based financial sector have been underway for nearly a decade, the number of locally-domiciled funds is growing and a number of prominent global service providers are active in the sector.
For Dubai, one of the twin business capitals of the United Arab Emirates along with Abu Dhabi, establishing an attractive environment for the establishment of funds has been a learning curve. The first regulatory framework, introduced by the Dubai Financial Services Authority in 2006, enjoyed relatively limited success, with the establishment of just five funds, so the regime was revamped two years ago to offer greater flexibility and ease of establishment.
Drawing on recommendations from a panel of market practitioners, the Dubai authorities have sought to create a business-friendly environment that will support fund management businesses from the region as well as international asset managers looking to tap into the growth potential of Gulf investment markets, while adhering to the IOSCO principles on regulation of collective investment schemes.
The DFSA regulates key players in the fund services sector including administrators, asset managers, custodians and trustees. Its public fund regime aimed at retail investors provides greater protection through requirements for independent oversight and detailed disclosure in the fund’s prospectus.
According to Dominique Lecocq of law firm lecocqassociate, exempt funds are limited to a maximum of 100 investors who must meet the regulator’s professional client test and make a minimum initial investment of at least USD50,000; they enjoy a fast-track process and lower regulatory requirements than public funds.
Fund managers based in the Dubai International Financial Centre and licensed by the DFSA may establish and manage funds in the DIFC as well as outside jurisdictions, and may also distribute foreign-domiciled funds in and from the DIFC.
Asset managers based in other jurisdictions recognised by the Dubai regulator may obtain authorisation to set up and run DIFC-based funds. The regulator emphasises its bespoke governance rules for Islamic funds to ensure Shariah compliance, as well as special regulatory requirements to accommodate alternative investments such as private equity, property and hedge funds.
Lecocq says the formation of an exempt Islamic fund is a three-stage process. “The fund manager must first register as a DFSA-authorised firm in order to manage an Islamic collective investment fund,” he says. “Mandatory appointments include a senior executive officer, compliance officer and money-laundering reporting officer, all of which must be UAE-resident, as well as a finance officer, plus directors and other individuals all need to be authorised. The firm must also obtain a DFSA Islamic endorsement. In parallel, it can launch the company registry process.”
The manager of an exempt Islamic fund must ensure that a Shariah supervisory board is appointed at firm level, and that the fund is managed in accordance with Shariah principles, a responsibility that may be carried out by a member of the board. The preparation and maintenance of financial accounts and statements must be carried out in accordance with the standards of the Bahrain-based Accounting & Auditing Organization for Islamic Financial Institutions.
The DFSA currently has a mix of 14 public, private and exempt funds on its register, a mix of open-ended and closed-ended vehicles that include Shariah-compliant, public equity, private equity, infrastructure and real estate funds. The authority’s roster of fund administrators includes Apex Fund Services, Maples Fund Services, HSBC, Deutsche Bank, Louvre Group and Sanne Group.
Founded eight years ago, the DIFC now has more than 300 firms originating from all over the world, including 18 of the 25 leading global banks, and it aims to double in size again over the next five years, According to managing director for business development Kevin Birkett, the centre is targeting a role as a multi-faceted international financial centre sitting between London and Singapore, of which the growth of the fund industry is a key element.
The DIFC authorities believe the jurisdiction has grown in appeal over the past few years because Dubai and the UAE have not been caught up in the controversy experienced by other leading fund and manager domiciles over tax compliance, financial industry secrecy and exchange of information mechanisms. On the other hand, it offers the familiarity and certainty of a legal system based on English common law, while much of the regulatory rulebook is based on that of the UK’s Financial Services Authority.
Birkett stresses that the DIFC is flexible in its response to firms looking to set up either a management company or funds in the jurisdiction. The authority encourages the establishment of both Shariah-compliant and conventional structures, and is ready to authorise funds from other domiciles for local distribution.
“We want to encourage an open fund architecture provided each component can demonstrate solid regulation,” he says. An exempt fund’s investment manager, administrator and custodian can be a firm registered outside the DIFC, as long as it is in a recognised jurisdiction, although the fund’s auditor must be registered with the DFSA.
An important step for the local fund industry would be the assurance that DIFC-registered funds can be marketed to other states of the UAE, especially Abu Dhabi – something that has been called into question under new regulations issued by the country’s Securities and Commodities Authority in September.
