Those familiar with fundraising in the Middle East will be familiar with the concept of what is loosely dubbed “market” or “tolerated” practice. The terms are, in most people’s minds, interchangeable, but in fact look at the same issue from two different perspectives.
“Tolerated Practice” is what regulators are willing to accept – it has arisen through a perceived inability by Middle Eastern regulators to police the market, an acceptance that activities aimed at institutional investors and high net worth (“HNW”) or sophisticated investors are less risky than those aimed at retail investors, and a long-standing lack of comprehensive regulations that are equivalent to those in place in the EU and the United States.
“Market Practice” is what participants look at to measure their acts – participants in the market have leveraged off the “tolerated practice” and adopted certain behaviors on the basis that a) this has been the practice for many years, and b) “everyone else is doing it.” Essentially, participants are using herd behavior to influence their attitude toward risk.
What Is Changing?
The change in approach can be traced back to a number of relatively recent developments:
Regulations introduced in Kuwait in 2010 have now been fully implemented by a new regulatory body, the Capital Markets Authority, which has significantly revised domestic financial services regulation.
New regulations were issued in the United Arab Emirates by the Emirates Securities and Commodities Authority, governing the authorization and marketing of investment funds.
The Capital Markets Authority of the Kingdom of Saudi Arabia has made a number of public pronouncements, reminding market participants that both conducting “securities business” and marketing financial products in the Kingdom of Saudi Arabia requires authorization, and describing the penalties for violation.
High-profile litigation disputes have centered on the mis-selling of financial products in the Middle East, where the complainant relies on a violation of local securities regulation to seek to rescind the investment contract.
There has been an overall increase in enforcement and supervision, as well as the issuance of updates and/or supplemental regulations by all regulators across the region.
If the parameters of tolerated practice are changing, should market participants therefore also re-evaluate the parameters of acceptable market practice? If this is the case, then it would be helpful to consider some of the common themes and issues that arise in respect of the marketing and promotion of not only investment funds, but financial products more generally in the Middle East. This is regardless of whether the participants are promoters, fund sponsors or financial institutions, and irrespective of whether they are based “onshore” or in special “free zones” in the Middle East region or whether they are based outside the region but are promoting their products within the region.
While there is some overlap between the following key themes, and differences from jurisdiction to jurisdiction in the detail of scope and implementation, the following provides a good sense of how the Middle East views marketing and promotion issues, and how these issues may develop in the short term.
Registration and establishment in one Middle Eastern jurisdiction (including, to an extent, UAE free zones) does not grant passporting rights into other Middle Eastern jurisdictions. The same is true for a non-Middle Eastern promoter. Local laws and regulations must be complied with on a jurisdiction-by-jurisdiction basis.
Public v. Private Placement Offers
Generally, no distinctions are made between a “public” and a “private” placement offer. The concept arises only from the twin features of tolerated and market practice, and has no basis in local regulation or laws. A distinction can at most be made (i) in as much as a notification to the local regulator is required prior to marketing an investment fund by way of a private offer, but approval is required from the local regulator for a public offer, and (ii) the classification as a “private” or “public” offer may impose certain obligations under local regulations and law on the terms of a fund (such as proscribed reporting requirements or the requirement for the inclusion of redemption rights for any placement that has been distributed by way of public offer).
Exemptions for Institutions, HNWs and Sovereign Wealth Funds (“SWFs”)
Middle Eastern financial institutions, HNWs, family offices, SWFs and so-called “quasi-SWFs” (of which there are a greater number in the Middle East than elsewhere) generally are not exempted from marketing restrictions and do not fall within safe harbor provisions under either local financial promotion rules or rules regulating financial service activities more broadly.
Financial Promotion Activities and Financial Service Activities
It is important to make a distinction between financial promotion activities (i.e., the promotion of financial products to entities in a local jurisdiction) and financial service activities (i.e., undertaking financial service activities in a local jurisdiction). Such financial service activities could include “arranging” or “advising” on financial products. Activities deemed “financial service activities” in a jurisdiction can trigger requirements for authorization of the entity in addition to compliance with any rules relating to financial promotion activities.
It is important to consider any activities in light of both requirements.
Often this can be the most blurred area; for instance, it can become unclear – especially some time later – when and where an individual or entity actually becomes a client. This can lead to the question of whether client servicing may in fact be the offer of further, or first, financial products in the jurisdiction in question, which may require a consideration of financial promoting activities and financial services activities, as noted above. Regulators in the region take very different views, and it is important that the analysis be conducted on a jurisdiction-by-jurisdiction basis.
Investment funds generally require registration, either by way of approval or notification. Currently, most other financial products do not require either. However, the majority of regulators in the Middle East have publicly announced that they will extend regulation to other financial products, although the time period for this is not known. In any event, notwithstanding the lack of a requirement for the registration of financial products, care needs to be taken as to the activity related to the promotion of such products, so as to ensure that this does not of itself constitute a financial service activity and thus trigger a requirement for authorization or registration of the entity deemed to be undertaking the promotion activities.
Reverse Solicitation / Reverse Enquiry
Without exception, an exemption for reverse solicitation or enquiry is not enshrined in any Middle East jurisdiction law or regulation. The analysis of a reverse solicitation scenario (i.e., one where, without prompting or encouragement, a potential investor initiates contact) will always depend on facts and circumstances specific to a given jurisdiction. Care will be needed so that it can be clearly established when and how such contact was made; for instance, was it via a road show or circulation of marketing materials, a form of follow-up from a meeting or a speaking engagement? Specific advice should be sought on a jurisdiction-by-jurisdiction basis, as practice in this area differs among regulators in the region.
Generally, activities that might be deemed to constitute financial service activities and/or the promotion of financial products into the Middle East need to take place in, or be aimed at, a relevant jurisdiction in order for issues of local laws and regulation to apply. However, jurisdictional boundaries are frequently blurred by websites or investor portals that are aimed specifically at one or more jurisdictions, or where initial meetings are held or contact is made outside of a given jurisdiction, but where subsequent steps (such as the sending of materials) are taken in or made with respect to another jurisdiction.
What is Next?
In view of the increasing amount of supervision of, and the commencement of enforcement actions in relation to, financial services activities (the latter of which brings the increased possibility of fines and public censure, and therefore reputational risk), market participants should pay increased attention to a regulatory framework that is, without exception across the Middle East, increasing in complexity and sophistication. Once accepted behaviors are unlikely to be looked upon favorably by regulators, and obtaining focused advice – rather than relying on accepted practices – is more likely to ensure that a successful fundraising effort stays just that.