I OVERVIEW OF RECENT ACTIVITY
The United Arab Emirates (UAE) is arguably the centre of the private equity and asset management industries in the Middle East. With a recent focus on economic and legal reforms, a low-tax regime and a high quality of life, numerous international firms have set up their regional hubs in the UAE, and many talented and educated expatriate and local professionals have put down roots in the UAE. Among other factors, the historical strength of the UAE’s economy and stable government as well as the country’s expected growth led MSCI to upgrade the UAE to its emerging market index in mid-2014.
Within the UAE, Dubai has become the epicentre of financial services transactions and innovation in the asset management sector in the Gulf Cooperation Council (GCC) and greater Middle East region, surpassing Beirut, Bahrain, Kuwait and Riyadh. Abu Dhabi, the country’s capital, is known for its more conservative and patient investment strategy, and is home to some of the world’s largest and most prominent sovereign wealth funds.
During the global financial crisis, Dubai, with a focus on financial transactions, was particularly hard hit, resulting in a near-default on its debt payments and a subsequent bailout from Abu Dhabi. Many predicted the financial crisis would be the end of Dubai and would result in a transformative change to Dubai’s free-spending and ‘casino-like’ culture. However, following certain significant restructurings and policy changes, Dubai has entered a period of sustainable growth, with significant projects in the tourism and real estate sectors announced in anticipation of the World Expo in 2020.
Abu Dhabi weathered the financial crisis by implementing a patient economic vision, buoyed by high oil prices. This approach resulted in four straight years of double-digit fiscal surpluses in the lead-up to 2015, which in turn led to massive budgets for the government to invest in mega-projects, and to focus on important sectors of the economy such as health care and education. With an economy predominantly based on oil and related hydrocarbon revenues, the recent slump in oil prices has drastically reduced revenues for Abu Dhabi, which appears to be entering a stage of economic transition toward a more sustainable and diversified economy highlighted in Abu Dhabi Vision 2030.
The slump in oil prices has taken a considerable bite out of the total market capitalisation as many of the companies listed on the stock exchanges in the UAE (NASDAQ Dubai, the Dubai Financial Market (DFM) and the Abu Dhabi Securities Exchange (ADX)) derive substantial revenues from oil production and related-energy industries. Stock exchanges in the UAE have recorded lower net profits with the DFM recording a net profit of US$38 million for the first six months of 2016, 30 per cent lower than the same period in 2015, while the ADX has dropped by 9 per cent over the past year. Although oil prices have recovered from early-2016’s multi-year lows, they remain well below the average prices of previous years. In response to the new reality of decreasing oil revenues, the UAE has reformed its budget by cutting spending through a reduction in fuel subsidies and electricity subsidies. In Abu Dhabi, for example, electricity subsidies have been scaled back and water tariffs increased.
To create additional income to cover the decrease in oil revenues, the government is imposing corporate taxes on onshore companies and implementing VAT. The International Monetary Fund has hailed this decision, which it believes will strengthen the country’s fiscal position. It is not expected that taxes would be imposed on companies operating in a free zone in the UAE, where most funds and investment managers are domiciled. Accordingly, it is not expected that the proposed taxes will have a substantial negative impact on the asset management industry in the UAE. It has been announced that two of Abu Dhabi’s sovereign wealth funds, the International Petroleum Investment Company (IPIC) and Mubadala Development Company (Mubadala), will be merged, thereby creating an entity with assets worth an estimated US$130 billion, as part of a larger government strategy to diversify the economy and create stronger entities for the growth of the economy. While some cost-saving measures have been put in place and attempts have been made by the government to rein in spending, there has also been investment into other regional asset managers – the recent announcement of the acquisition of a 20 per cent stake by Mubadala Development Company in Bahraini investment manager Investcorp being an example of this.
