In line with its position as the leading financial hub for the Middle East and North Africa region, the Dubai International Financial Centre (DIFC) has improved the flexibility of its funds regime, which should make it more attractive for fund managers seeking to establish collective investment funds in a dynamic gateway financial centre. These changes are part of a broader series of updates to the DIFC legislative framework, such as the proposed Marketing Facility, and the recent amendment to the DIFC Companies Law.

Changes Coming into Force on 18 December 2018

The DIFC positions itself as the leading financial hub for the Middle East and North Africa region, and the number of collective investment funds being established in the DIFC is growing steadily. In order to ensure the DIFC’s continued attractiveness as a destination for fund establishment, the DIFC’s funds regime is undergoing changes to provide additional flexibility and clarity around the operation of collective investment funds in the DIFC, and to provide a legal and regulatory atmosphere equivalent to other important financial centres (in particular the European Union).

This LawFlash discusses the main changes to the DIFC Collective Investment Law No. 2 of 2010 (CIL), which have recently been enacted by the Ruler of Dubai and will come into force on 18 December 2018; as well as the updated Collective Investment Rules module of Dubai Financial Services Authority (DFSA) Rulebook, which has been correspondingly revised (together with the amended CIL, the DIFC Funds Regime).

(1) Removal of Number-Based Limits on Investors

There are three categories of funds in the DIFC:

• Public Funds (which may be offered publicly and to retail investors)
• Exempt Funds (which may only be offered by private placement to Professional Clients (as defined in the DFSA Rulebook) making an initial investment of at least $50,000)
• Qualified Investor Funds (which may only be offered by private placement to professional clients making an initial investment of at least $500,000)

Previously, Public Funds had to have more than 100 investors, Exempt Funds had to have 100 or fewer investors, and Qualified Investor Funds 50 or fewer investors. These number-based limits have been removed, though all other requirements distinguishing the three categories remain. This will give more flexibility to managers seeking to raise funds domiciled in the DIFC or to manage non-DIFC funds from within the DIFC.

In addition, foreign funds being marketed into the DIFC which are not “Designated Funds in a Recognised Jurisdiction” (which generally captures registered and mutual funds) will no longer be subject to the requirement that they have a maximum of 100 investors, which will enhance the ability of managers of foreign private funds to place their fund interests into the DIFC.

(2) New Structures Available for Real Estate Funds

Previously, all DIFC real estate funds were required to be closed-ended. The DIFC Funds Regime now permits real estate funds which are regulated as Exempt Funds or Qualified Investor Funds to be structured as open-ended funds. This will permit DIFC real estate fund managers to offer more tailored real estate fund solutions for their clients, and demonstrates the DIFC’s commitment to innovation within a stable legal and regulatory framework.

The DIFC Funds Regime has always provided for Real Estate Investment Trusts (REITs) as a particular subset of real estate funds, which must (a) be structured as investment companies or investment trusts; (b) be primarily aimed at investments in income-generating real property; and (c) distribute to investors at least 80% of audited annual net income. Previously, all REITs had to be Public Funds, which is the most highly regulated category of funds available in the DIFC. The DIFC Funds Regime now permits REITs to be regulated as Exempt Funds or Qualified Investor Funds provided they satisfy the above three requirements. Interestingly, REITs subject to these lighter touch regulatory options will also have more portfolio flexibility than Public REITs, as they will not be subject to the requirement that development assets represent a maximum of 30% of net asset value of a Public REIT’s property. This increased flexibility within the REIT framework recognises the high investor demand for these products.

(3) Introduction of Exchange Traded Funds (ETFs)

In order to cater to another type of collective investment fund which has in recent years become very popular globally with investors, ETFs have now been designated as a new type of fund which may be established in the DIFC.

In line with the DFSA’s historic approach of aligning its standard of regulation with international standards and best practice, the DIFC Funds Regime for ETFs is largely based on the nine principles for regulating ETFs issued by the International Organisation of Securities Commissions (IOSCO). However, the only investment objective permitted to DIFC ETFs is passive index tracking, although this may include synthetic ETFs. As a result, DIFC fund managers may not establish active ETFs, or hybrid passive/active ETFs. The DFSA has taken this position on the basis that there is less transparency for investors relating to the underlying portfolio of assets for active ETFs because the manager can deviate from the composition of an index, and accordingly there is greater difficulty for investors in clearly identifying the risks associated investing in such ETFs.

