As the financial regulator for the Dubai International Financial Centre (DIFC), the Dubai Financial Services Authority (DFSA) is responsible for developing and administering the laws that establish the regulatory framework by which entities may be authorised in the DIFC. This includes taking an active role in the regulation of investment funds, and DFSA authorisation is required for DIFC-based financial services of operating a collective investment fund (CIF), fund administration, asset management, arranging credit and deals in investment and dealing as an agent. Such authorisation requires significant transparency from the applicant, including ‘fitness and probity checks’ of applicants and their responsible governing bodies and employees.
A little more than a year has passed since the implementation of the DIFC fund regime in April 2006. This period has identified some key issues faced by fund sponsors (and their advisers) seeking to establish themselves in the Middle East when deciding whether to locate in the DIFC. It is interesting to note how the approach in the DIFC to certain issues contrasts with that taken in the UK.
Rather than adopting a ‘light touch’ approach familiar in other offshore jurisdictions, the DIFC’s collective investment law (CIL) and the DFSA’s collective investment rules (CIR) are more commensurate with onshore fund regimes, such as that in the UK. Indeed, the CIL adopts the Financial Services and Markets Act 2000 definition of ‘collective investment scheme’ as its definition of a CIF. However, there are some important differences from the UK regime; in particular, there is no exemption for closed-ended investment companies.
The CIL and CIR focus primarily on regulating domestic rather than foreign funds, and the bulk of the rules relate to public funds – normally domestic funds with more than 100 unit-holders whose units are offered to the public. However, many of the rules, including those governing fund operation, also apply to private funds. This is different to the UK regime, where private funds are essentially unregulated.
From a fund structuring viewpoint, the answers to the big picture questions concerning the appropriate location in which to establish and operate a fund and the most suitable fund vehicle are heavily influenced by the prohibitions in the CIL on: operating a domestic fund from outside the DIFC; and operating a foreign fund from the DIFC.
This means that, not only must operators of domestic funds be DFSA-authorised, but sponsors looking to establish funds in low-regulation territories will need to ensure that they do not operate the funds from the DIFC. Identification of the operator is, therefore, a crucial issue.
In the UK the term ‘operator’ is defined on a non-exhaustive basis as, in the case of a unit trust scheme with a separate manager, the ‘manager’, and in the case of an open-ended investment company, the company itself. In all other cases it is necessary to determine the operator from basic principles. However, the CIL states that “a person ‘operates’ a Fund if he: (a) is responsible for the management of the property held for or within a fund under the fund’s constitution; and (b) establishes, operates or winds up the fund.”
There is not yet any case law on this rule, but the DFSA has taken a different approach to that in the UK when identifying the operators of limited partnerships and companies.
The DFSA considers that the definition of ‘operator’ in the CIL will always be the general partner of a limited partnership, regardless of whether a separate manager has been appointed for the partnership to the exclusion of the general partner – the structure commonly adopted in the UK.
This has a number of implications for DIFC-based sponsors seeking to establish multiple domestic funds structured as limited partnerships. In particular, it is currently necessary to establish a separately authorised company to be the general partner of each partnership, as the alternative would involve the risk that the insolvency of one partnership would have an impact on the operation of other partnerships under the same general partner – a risk that is unacceptable to investors. It does, however, mean that a DIFC-based manager may be appointed by a foreign partnership without running the risk of being regarded as its operator, in breach of the prohibition in the CIL. Consequently, sponsors looking to establish domestic funds have to weigh the benefits that the DIFC offers against the time, cost and regulatory burden resulting from establishing multiple authorised general partner operators.
However, it is understood that the DFSA is reconsidering its interpretation of the meaning of ‘operator’ in the context of limited partnerships and may move towards an approach somewhat closer to that adopted in the UK. This would undoubtedly make the DIFC a more attractive location in which to establish limited partnership-based funds and may result in a greater use of the DIFC limited partnership law enacted last summer.
The CIL also prescribes that a domestic fund must be operated by a corporate body. In contrast to the approach in the UK, where the operator of an open-ended investment company is the company itself, under the CIL the DFSA regards the operator of a corporate fund to be its board of directors. Not only does this necessitate the appointment of a separate authorised corporate director (ACD) to operate the fund, it also appears to rule out the possibility of individuals serving on the board of directors of a DIFC closed-ended investment company. Furthermore, the rule applies to both public and private funds, again differing from the position in the UK, where ACDs are only relevant to authorised (ie public) corporate funds.
The DIFC is clearly positioning itself as an attractive location for fund managers and operators. It offers a number of benefits, such as a zero tax rate on profit, permitted foreign ownership of up to 100 per cent and no restriction on foreign exchange or repatriation of capital, as well as a robust regulatory regime that should instil confidence in investors. The funds regime is, however, still in its infancy and it will be interesting to see how the DIFC develops as a fund formation jurisdiction as sponsors and operators become more familiar with the nuances of the legislation and the DFSA’s interpretation of it.
•Mark Watterson is a partner and Tim Coak is an associate at Freshfields Bruckhaus Deringer