The past year continued to be challenging for banks and financial institutions in the UAE. The impact of the slowdown in the global economy and persistently low oil prices have affected the balance sheets of many banks in the region, particularly banks with exposure to small and medium-sized business enterprises.
ii THE REGULATORY REGIME APPLICABLE TO BANKS
The regulatory framework for banking in the UAE is based on Federal Law No. 10 of 1980 concerning the Central Bank, the monetary system and the organisation of banking (Banking Law). Under the Banking Law, the Central Bank of the UAE was created and entrusted with the issuance and management of the country’s currency, and the regulation of the banking and financial sectors. The Banking Law provides for the licensing and regulation by the Central Bank of:
- a commercial banks, which are defined to include institutions that customarily receive funds from the public, grant loans, issue and collect cheques, place bonds, trade in foreign exchange and precious metals, or carry on other operations allowed by law or by customary banking practice;
- b investment banks and companies, which manage portfolios on behalf of individuals or companies, advise clients on raising or placing equity and debt, subscribe to equity and debt instruments, prepare feasibility studies for projects, market shares and debt instruments, and establish and manage funds. Investment banks are distinguished from commercial banks principally in that they do not accept deposits for less than two years;
- c finance companies, which provide corporate and consumer credit facilities but may not accept deposits from individuals;
- d financial intermediaries, which broker the purchase or sale of domestic or foreign shares or instruments;
- e monetary intermediaries, which are foreign exchange dealers who purchase and sell currencies;
- f representative offices, which are regional or liaison offices of foreign banks and financial institutions;
- g Islamic banks, finance companies and investment companies, which institutions are regulated by the Central Bank under Federal Law No. 6 of 1985 regarding Islamic Banks, Financial Institutions and Investment Companies. Islamic banks undertake all the activities of a commercial bank, and additionally can own assets financed by them. Islamic finance companies may provide personal and consumer, property, vehicle and trade finance, issue guarantees and enter into foreign exchange contracts with corporate entities, subscribe to shares, bonds and certificates of deposits, accept deposits from corporate entities and manage investment vehicles. All Islamic institutions must operate in accordance with the principles of Islamic shariah; and
- h real estate banks and finance companies, which specialise in funding real estate projects on a conventional or shariah-compliant basis.
The Banking Law does not apply to statutory public credit institutions, governmental investment institutions and development funds, private savings and pension funds, or to the insurance sector.
While the Central Bank is the principal regulatory authority of banks and financial institutions in the UAE, such entities are also subject to additional registration and licensing requirements at the federal and emirate levels.
All commercial banks incorporated in the UAE must be established as public shareholding companies and must be majority-owned by UAE nationals. A majority of directors of such companies must be UAE nationals. While for monetary intermediaries and investment companies the minimum UAE national shareholding requirement is 51 per cent, for finance companies, commercial banks and investment banks the minimum UAE national shareholding requirement is 60 per cent. Although branches of foreign companies established in the UAE are required to appoint a UAE national as a national agent, foreign banks are not required to have an agent.
In recent years, some banks incorporated in Member States of the Gulf Cooperation Council (GCC) have been allowed to establish fully fledged branches. GCC banks have also been allowed to acquire controlling stakes in UAE banks and financial institutions. A few banks were issued wholesale banking licences in 2014 and 2015.
The number of banks incorporated in the UAE has remained unchanged for the past four years at 23. These banks had 846 branches as at 31 December 2016. The number of foreign banks registered in the UAE remained unchanged for the past three years at 26. Foreign banks had 85 branches in the UAE as of 31 December 2016.
The principal difference in the treatment of local and foreign commercial banks is that local banks are not subject to any taxation on their income, whereas foreign banks are subject to tax at the emirate level.
