The UAE has been home to a large amount of sovereign wealth for many decades. As part of its strategy to manage and grow this sovereign wealth, the UAE established some of the world’s most prominent sovereign wealth funds, and the country became a place where large Western fund managers would seek to source investment, flying in and out with limited on-the-ground presence. This has now changed.
The UAE Government’s highly effective management of the COVID pandemic, the country’s diversification away from fossil fuel production to renewable and other low carbon energy sources and focus on – amongst others – tourism and financial services sectors, show great foresight, contributing to wise policymaking and further UAE liberalisation given increased regional and global competition for investment. This has seen the UAE Government incentivise foreign investors to set up a substantive presence locally, which is being made easier given the attractive lifestyle and personal tax advantages that the UAE offers.
In the wake of a bourgeoning global appetite for investment from the Middle East and economic activity in the region, the commercial hubs of Dubai and Abu Dhabi and their financial free zones – the Dubai International Finance Centre (DIFC) and the Abu Dhabi Global Market (ADGM) – have continued to grow in popularity, setting the foundation for an influx of funds to the UAE, in particular hedge funds. This article will explore the reasons behind an increase in interest in the UAE and the related regulatory environment for hedge funds.
Background On UAE’s Legal Regime Governing Funds
Unlike other jurisdictions, for the purposes of funds regulations, the UAE is not a unitary jurisdiction. It is comprised of two categories of jurisdictions: onshore UAE and offshore UAE. Onshore UAE comprises the UAE’s seven emirates, including its economic free zones but excluding the UAE’s two financial free zones, and is regulated by the Central Bank of the UAE (CBUAE) and the Securities and Commodities Authority (SCA), with SCA being the relevant authority in respect of funds regulations. Offshore UAE is made up of the financial free zones, the DIFC and ADGM. The competent financial services regulator in the DIFC is the Dubai Financial Services Authority (DFSA), while in the ADGM it is the Financial Services Regulatory Authority (FSRA).
Accordingly, onshore UAE, the DIFC and the ADGM are generally considered separate and distinct legal jurisdictions. Except for UAE criminal law and AML/CFT/sanctions obligations, UAE federal laws and the laws of each emirate typically do not apply in the financial free zones.
Attracting Funds To The UAE
The UAE has established itself as a formidable financial and innovations hub in the MENA region. It is now growing to become a major global hub, which in the context of funds, could rival Luxembourg and the Cayman Islands. To date, Dubai (and the DIFC in particular) has attracted 17 of the top 20 global banks and five of the top ten asset managers.
The UAE’s sovereign wealth market is valued in excess of USD 3 trillion. A similar amount of private capital is also available for investment. Against this backdrop, the UAE (and particularly offshore UAE) attracts hedge funds through its accessible and user-friendly offering, which includes the following key features:
• The DFSA / FSRA – the respective regulators of the DIFC and ADGM – are globally recognised for their governance and transparency levels.
• The DIFC and ADGM operate as financial free zones with 100 per cent foreign ownership, independent judicial systems based on English Common Law, and no restrictions on capital repatriation.
• The UAE is optimally situated between time zones and markets in the West and the East – it is estimated that 2.5 billion people can be reached from the UAE within a four-hour flight.
• The UAE’s ability to attract top talent. Dubai and Abu Dhabi are some of the best cities to live and work in, given their appealing lifestyle. A benign tax regime is equally attractive when luring talent to the UAE. It has negligible crime and is politically stable. It has world-class infrastructure, including hotels, galleries and restaurants, making it easy to mingle, entertain and develop business relationships. The UAE has also recently liberalised certain social laws to become even more attractive to Western professionals.
Setting up a business is a simple, streamlined process. All required documentation (including licences and visas) is handled through digital onboarding platforms. There are also reduced fees for fund management licences and office space, with serviced ‘plug and play’ facilities readily available. The UAE has also introduced new visas which mean that ex-pats no longer need a local sponsor to obtain visas. These include a ‘digital nomad visa’ for remote workers and a ‘freelance visa’ for self-employed.
Regulatory Environment: Onshore Funds
In 2023, the SCA issued Decision No. (01/RM) of 2023 and Decision No. (04/RM) of 2023, outlining a new onshore UAE funds regime. The regulations set out a clearer approach for sponsors to structure and launch their funds, with the following types of funds available:
General Funds: Public funds, private funds, master/feeder funds, umbrella funds & sub-funds, open-ended funds and close-ended funds.