DIFC ETFs must (a) be constituted as an open-ended Public Fund; (b) have units available for trading throughout the day on an exchange regulated either by the DFSA or by another regulator which has an information sharing memorandum of understanding with the DFSA, including the IOSCO Multilateral Memorandum of Understanding for sharing information; and (c) have at least one market maker (“Authorised Participant”) who purchases and redeems “creation units” of the ETF from the fund manager and is prepared to buy and sell units of the ETF throughout the day on the relevant exchange.

(4) Introduction of “Internally Managed Investment Companies”

The DFSA has seemingly drawn here on the “self-managed” Alternative Investment Fund (AIF) regime in the European Union, and leveraged the existing permission in the DIFC’s Investment Companies Regulations for investment companies to have a sole corporate director. The DIFC Funds Regime now provides that such sole corporate director may be the fund manager, if appropriately licensed for managing a collective investment fund by the DFSA. However, such a fund manager will only be permitted to manage that single fund of which it is a corporate director. Accordingly, to the extent a DIFC fund manager wishes to manage multiple funds, it will have to operate these by way of appointment as manager under a contractual arrangement, rather than as the sole corporate director. Nevertheless, the availability of this internally managed option provides additional flexibility for DIFC fund managers and improves their ability to provide bespoke investment solutions for their clients.

Other Proposed Changes to the DIFC Funds Regime

On 27 November 2018, the DFSA released consultation paper No. 123, relating to proposed rules governing a new fund marketing facility (the Marketing Facility) to be agreed between the Securities and Commodities Authority (the SCA) of the United Arab Emirates (UAE), the DFSA, and the Financial Services Regulatory Authority (FSRA) of the Abu Dhabi Global Market (ADGM).[1]

The purpose of the Marketing Facility is to create a framework whereby funds established in any of the DIFC, ADGM, or the UAE may, via a simple registration process with the regulators in one of the other areas, be marketed in such other area. This would be the first attempt at a passporting framework for the marketing of funds between financial free zones and the UAE, and would greatly improve access by DIFC fund managers to the UAE and ADGM markets, because the intention is that no additional administrative or regulatory requirements of the SCA or FSRA (respectively) will apply to a passported DIFC fund.

There would be a small number of new conditions to be met by a DIFC fund seeking to access this Marketing Facility, but most of these apply only to Public Funds, including the appointment of an SCA-licensed custodian (not applicable for property funds), and the production of a “Key Investor Information Document” in English and Arabic. For DIFC funds which are marketed only by way of private placement, only an additional prospectus disclosure will be required. The proposed fees for accessing this Marketing Facility are an initial notification fee of $9,500, and thereafter annual fees of $2,000.

However, the regulatory cooperation required in order to implement the Marketing Facility means that

• the SCA or FSRA could request to carry out an on-site inspection of a DIFC fund which is registered to use the Marketing Facility; and
• following consultation with the SCA or FSRA (as applicable), the DFSA could impose a penalty on an SCA or ADGM fund manager, where its activities or those of its agents “appear to the DFSA to be materially prejudicial to either unitholders of the fund who are situated in the DIFC, or the interest of the DIFC.”

Therefore, utilising the Marketing Facility will result in oversight of a DIFC fund manager by the SCA and/or FSRA (depending on whether the DIFC manager wishes to market in the UAE, in ADGM, or both) and, assuming reciprocal provisions in the equivalent rules of the SCA or FSRA, then a DIFC manager utilising the Marketing Facility may be subject to oversight and penalties from those regulators in certain circumstances.

Although the current proposals are limited to the marketing of funds established in one of the DIFC, ADGM, or the UAE, the DFSA has noted that it intends to seek the agreement of the other regulators to expand the proposals in the future to include other financial products in order to improve the ease of doing business from the DIFC in the broader UAE.