Non-resident banks grant bilateral credit facilities and also participate in syndications in the UAE. They are not deemed to be resident, domiciled or carrying on business in the UAE, and are not liable to pay tax in the UAE merely on account of such bilateral facilities or participation in syndications. The confidentiality of customer information by banks is not specifically provided for under the Banking Law, but the principle is recognised as a customary banking practice, and, implicitly, under certain regulations issued by the Central Bank. The Central Bank has wide powers to obtain information.
ii Emirates Securities and Commodities Authority (SCA)
The SCA regulates the securities markets in the UAE. All UAE banks are listed on one of the two onshore markets: the Abu Dhabi Exchange and the Dubai Financial Market. The SCA licenses all brokers, consultants and custodians who provide services related to listed securities. The Investment Funds Regulation issued by the SCA in July 2013 transferred regulatory responsibility for the licensing and marketing of investment funds and for a number of related activities from the Central Bank to the SCA. The sale, marketing and promotion of foreign securities and funds in the UAE and the establishment of domestic funds require the approval of the SCA. This requirement has been further clarified and established under SCA Board of Directors Decision No. 3 of 2017 on the Regulation of Promotion and Arranging Activities.
iii Dubai International Financial Centre (DIFC)
The Dubai Financial Services Authority (DFSA) has adopted a regulatory approach modelled, at least in part, on the Financial Services Authority in the United Kingdom. The DFSA does not grant banking licences per se; it authorises financial service providers to undertake specific financial services. The relevant financial services in respect of banks would include providing credit and accepting deposits. There are about 450 financial services firms with a presence in the DIFC. Of these, a substantial number of institutions do not have authority to accept deposits. This reluctance on the part of various institutions to be a ‘true’ bank can be traced back to two reasons. First, DIFC entities were historically not able to deal with retail customers. This restriction was lifted several years ago, but the business model of the vast majority of institutions within the DIFC has been to focus on corporate clients or high net worth individuals. The second reason that banks have been reluctant to apply for the ‘accepting deposits’ authorisation is that they remain unable to deal in dirhams or accept deposits from the UAE markets. Most of the banks that have set up in the DIFC have done so as branches of overseas companies; this has been done for capital adequacy reasons. Recently, however, it has been the policy of the DFSA to encourage banks to incorporate new subsidiaries within the DIFC and capitalise those subsidiaries to an acceptable level.
iv Abu Dhabi Global Market (ADGM)
Following the success of the DIFC, a new financial free zone, the ADGM, was set up in Abu Dhabi and it became operational in the second half of 2015. The financial services regulatory framework for the ADGM aims to reflect current international best practices by assimilating the key aspects of other regulatory regimes across the world. The ADGM has its own regulator, the Financial Services Regulatory Authority (FSRA). Like the DFSA, the FSRA does not grant banking licences per se. Banks licensed in the ADGM are prohibited from accepting deposits from the UAE market, and may not accept deposits or undertake foreign exchange transactions involving UAE dirhams.
Given that the ADGM is still in its nascent stage, this chapter deals with the ADGM in a limited manner.
v US Foreign Account Tax Compliance Act (FATCA)
The UAE and the US reached an agreement in substance in May 2014 to include the UAE on the list of jurisdictions to be treated as having an intergovernmental agreement (IGA) in effect in relation to FATCA. The UAE has adopted Model 1. Since 1 July 2014, banks and financial institutions in the UAE must comply with the requirements of the IGA.
vi Common Reporting Standard (CRS)
The UAE Cabinet has approved the agreement on mutual administrative assistance in tax matters and the multilateral competent authority agreement by way of Cabinet Resolution No. 9 of 2016. Thus, the Organisation for Economic Co-operation and Development (OECD) CRS have been effective in the UAE from 1 January 2017 to implement automatic exchange of information of financial accounts.
In December 2016, the Ministry of Finance (MoF) announced that the UAE will begin implementing the standards of joint disclosures and the exchange of information for tax purposes set out by the G20 and the OECD from 2018. This follows the UAE Cabinet’s decision for MoF to coordinate with various government authorities to collect financial information to implement information exchanges for tax purposes. The CRS calls on jurisdictions to obtain information from their financial institutions and automatically exchange that information with other jurisdictions on an annual basis. Banks and financial institutions started collecting the required financial data from 1 January 2017, and this information is to be provided to the relevant authority in the UAE.
iii PRUDENTIAL REGULATION
The Central Bank has issued regulations on a whole range of issues and ensures compliance with such regulations on the basis of a bank-examiner type approach.
