Over the last 10 years, there have been many changes to the Dubai International Financial Centre (DIFC) funds regime to help make the centre more attractive to domicile funds and establish Fund Managers as well as Asset Managers. Following the introduction of Money Market Funds into the DIFC it’s a good time to look back and consider the changes that have been made in the DIFC over the last 10 years to attract funds away from traditional funds jurisdictions and to reflect on how well the DIFC is now positioned in the international market.
Timeline of some of the key changes to the DIFC funds regime:
2006 The Collective Investment funds regime came in to force
2010 Introduction of the Exempt Fund and recommendation based offers
2014 Introduction of the Qualified Investor Funds (“QIF”)
2016 Property Funds and Money Markets Funds
In 2006 the DIFC funds regime set out the key provisions relating to setting up a fund in the DIFC or marketing a fund in or from the DIFC. The focus of this regime was very much public funds and was limited in its appeal. As such, for several years Firms looked at the cost and complexity of domestic funds and shied away from establishing in the DIFC. At this time, even the marketing of funds was much more restrictive than in Europe, for instance.
Eventually, in 2009, the need for change became clear and we started to see the transformation of the funds regime into what we have today.
In 2009 the DIFC realised it was not attracting Fund Managers to domicile their funds in the DIFC and therefore set up a panel of practitioners to identify ways of improving the regime in order to attract this type of business. In 2010 the Dubai Financial Services Authority (DFSA) released the new rules, which were based on the recommendations issued by the panel. Some of the key features of the new rules that emerged were as follows:
- Public Fund provides greater protection to retail investors through requirements such as independent oversight and detailed disclosure in Prospectuses;
- Exempt Fund is a type of fund that is open only to professional investors (investors who meet the Professional Client test and make at least a US $50,000 minimum investment). These funds offered a fast-track process and attract lower regulatory requirements than a Public Fund since an Exempt Fund is not open to Retail Clients;
- DFSA licensed (i.e. DIFC-based) Fund Managers able to establish and manage funds in the DIFC, as well as in jurisdictions outside the DIFC;
- Fund Managers from reputable jurisdictions (e.g. DFSA Recognised Jurisdictions) able to establish and manage funds in the DIFC under certain circumstances;
- DFSA licensed firms being allowed to distribute a wider range of Foreign Funds in or from the DIFC, particularly where a recommendation about the suitability of the investment is made to a client;
- A more competitive fee structure being applied to Fund Managers and funds;
- Fund Managers of Umbrella Funds having the flexibility to use the Protected Cell Company (PCC) structure for open-ended Umbrella Funds, thereby giving investors in each sub-fund of the Umbrella legal segregation from liabilities arising in other sub-funds and the Umbrella;
- Bespoke Shari’a governance requirements applying to Islamic Funds, which promote high Shari’a governance standards with flexibility of application;
- Bespoke regulatory requirements to accommodate specialist funds, such as Private Equity, Property and Hedge Funds.
The above changes did bring a new dimension to the DIFC offering and the Exempt Fund, in particular, was seen as a possible alternative to a fund in more traditional jurisdictions. It also released asset managers and investment advisors in the DIFC from the age old problem of marketing of only designated and non-designated foreign funds i.e. either those which were recognised as effectively regulated funds, those that were rated by an international ratings agency or funds which have both a custodian and an investment manager that were regulated in recognised jurisdictions. However, whilst Exempt Funds helped to bring the DIFC more in line with other jurisdictions it still did not take off as a real alternative to places like the Cayman Islands, BVI or Luxembourg. This has only really started to happen following the introduction of the QIF.
In 2014 the DIFC introduced Qualified Investor Funds to persuade more sponsors to establish funds in the financial centre, by creating a new class of funds with less stringent regulation – and therefore lower costs – the DIFC hoped to attract Fund Managers to set up funds such as Hedge Funds and Private Equity Funds, serving Professional Clients who were the most risk-tolerant investors. Despite the fact the DIFC had by this stage emerged as the Middle East’s top banking hub, it had not come close to competing with other jurisdictions as a top domicile for funds. Only nine funds had been domiciled in the DIFC since the 2010 funds regime was introduced, compared with hundreds established in the leading centres.
The QIF was therefore introduced after a review of other fund jurisdictions, including Bahrain, Luxembourg, Dublin, the Cayman Islands and Singapore. Additionally, the European Union had just introduced its Alternative Investment Fund Managers Directive (AIFMD), tightening the EU’s regulation of Hedge Funds and Private Equity Funds in the wake of the global financial crisis, adding to the attraction of alternative markets.