Despite some uncertainty, the future of the asset management industry in the UAE albeit in a state of transition looks strong, and the UAE is a very bright spot in a turbulent region. To sustain the growth in the financial services and asset management sectors, the UAE and the emirates of Dubai and Abu Dhabi have recently published new financial services and funds regulations seeking to provide clarity and confidence to both managers and investors alike and to encourage further growth of the industry.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
Financial services such as investment management are generally provided in the UAE from three hubs, namely onshore in the UAE (i.e., outside of a designated free zone); the Dubai International Financial Centre (DIFC); and the Abu Dhabi Global Market (ADGM), each of which has its own rules and regulations. The DIFC and the recently created ADGM are economic free zones within the UAE that have been created to encourage foreign investment by offering foreign businesses attractive concessions and a number of investment incentives, including a zero per cent tax rate and the ability to own a 100 per cent subsidiary (foreign ownership restrictions apply outside the free zones).
i Onshore UAE
Prior to the introduction of the UAE Investment Fund Regulations and the Investment Management Regulations in August 2012 and February 2014 respectively, the UAE Central Bank (Central Bank) regulated asset management activities in the UAE, and granted investment company licences to entities other than banks pursuant to which such activities (including the establishment of funds) could be undertaken. The publication of the amendment to the Investment Fund Regulations in March 2013 and the introduction of the Investment Management Regulations the following year marked a shift in the regulation of investment management in the UAE. Primary responsibility for overseeing the licensing, regulation and marketing of investment management was transferred from the Central Bank to the Emirates Securities and Commodities Authority (SCA) with the SCA confirming the implementation in the UAE of a ‘twin peaks’ model of financial services regulation and supervision. Under this model, the Central Bank remains responsible for systemic stability, prudential oversight and monetary policy, while the SCA is responsible for conduct of business matters (including consumer protection and financial markets oversight). Any firm (whether based inside or outside the UAE, including free zones in the UAE) that intends to conduct investment management activities in the UAE outside of a free zone must obtain a licence from the SCA prior to conducting such activities. The Investment Management Regulations define ‘investment management’ as the management of securities portfolios for the account of third parties, or the management of mutual funds in accordance with the investment objectives and policies defined in the investment management agreement between the investment manager and its client. There is an exemption with regard to financial portfolios owned by federal and local government entities. This exemption does not extend to high-net-worth individuals, non-governmental institutions or family offices.
The Dubai Financial Services Authority (DFSA) is the independent regulator of all financial and ancillary services conducted through the DIFC, including investment management. The rules and regulations governing investment management in the DIFC are set out in the Collective Investment Law 2010, the Collective Investment Rules module of the DFSA Rulebook (CIR) and the Regulatory Law. The Regulatory Law provides that financial services may only be carried on in the DIFC by a firm authorised and licensed by the DFSA. Managing a collective investment fund is defined under the General Module of the DFSA Rulebook as being legally accountable to the unitholders in a fund for the management of the property held for or within a fund under the fund’s constitution; and establishing, managing or otherwise operating or winding up a collective investment fund. A DFSA fund management licence is required in order to manage a collective investment fund in the DIFC. Fund managers from reputable jurisdictions outside the DIFC (external fund managers) may establish and manage DIFC based domestic funds without having to obtain a DFSA licence provided certain conditions are satisfied. For example, the domestic fund must be managed from a place of business that is in a jurisdiction either included in the DFSA’s Recognised Jurisdictions List (as published on the DFSA website) or assessed by the DFSA as providing an adequate level of regulation.
In October 2015, the ADGM financial services regulations (the Regulations) were enacted. Under the Regulations, firms carrying on financial services business such as investment management in the ADGM are subject to licensing by both the ADGM (in terms of the obligation to hold a commercial licence) and the ADGM Financial Services Regulatory Authority (in respect of the financial services licensing). The Regulations contain two key prohibitions, namely providing financial services without a licence or exemption, and making an authorised financial promotion. The Regulations to some extent mimic the types of funds permitted in the DIFC, and contemplate public funds, exempt funds and qualified investor funds. There is no exemption in the Regulations for financial promotions to high-net-worth individuals.
III COMMON ASSET MANAGEMENT STRUCTURES
The most common forms of asset management in the UAE are privately managed accounts and offshore structures. Privately managed accounts have long been popular in the region as managers have targeted capital from high-net-worth individuals and family offices in the UAE. For collective investment schemes, managers have generally looked to the Cayman Islands (and to a lesser extent other offshore jurisdictions) as the domicile of choice due to comprehensive corporate and funds laws and predictable legal regimes.