In a significant development, the Central Bank issued Circular No. 52 of 2017, which came into effect on 1 February 2017, on capital adequacy norms by way of the phased implementation of Basel III. Article 2 of the regulations explains quantitative requirements and states that the total regulatory capital comprises the sum of two tiers, where Tier 1 capital is composed of a common equity Tier 1 (CET1) and an additional Tier 1 (AT1). Banks must comply with the following minimum requirements at all times: CET1 must be at least 7 per cent of risk weighted assets (RWA); Tier 1 capital must be at least 8.5 per cent of RWA; and total capital, calculated as the sum of Tier 1 capital and Tier 2 capital, must be at least 10.5 per cent of RWA. The norms are required to be followed for 2017 itself in a phased manner as detailed in the regulations.
Circular No. 16/93 issued by the Central Bank governed large exposures incurred by banks. Large exposures were funded exposures. Banks were restricted from exceeding the maximum exposure per client or group. Circular No. 32/2013 was issued by the Central Bank in November 2013 to replace Circular No. 16/93. Now large exposures include funded and unfunded exposures and unutilised committed lines. Revised restrictions have been imposed with regard to lending to government and government-owned entities. Banks cannot lend sums exceeding 100 per cent of their capital to governments and their related companies, or more than 25 per cent to an individual borrower. The rules also prescribe the manner in which different categories of assets are to be risk-weighted. The new Circular allows banks five years within which to bring their exposure within the limits prescribed by the Circular.
In 2012, a circular was issued by the Central Bank to restrict mortgage loans to expatriates to 50 per cent of the value of a first home and 40 per cent of the value of a second home. Loans to UAE nationals were capped at 70 per cent of the value of their first home and 60 per cent of their second home. At the request of the banks, the circular was reconsidered by the Central Bank and reissued in October 2013. As reissued, the mortgage caps have been revised, and banks are now permitted to grant mortgage loans to expatriates up to 75 per cent of the value of a first home and up to 60 per cent of the value of a second. Loans to UAE nationals are capped at 80 per cent of the value of their first home and up to 65 per cent of the value of the second. If the value of the first home exceeds 5 million dirhams, the mortgage loan cap applicable to an expatriate and a UAE national is 60 and 65 per cent, respectively.
Relationship with the prudential regulator
Firms authorised by the DFSA are required to notify the DFSA of all matters that could reasonably be expected to be notified to the DFSA. There are quarterly reporting requirements in respect of capital adequacy. The DFSA conducts themed reviews on a regular basis. Previous reviews have focused on prevention of money laundering and terrorism financing. The DFSA has also focused on authorised firms’ compliance with restrictions imposed on dealing with Iranian counterparties arising from the UN sanctions relating to non-nuclear proliferation and political exposed persons. Recent reviews have also looked at client take-on processes and suitability assessments.
Management of banks
The DFSA requires all financial institutions active in the DIFC to have adequate systems and controls in place to ensure that they are properly managed. There are a number of mandatory appointments (senior executive officer, chief financial officer, etc.). Individuals holding mandatory appointment positions are subject to prior clearance by the DFSA. The DFSA does not impose any requirements or make any restrictions in respect of bonus payments to management and employees of banking groups.
Those firms holding authorisations to accept deposits and provide credit fall into prudential category 1 (being the highest of categories 1 to 5). Category 1 firms have a base capital requirement of US$10 million. The actual capital requirement may be significantly higher, depending upon the volume of business being conducted and other factors set out in the DFSA Rulebook. As previously mentioned, historically, most banking groups established branches in the DIFC and were able to obtain waivers of the capital adequacy requirements on that basis – in short, they looked to their head office balance sheet as support for their DIFC functions. This approach is becoming less and less acceptable to the DFSA, particularly for smaller financial institutions coming from jurisdictions other than Tier I jurisdictions.