Specialised Funds: Family funds, self-managed funds, real estate development funds, precious metal funds, direct financing funds, ESG funds, capital protection funds, protected-cell funds, charity investment funds and commodities investment funds. Specialised funds do not include a category for hedge funds and there are no hedge fund specific regulations.
ADGM / DIFC Fund Types
Both the DIFC and ADGM have three main categories for domestic funds:
Public Funds: Subject to detailed regulation in line with IOSCO standards. These funds are open to retail clients, and units can be offered to investors through a public offering. Investors benefit from high levels of protection including detailed disclosures.
Exempt Funds: Subject to less regulatory scrutiny and only open to professional investors. Units must be offered through private placement. The minimum subscription amount is equivalent to USD 50,000.
Qualified Investor Fund (QIF): QIFs are subject to a less stringent regulatory regime than Exempt Funds. This provides flexibility to managers (eg self-certification for adequacy of systems and controls). Only professional clients are eligible to invest in a QIF and units must be offered via private placement. The minimum subscription amount is equivalent to USD 500,000.
Regulation of DIFC Hedge Funds
In addition to a main category, a hedge fund is also classified as a ‘specialist’ fund under the DIFC Collective Investment Rules if all or part of the following criteria is satisfied:
• It has a broad mandate giving its fund manager flexibility to shift strategy;
• The aim of achieving absolute returns (as opposed to returns relative to the market); and
• The use of some or all of the following techniques: (i) pursuit of absolute returns or “alpha”; (ii) short-selling; (iii) derivatives for investment purposes; (iv) economic or debt leverage (including leverage embedded in financial instruments); (v) the acquisition of distressed debt with a view to its realisation at a profit; or (vi) ‘high yield’ debt securities.
A code of conduct for hedge fund managers in the DIFC serves as a standard for good practice and aims to address inherent operational risks, covering skills and resources, investment strategies, systems and controls and ethical practices.
Regulation Of ADGM Hedge Funds
Like the DIFC, the ADGM sets out ‘specialist’ fund types such as venture capital funds and credit funds. However, hedge funds do not fall within their own specialist class of funds and there are no specific regulations aimed at hedge funds in the ADGM.
The SCA, the DFSA and the FSRA have a common regulatory framework to facilitate marketing and offering of funds across the UAE. This allows fund managers licenced in one UAE jurisdiction to promote their funds to “qualified investors” in other UAE jurisdictions.
As part of the regime, the fund manager makes a straightforward notification to their ‘home’ regulator. The notification will specify the other UAE jurisdiction(s) they wish to promote their fund in. The notification will (save in limited circumstances) lead to the publication of details of the passported fund on the register of passported funds of both the home regulator and other regulator(s). The fund will then become a passported fund. The passporting regime does not apply to promotion of foreign funds in the UAE.
Looking forward, fund managers should consider their immediate commercial needs when deciding which UAE jurisdiction to set up in. This may depend on the location of key clients or a preference for one or the other location based on other factors. In the medium to long term, the passporting regime makes it convenient to branch out into other UAE jurisdictions.
With hedge funds looking for new sources of investment, the UAE’s rapidly growing sovereign wealth presents a potentially very attractive source of capital. But hedge fund managers need to be alive to the new expectation of substantive on-the-ground presence in the country, something made increasingly less challenging by the appeal the UAE now presents to ambitious professionals.
Those hedge funds that wish to set up in this part of the world have the option of choosing from onshore UAE, DIFC and ADGM funds regimes, each with its own nuances and distinctions but connected by a passporting regime across the UAE, allowing hedge funds to get a slice of the vast amounts of sovereign wealth in the market.
Arnold is an associate in the White & Case Dubai office, having joined from the London office of Kirkland & Ellis in October 2022. Arnold has experience advising alternative investment funds, fund managers, GCC sovereigns and investment firms across a wide range of matters with a principal focus on financial services regulatory (including acquisitions in the financial services sector), funds and funds regulatory matters in the DIFC, the ADGM, mainland UAE and the wider Middle East region. He also has experience advising technology companies and fintechs on matters related to technology, Web3, the metaverse and digital tokens. Any views expressed in this publication are strictly those of the authors and should not be attributed in any way to White & Case LLP.
Stefan is a Corporate M&A/Regulatory Partner at White & Case, Dubai. He advises Middle East and Western corporates, financial institutions, fintechs and technology companies in connection with corporate M&A, joint venture, financial services regulatory and tech matters. Any views expressed in this publication are strictly those of the authors and should not be attributed in any way to White & Case LLP.