A QIF is defined as:
- having 50 or fewer Unitholders;
its Units are offered to persons only by way of a Private Placement;
- all its Unitholders are persons who meet the criteria to be classified as Professional Clients; and
- the initial subscription to be paid by a person to become a Unitholder is at least US $500,000
The interesting thing with the QIF regime is not only is this a real alternative, it also sparked real interest in Exempt Funds which had been in existence for a few years by this stage.
In 2015 the DFSA issued CP102 on changes to the Property Fund rules and also to introduce a Money Markets Funds regime. Certain rules relating to property funds had been difficult to implement and the DIFC didn’t have a Money Markets Fund offering. As such they made the following amendments to the rulebook:
DIFC Property Funds - closed-ended funds dedicated to investment in Real Property and in Securities issued by Bodies Corporate whose main activities are to invest in, deal in, develop or redevelop Real Property. Real Estate Investment Trusts (“REITs”) are a sub-category of Property Funds. REITs can only be set up as Public Funds. The amendments issued now offers greater flexibility and also takes into consideration the specificities of the UAE real estate market and are as follows:
Before 1 February 2016, the custody of Fund Property had to be delegated to an Eligible Custodian who was a separate legal entity from the Fund Manager. Now the Fund Manager of a Public or Exempt Property Fund is permitted to act as custodian of the Real Property provided that certain controls are in place. This was always a big hurdle for Firms before and has once again aligned the DIFC more with other jurisdictions
Another change is in relation to the borrowing limits, which once again the DIFC has aligned with other jurisdictions such as Singapore and Malaysia, have been amended to 50% of the gross asset value.
Affected Person transactions (now Related Party transactions)
The Collective Investment Rules (“CIR”) contain requirements that Fund Managers must comply with before entering into transactions with Affected Persons. An Affected Person in relation to a fund is:
(a) its Fund Manager;
(b) its Governing Body;
(c) its Custodian;
(d) its Trustee or other Persons providing oversight;
(e) any Advisor;
(f) a holder of 5% or more of the Units of the Fund; or
(g) any Associate of any person in (a) to (f).
These changes are helpful, especially where a number of shareholders in a Property Fund are themselves Unitholders in UAE real estate companies, who could seek to acquire the same UAE based properties as the Property Fund proposes to acquire. Also considering the specificities of the UAE market, many local property agents have key UAE institutions or nationals as shareholders or beneficial owners, who may be connected to Unitholders of the Fund or other Affected Persons. The previous rule rendered it almost impossible for some Fund Managers to find a suitable property
agent in the UAE to serve the fund.
The Fund Manager must appoint an independent valuer who will value each Real Property prior to its acquisition or disposal. This valuer can now hold this position for up to 5 years rather than 2 years as previously required and clarification was given that the valuation reports have to be every 6 months
Disclosure in the Exempt Property Fund’s Constitution
Exempt Property Funds are now required to disclose their investment objectives, including the type of assets in which they may invest, as well as any borrowing restrictions, in their Constitution.
Money Market Funds
A new category of fund has been introduced: the Money Market Fund.
Money Market Funds are defined as funds whose investment objectives are to preserve the capital of the fund and provide daily liquidity, while achieving returns that are in line with money market rates.
The DFSA has introduced a number of investment restrictions and risk diversification rules that a Money Market Fund has to comply with. The aim is to limit investments to investments in high-quality deposits and debt instruments in order to minimise liquidity risks and enable a Fund Manager to deal with redemption requests at any time. At least 90% of the NAV of the Fund Property must be invested in high-quality Deposits or Debentures.
Is this the end of the changes? Probably not. The introduction of the Money Markets Funds is progress but the restrictions make it less appealing than other jurisdictions.
So why should Fund Managers establish a fund in the DIFC? Many fund sponsors and investors are increasingly seeking alternatives to common onshore and offshore jurisdictions for domiciling a fund. The DIFC’s fund regime combines regional presence, which can be important when investing in the GCC due to foreign ownership restrictions, as well as tax advantages through multiple double taxation treaties, ease of establishment within a well-regulated, cost efficient onshore status in a common law jurisdiction. Whilst the DIFC do not specifically state the benefits of the DIFC’s fund regime over those of Cayman, for instance, they have been very keen to confirm that they have benchmarked the regime against these relevant jurisdictions. The key hurdle for the DIFC fund regime now is not so much how it is structured, which really does offer an alternative, but convincing Fund Managers and investors, who have grown comfortable with other jurisdictions, that the DIFC is a realistic alternative.