The Prudential – Investments, Insurance Intermediation and Banking Rules (PRU) have been promulgated by the FSRA. Regulated firms are classified into five categories primarily on the basis of the activities for which they are authorised. Banking activities including taking deposits fall into category 1, attracting stricter requirements such as a base capital requirement of US$10 million. Firms that are authorised to deal in investments as principal or provide credit but cannot accept deposits fall under category 2 with a base capital requirement of US$2 million.
iv CONDUCT OF BUSINESS
Local banks have a board of directors, a chief executive, a number of board committees and senior executives. There is currently no regulation of bonus payments to management; bonus payments have, however, not been of a magnitude that requires regulation.
UAE banks are all publicly listed companies, and must comply with the Central Bank law, UAE companies law and SCA laws, all of which, inter alia, regulate management.
There is currently little or no regulation of bank holding companies or subsidiaries.
Banks are required to publish quarterly audited accounts and to have their annual audited accounts approved by the Central Bank before they are published. Banks are required to obtain prior approval from the Central Bank to changes in directors, senior management, shareholders (holding over 5 per cent equity), constitutional documents and capital.
The Banking Law, along with the various circulars and notices issued from time to time by the Central Bank, govern the conduct of business by banks in the UAE. Any violations of the Banking Law or any of the circulars or notices issued by the Central Bank would attract fines, and additionally could attract other penalties such as warnings, reduction or suspension of credit facilities granted to the bank, a prohibition or restriction on carrying on certain activities, or revocation of its licence to conduct banking business, depending upon the gravity of the offence. Accordingly, a bank may be subject to civil or regulatory liability under the Banking Law. There may also be occasions where a bank may be exposed to criminal liability under the UAE Federal Penal Code.
In a significant development, Federal Law No. 2 of 2015 (New Companies Law) came into force on 1 July 2015, replacing Federal Law No. 8 of 1984, the previous companies law of the UAE. Under the New Companies Law, neither a company nor any of its subsidiaries can give financial assistance to any person to subscribe to its shares, bonds or sukuk. The term ‘financial assistance’ extends to giving loans or gifts, or providing any securities or guarantees. This is likely to have a significant impact on acquisition finance transactions in the UAE. In a positive development, a mortgage of shares of UAE companies is recognised as a registrable security under the New Companies Law.
The newly promulgated Federal Companies Law has also empowered the SCA to regulate the listing of public companies. These regulations are yet to be issued.
Dubai Law No. 31 of 2016 was promulgated last year. This imposes restrictions on the registration of mortgages of granted or gifted land in the Emirate of Dubai.
The DFSA Rulebook contains a detailed conduct of business module. The Rulebook is essentially a principle-based system.2 For example, principle 1 (integrity) states that an authorised firm must observe high standards of integrity and fair dealing. Principle 5 (marketing conduct) states that an authorised firm must observe proper standards of conduct in financial markets. There are 12 principles, the final two being principle 11 (compliance with high standards of corporate governance), which states that an authorised firm must meet the applicable standards of corporate governance as appropriate considering the nature, size and complexity of the authorised firm’s activities; and principle 12 (remuneration practices), which states that an authorised firm must have a remuneration structure and strategies that are well aligned with the long-term interests of the firm, and that are appropriate to the nature, scale and complexity of its business. A bank operating in the DIFC will be subject to civil liability under the various DIFC laws, regulatory liability in respect of the applicable DIFC laws such as the Market Law and the Regulatory Law, plus the provisions of the DFSA Rulebook. Depending on the relevant customer documentation, a bank in the DIFC may also be exposed to civil liability under the laws of the UAE outside the DIFC. Finally, there may be occasions where a bank in the DIFC would be exposed to criminal liability (i.e., under the UAE Federal Penal Code).
The FSRA promulgated the Code of Business Rulebook (COBS), which needs to be followed by regulated firms operating in the ADGM. This Rulebook describes the standard of business and client treatment obligations of these entities. The COBS consists of 16 chapters of various rules and regulations.
Under the Banking Law, commercial and investment banks must have a minimum paid-up capital. All foreign banks are required to allocate capital for their UAE operations. At least 10 per cent of the annual net profits of banks is required to be allocated to a special reserve, until such reserve equals 50 per cent of the bank’s paid-up capital or, in the case of a foreign bank, the amount allocated as capital for its UAE operations.