Large local banks, such as National Bank of Abu Dhabi and Emirates NBD, have established public mutual funds onshore under the Central Bank and SCA regulations. However, to manage an onshore fund, a manager requires a SCA fund management licence, which the SCA only recently began issuing. Similar to other funds jurisdictions in the region, onshore funds are not legal entities, but rather are contractual entities formed upon execution by the manager and the investors of the fund’s terms.
The DIFC and DFSA have actively promoted the funds industry in the DIFC, with the DIFC recently publishing its 2024 growth strategy that outlines fund management as its strategic focus area of the long term. However, the DIFC funds industry has yet to flourish, and only approximately 25 funds have been established in this jurisdiction. However, the DIFC recently adopted the qualified investor fund (QIF) regime, which can be established in an expedited time frame and is subject to significantly less oversight than other UAE-based fund structures. A QIF structure is designed to be offered only through private placement to experienced investors, with a minimum investment of US$500,000 per investor and a maximum of 50 investors per fund. To manage a QIF or any other DIFC-domiciled fund, an entity must be licensed by the DFSA. As further encouragement to consider establishing in the DIFC, the DFSA has introduced a fast-track licensing process for those entities that are seeking to establish in the DIFC for the purpose of launching a fund.
The DIFC has also adopted a special purpose company (SPC) structure through which many managers effect their private equity, real estate and alternative investments. Managers have looked to the SPC structure due to the short time frame to establish an SPC (i.e., one week versus potentially months to establish in other local jurisdictions), as well as the DIFC’s legal regime (which is based on English law) and the general recognition and treatment of DIFC companies as onshore companies for tax and regulatory purposes in the GCC.
IV MAIN SOURCES OF INVESTMENT
The UAE is home to several prominent sovereign wealth funds, including the second largest in the world in terms of assets under management (Abu Dhabi Investment Authority, with approximately US$775 billion under management). These sovereign wealth funds are funded through revenues of the government, which are primarily generated through the sale of oil and other related hydrocarbons, and income from their existing portfolios.
The UAE is also home to the DIFC, which is arguably the most popular and successful financial centre in the Middle East. In 2014, assets under management of fund managers and financial institutions in the DIFC stood at US$10.4 billion. This is expected to grow to US$250 billion by 2024, signalling the expected growth in the asset management industry in the UAE.
Local banks dominate the mutual funds industry in the UAE. These mutual funds generally target retail investors in the UAE and invest into listed equities, primarily in the UAE and the greater GCC region, but also into rated debt and other fixed income products.
Private equity fund managers in the UAE have tended to be domiciled in the DIFC (e.g., Abraaj, Franklin Templeton, Duet Group and NBK Capital). These private equity managers tend to target regional and international institutional investors and family office investors. Over the past five years, fund managers have deployed nearly US$2.1 billion in capital to UAE-based companies, primarily investing in the retail and healthcare sectors.
V KEY TRENDS
The country’s sovereign wealth funds have long invested internationally into diversified portfolios. Because of less exposure in the region, which has seen a downturn due to the slide in oil prices, and more investment in stronger international markets, the value of these fund’s portfolios has not dramatically dwindled. However, it can be expected that the future budgets for UAE sovereign wealth funds will be significantly lower if the country is facing a budget deficit.
The primary asset classes for investment by local managers have been regional listed equities and real estate. With the local stock markets hit by the slump in oil revenues, managers have fallen back onto real estate more than ever. However, as opposed to the 2008 downturn, recently managers have looked to other alternative classes such as debt, venture capital and private equity. While real estate remains the dominant asset class, the past two years have seen a rise of credit funds (across the sector, including mezzanine, distressed and real estate financing funds) as well as blind-pool venture capital and private equity funds.
In 2014, the DFSA introduced the QIF regime to streamline the fund formation process in the DIFC. It is expected many managers will take advantage of this more flexible structure which is as quick to establish as vehicles in more traditional offshore funds jurisdictions. Managers setting up investment funds in the DIFC have generally been focused on private equity and real estate assets.