The regulations confirm the SCA’s regulatory authority over various categories of service provider to investment funds, as well as over local funds and transactions in all funds (whether local or foreign). It enshrines a twin-track approach toward financial sector regulation by making business conduct and investor protection functions the responsibility of the SCA, and prudential, safety and soundness functions that of the UAE Central Bank.
Regulated investment funds are divided into local funds, those established in the UAE excluding so-called ‘free zones’, and licensed by the SCA, and foreign funds, those established outside the UAE under the laws and regulations of another jurisdiction. US law firm Bracewell & Giuliani, which has an office in Dubai, notes: “By way of example, investment funds established in the Dubai International Financial Centre are treated as foreign funds under the regulations.”
Industry members say the issue represents a difference in opinion between the national securities regulator and the DIFC. “ESCA is saying that they really want the work to be done here on the ground, that they don’t recognise DIFC as being part of the UAE, and that therefore you can’t market a DIFC fund to Abu Dhabi, for example,” says Peter Hughes, chief executive of fund administrator Apex Fund Services. “This has created a lot of uncertainty, and left managers unsure whether the best approach is to set up a DIFC structure, an offshore Cayman structure, or a local UAE fund structure.”
Resolving the issue is a priority for the DIFC, and Birkett insists the Dubai authorities are making all efforts to find a solution. “It is important to find a way to work together and get clarity on the issue,” he says.
Dubai still has some work to do to catch up with Bahrain, where foreign mutual funds were marketed as early as the 1980s, with the first locally-domiciled fund being launched in 1984. The Collective Investments Schemes rules were issued by the Central Bank of Bahrain in 1992 and updated in June 2007.
At the end of June 2012, 2,795 funds were authorised by the Bahrain regulator, including 121 locally-domiciled vehicles and 101 Shariah-compliant funds. As of March, the net assets under management of locally-domiciled funds amounted to USD5.68bn, while Shariah funds accounted for USD2.2bn.
Apex Fund Services is among the fund service providers with the deepest roots in the region, having been the first administrator to be licensed in the DIFC six years ago. Today the firm has offices in Bahrain and Abu Dhabi as well as Dubai, and Hughes says: “These are people on the ground doing actual fund administration work, not representative offices. They’re a commitment to being there and doing business locally.”
Apex has established its global middle office hub in Abu Dhabi. Says Hughes: “We chose that location because it’s three or four hours ahead of Europe, so we can have the previous day’s reconciliations ready on people’s desks when they come in the next morning. We do Arabic reporting, and meet the needs of clients that want their contract notes and statements in Arabic. Rather than commoditise everything, we tailor our services specifically to what each client requires.”
According to Hughes, the past few years have seen significant changes in the Middle East fund services market. “When we first arrived the issue was educating managers on the importance of independent administration and how that would benefit them,” he says. “Over the past few years it’s become more widely accepted. That is not only important for shareholder protection in the region, it helps managers to raise money from institutions globally, whereas previously they were only accessing local investors.”
The fact that Apex is present in three jurisdictions in the Gulf reflects the firm’s philosophy of developing close relationships through proximity to its clients. “When you’re dealing with the particularities of a region, you need to have people on the ground,” Hughes says. “The suitcase banking model doesn’t work. Our strategy is to be close to where our clients, so that when traders leave the big banks to set up funds on their own, they come to us first.”
Becoming the first point of contact for fledgling fund managers entails more than just fund administration but a broader advisory role, where start-up clients would once have been reliant on the recommendations of lawyers and brokers. “Because we’re in so many places and service all the main fund domiciles, we can provide totally objective advice on the best way to build their business,” Hughes says. “That’s particularly valuable at a time of so much new regulation globally, which is pushing up operating costs for fund managers.”
But he also notes that the ambitions of regional centres to develop their global profile can work to managers’ advantage. “If a manager wants to set up a fund, has no deep ties to the UK and is ready for a move because being regulated by the FSA and hiring staff is expensive, why not go to the Qatar Financial Centre?” Hughes says. “They will welcome you, seed the fund, provide a clean regulatory environment and want you to come and live there. There are some compelling reasons for people to move their businesses into the region.”