There is no Central Bank or equivalent within the DIFC; therefore, banks registered within the DIFC must fund their activities through support from other branches of their international operations or debt issuance programmes of their own. As previously mentioned, deposit taking is not a significant source of funding for any institution in the DIFC.
The analysis set out above in relation to the DIFC is valid for the ADGM.
vi CONTROL OF BANKS AND TRANSFERS OF BANKING BUSINESS
There is no specific definition of control (except in relation to determination of large exposures). ‘Control’ is generally viewed as a majority shareholding interest, a right to appoint the majority of the board of directors of a bank, or both. Any change in such control requires the prior approval of the Central Bank.
A transfer of customer relationships (e.g., deposits, loans, credit cards, accounts, investment products) generally requires customer consent. There is no statutory mechanism for the transfer of such relationships. In recent acquisition activities, customer consent has been assumed on the basis of the provision of information regarding such acquisition activities to the customer, as well as correspondence by both the acquiring and the selling parties to the customer and the customer’s failure to object.
Any material change of control in a DFSA-authorised firm requires prior approval from the DFSA.
The DFSA Rulebook does not include detailed provisions regarding the methods by which banks may transfer all or part of their business (comprising deposits and possibly loan agreements and other assets) to another entity without the consent of the customers concerned. The ability of an institution to do this would be governed by the assignment clauses in their contractual documentation as interpreted in accordance with the DIFC Contract Law.
The change of control provisions are set out in the Financial Services and Markets Regulations (FSMR) issued by the FSRA. Any material change of control in an ADGM regulated firm requires a prior approval from the FSRA. Part 10 of the FSMR deals with changes in control.
vii THE YEAR IN REVIEW
UAE Federal Law No. 9 of 2016 on Bankruptcy was enacted in 2016 (Bankruptcy Code). The Bankruptcy Code provides a bankruptcy regime in the UAE. It also provides for court-monitored restructuring of companies under financial stress. The Bankruptcy Code overrides and repeals the provisions on bankruptcy and deeds of arrangement set forth in Volume 5 (Articles 645–900) of the Commercial Code.
Another significant development, Federal Law No. 20 of 2016 on Mortgaging Moveable Property as Surety for Debts (Pledge Law), was enacted on 12 December 2016 and became effective on 15 March 2017. The Pledge Law introduces a new regime for registering a pledge over moveable assets that are pledged as security for the repayment of a debt.
The UAE Central Bank recently announced a new circular dealing with capital adequacy and the phased implementation of Basel III.
In June 2016, the SCA issued Decision No. 9 of 2016 Concerning the Mutual Funds Regulation, which deals with various categories of funds such as public (open-ended or close-ended) mutual funds, private mutual funds and foreign mutual funds, and their management in the UAE.
In January 2017, the SCA issued Board of Director Decision No. 3 of 2017 on the Regulation of Promotion and Arranging Activities. This decision deals comprehensively with the issue of marketing and promotion of funds (including foreign funds) in the UAE.
The DIFC further consolidated its position as the regional financial hub in the past year.
The ADGM has made substantial developments in terms of issuing licences to new entities in the past year.
viii OUTLOOK and CONCLUSIONS
Value-added tax (VAT) will be introduced in the GCC countries including the UAE from January 2018. Businesses have been given until the end of 2017 to prepare for the VAT regime before the tax comes into effect from January 2018. VAT is likely to have a significant impact on the economy of the UAE, including its banking sector. The VAT rate in the UAE is likely to be between 3 to 5 per cent. As an exception, healthcare, education and certain food items will likely not be subject to VAT.
The ratio of non-oil revenue will continue to grow for the UAE.
As international standard setters continue to upgrade their regimes, it is anticipated that the DFSA will further amend the DIFC regulatory landscape to ensure closer adherence to those international standards.
For its part, the Central Bank has taken various steps in an effort to avoid the excessive leveraging that greatly affected the severity of the downturn of the UAE economy in 2009.
The ADGM is likely to become even more active, with a number of financial institutions looking to establish offices there.