VI SECTORAL REGULATION
The UAE Insurance Authority recently passed new regulations (Financial Regulations) restricting how insurance firms operating in the UAE can invest their money, how much exposure they can have in a particular asset class and restrictions in relation to the domicile of investments. Insurers are permitted to hold assets in a foreign jurisdiction with a sovereign rating that is better than or at least equivalent to the sovereign rating of the UAE. However, total invested assets held outside the UAE must not exceed 50 per cent of the total invested assets or 100 per cent of the total technical provisions for policies outside the UAE (excluding unit-linked funds), whichever is greater. The Financial Regulations came into force on 29 January 2015, with insurers licensed in the UAE required to restructure their investment portfolios to comply with the Financial Regulations within the following time frames: within three years in relation to assets held in respect of life insurance contracts (by 29 January 2018); within three years for investments in real estate assets; and within two years for investments in non-real estate assets (by 29 January 2017).
In general, pensions in the UAE are regulated by the General Authority for Pensions and Social Security (GAPSS). The primary objectives of GAPSS have been to expand insurance coverage for UAE nationals and expatriate residents in the UAE, and the rapid disbursement of insurance, pension and other compensation to their beneficiaries. It is expected that GAPSS may play a larger role in the future, as the UAE has contemplated pension schemes for expatriates resident in the UAE, in addition to the existing pensions for UAE nationals.
The Abu Dhabi Retirement Pensions and Benefits Fund (ADRPBF) manages contributions, pensions and employee benefits for UAE nationals working for government, semi-government and private employers in Abu Dhabi. ADRPBF is an active investor in private equity funds and has a large diversified portfolio of investments.
The UAE Ministry of Labour requires employers to pay employees ‘end-of-service gratuity’ pay upon termination of their employment. This payment is calculated based on the term of the employee’s employment with the company, provided that the maximum gratuity payable is two years’ wages. As an alternative, employers can establish pension schemes that employees can opt-into in lieu of the ‘end-of-service gratuity’ system. However, such pension schemes are not common.
iii Real property
Real estate remains the asset of choice for investors in the UAE, despite the precipitous drop in value during the financial crisis. 2013 and 2014 saw a dramatic surge in prices, but the government has taken steps to regulate the market through limited loans and mortgages, imposing transfer fees on sales and limiting certain investment structures.
Real estate companies in the UAE are increasingly seeking public listings allowing such companies to raise funds while enabling investors to gain direct exposure to prime real estate assets. Recent examples include the high-profile listing on the DFM of Dubai Parks and Resorts (a Meraas Holding group company), raising approximately US$680 million; and DAMAC Properties’ trading of global depository notes on the London Stock Exchange.
In the DIFC, the CIR sets out rules and regulations specific to real estate funds, including restrictions on the types of assets a real estate fund can invest into (e.g., a real estate fund may in certain circumstances only invest up to a maximum of 40 per cent of cash in government and public securities), the type of legal structure that can be used to establish a property fund in the DIFC and requirements in relation to the establishment of an advisory committee for real estate funds.
iv Hedge funds
Hedge funds in the DIFC are regulated by the CIR, similar to other investment funds. The DFSA has implemented the Hedge Fund Code of Practice, which sets out the principal risks associated with hedge funds and similar structures and sets out best practice standards. Hedge fund managers are permitted a degree of flexibility to adapt the standards to suit their particular businesses in light of market conditions and emerging issues. These standards, inter alia, address back-office systems, valuation procedures, and the skills and resources of the manager.
v Private equity
The UAE has attracted over 35 per cent of Middle East and North African investment activity by value in 2014, with fund managers having committed nearly US$2.1 billion in private capital to UAE-based companies over the past five years. The UAE is deemed an attractive market to private equity fund managers given its geopolitical stability and the increased availability of larger target assets. Private equity investors have, in particular, concentrated their activity primarily on consumer services and the healthcare sector in the UAE.
In the DIFC, the CIR sets out rules specific to private equity funds. For example, a fund manager of a private equity fund must ensure that, unless the purpose of the private equity fund is to invest in a single venture or undertaking, it does not invest more than 25 per cent of the fund in one such venture or undertaking. Additionally, the CIR sets out guidelines that must be followed by the fund manager of a private equity fund prior to entering into related party transactions (e.g., prior investor approval by special resolution).
vi Other sectors
Sovereign wealth funds
The UAE is home to some of the most prominent sovereign wealth funds: the Abu Dhabi Investment Authority (ADIA), the Abu Dhabi Investment Council (ADIC), the Mubadala Development Company (Mubadala), the Emirates Investment Authority (EIA) and the Investment Corporation of Dubai (ICD). ADIA, ADIC and Mubadala are all resident in Abu Dhabi, and focus on investments for the benefit primarily of Abu Dhabi but also for the UAE as a whole. EIA is a sovereign wealth fund established for the benefit of the seven emirates of the UAE. ICD was established in 2006 to hold the assets of the government of Dubai.
ADIA currently has an estimated US$775 billion in assets under management, which it commits to private equity, venture capital, real estate, debt and other alternatives. ADIA invests the surplus oil revenues generated in Abu Dhabi and focuses on international investments (with a focus on North America, Europe and emerging markets). ADIA tends to be a passive investor relying on the managers of the funds and companies in which it invests.
Formed in 2007, ADIC is a spinoff of ADIA and, similar to ADIA, it invests surplus oil revenues. Whereas ADIA primarily makes international investments, ADIC maintains a stronger focus on UAE and Middle East investments. ADIC is agnostic as to asset class, and will make both direct and fund investments. It is estimated that ADIC has approximately US$90 billion in assets under management.
Mubadala is a sovereign wealth fund established with the purpose of diversifying the Abu Dhabi economy and providing social benefits to the UAE. It has focused on infrastructure, transportation and energy, including renewable energy. One of its most prominent investments is Masdar City, located outside Abu Dhabi, which is designed to be a hub for clean-tech energy companies and is committed to zero carbon. It is estimated that Mubadala has approximately US$225 billion in assets under management. It was recently announced that Mubadala would merge with IPIC, which holds the UAE’s overseas oil assets and manages approximately US$58 billion, in an effort to realise synergies and promote growth in the energy, utilities, technology and aerospace sectors.
EIA was established in 2007 by royal decree to represent the seven emirates of the UAE. EIA invests in many companies that operate across the UAE, such as telecommunications companies and local banks. EIA currently has an estimated US$15 billion in assets under management.
ICD is a sovereign wealth fund owned by the government of Dubai. ICD’s purpose is generally to supervise and manage the assets of the government while adding value to the portfolio. ICD owns assets in the energy, transportation, banking, industrial, real estate and other sectors, including stakes in some of Dubai’s most prominent companies, such as Emaar Properties, Emirates NBD Bank and Emirates Airlines. It is estimated that ICD has approximately US$82 billion in assets under management.
Family groups are significant players in the asset management industry in the UAE, both on the manager and investor side, and are widely expected to be a very active investor group over the next year. While these family offices invest globally, many have a vested interest in investing in their home economies and the regional markets. There has been a trend of UAE family offices moving away from blind-pool funds and focusing more on trying to take direct stakes in their investments.
VII TAX LAW
Historically, the UAE has been a zero tax jurisdiction. However, in 2015, in an effort to bolster state revenues, the UAE enacted regulations introducing a value-added tax (VAT) that would become effective in January 2018. This has been perceived as a major shift in policy in the UAE, which has long promoted its low or no-tax environment to investors. Notwithstanding the introduction of VAT, the following taxes are not applicable in the UAE:
- a withholding tax;
- b corporate tax;
- c personal income tax; and
- d capital gains tax.
Oil, gas and petrochemical companies and branch office of foreign banks are, however, required to pay taxes.
Entities established in the DIFC and the ADGM and their employees are subject to a zero rate of tax (income tax, corporate tax, withholding, capital gains etc.). It is not expected that the new proposed taxes will be assessed on free zone entities. Therefore, it is hoped that the tax regulations will have a negligible effect on the asset management industry in the UAE.
Throughout the financial downturn and the recent slide in oil prices, the UAE has shown its resilience. It has proved that its economy operates outside of the oil and energy sectors, and that it has the infrastructure to maintain and grow its asset management industry. Regional and international managers see the UAE as the logical regional centre for the asset management industry, with Dubai serving as the hub. The DIFC is seeking to capitalise on this success by introducing simpler funds regulations to encourage more growth of the industry. In Abu Dhabi, the authorities have sought to emulate this success and make the ADGM a competitor to the DIFC as a regional funds jurisdiction. Despite the tumult around the region, the future of asset management looks bright in the UAE.
1 James Stull is a partner and Macky O’Sullivan is a senior associate at King & Spalding LLP.