The UAE is, in practical terms, comprised of two separate financial regulatory jurisdictions: the Dubai International Financial Centre (DIFC) and the rest of the UAE.
The DIFC is a 100-acre financial free zone inside the UAE, with its own financial services regulator, the Dubai Financial Services Authority (DFSA); its own securities exchange, the Dubai International Financial Exchange (DIFX); and its own system of codified civil and commercial laws. In addition, a commodities exchange, the Dubai Mercantile Exchange (DME), has applied to become an authorised market institution.
The rest of the UAE retains its own independent financial regulatory system, overseen by the Central Bank of the UAE, the Emirates Securities and Commodities Authority (ESCA) and the Ministry of Economy and Planning (MEP).
The Dubai International Financial Centre
The DIFC was established in 2004 with the aim of creating a world-class financial centre in the Middle East. The DIFC has its own court system, presently overseen by a former judge of the English Court of Appeal. Notwithstanding the fact that the DIFC has its own civil and commercial laws, federal criminal laws still apply within the DIFC. This means that firms and persons operating in the regulated sector are still susceptible to prosecution in the federal courts for activities such as fraud or money laundering.
The DIFC is run and managed by the following core institutions:
The DIFC Authority the DIFC Authority is the body charged with developing overall strategy and providing direction and supervision to the DIFC. Its responsibilities include attracting licensees to operate in the DIFC as well as the creation of laws and regulations that govern non-financial services activities.
The DIFX the DIFX is a wholly owned subsidiary of the DIFC Authority, created to provide investors and issuers with a larger and more liquid securities market than currently exists in the region.
The DIFC Registrar of Companies The DIFC Registrar is responsible for incorporating and registering all the companies that will operate within the DIFC, from authorized financial institutions through to non-financial services businesses seeking to establish a presence in the DIFC.
The DFSA the DFSA is the independent body responsible for regulating all financial and associated services conducted in or from the DIFC, as well as licensing, authorizing and registering businesses to conduct those services. The DFSA's regulatory framework is based on the best practices and laws of the world's leading financial jurisdictions. The DFSA regulates the full range of financial services, including banking, securities business and insurance, as well as ancillary activities such as trustee services, money services, custody, and insurance intermediation. There are also regimes for the regulation of exchanges, clearing houses and alternative trading systems, as there are in the United Kingdom. The Regulatory Law gives the DFSA the power to make rules governing the conduct of those operating within the regulated sector.
The Dubai courts the courts have a wide jurisdiction to hear and decide civil or commercial proceedings claims arising between DIFC-registered entities and out of DIFC operations. The official language of the DIFC courts is English.
The DIFC Judicial Authority the judicial authority is the autonomous body responsible for administering and enforcing civil and commercial laws at DIFC. At this stage in the DIFC's lifespan, the DIFC's dispute resolution laws, courts and arbitration tribunals are relatively untested.
Notwithstanding the fact that the DFSA regulates the full range of financial services, the DIFC is designed as a wholesale financial centre, primarily accommodating financial institutions, companies, other businesses and high-net-worth individuals. In this context, there is a prohibition on firms authorised by the DFSA carrying on financial services for retail investors. Rule 2.3.1 of the Conduct of Business Module of the DFSA's Rulebook (COB) specifies that, before accepting an individual as a client, an Authorized Firm must as a general rule ensure that the individual has at least $1 million in liquid assets; has sufficient financial experience and understanding to participate in a wholesale financial market; and has consented in writing to being treated as a wholesale client, without the usual protections afforded to retail clients (such as deposit protections schemes and other compensation rights).
There are other restrictions on the type of business that may be conducted in or from the DIFC. For example, the DIFC has been designed as a foreign currency jurisdiction, and in this context there is a prohibition on entering into dirham-denominated loans or otherwise undertaking business in the dirham in or from the DIFC. In addition, companies and entities established in the DIFC are prohibited from taking deposits from the national UAE market (Federal Law 8); the aim of these rules is to protect the business of local deposit-taking institutions and preserve the local lending market. Further, there are rules aimed at protecting the UAE's main insurance markets; specifically, there are prohibitions on (a) insuring risks in the UAE from an establishment in the DIFC (Rule 2.2.2 COB); and (b) carrying on a primary insurance business from the DIFC (Article 4(4), Federal Law (8) of 2004 Concerning Financial Free Zones).
Any entity wishing to carry on financial services in or from the DIFC will need to make an application to the DFSA using the relevant DFSA prescribed forms. The DFSA undertakes to process any application within 60 days.
The DFSA will authorize a firm if it is satisfied that the firm is fit and proper to carry on the business proposed. In making this assessment, the DFSA will take in to consideration the applicants' connection with its controllers or any other person; the specific financial services for which application is being made; whether the applicant's affairs will be conducted and managed in a sound and prudent manner; and any other relevant matters, such as location of the firm's offices, legal status, background and history, ownership and group, resources and the collective suitability of individuals or other persons connected to the applicant.
Individuals within the firm who carry on specified functions referred to as licensed functions will also need to be individually authorised by the DFSA. These functions relate to those charged with managing a firm and those ensuring that the firm complies with the DIFC regulatory regime and its anti-money laundering obligations. The DFSA will authorize an individual if it is satisfied that the individual is suitable to carry on the relevant function.
A DFSA license or DIFC registration does not entitle an entity to carry on business (including the marketing of its services) outside of the DIFC in the wider UAE. A DFSA-authorized firm wishing to operate in the wider UAE requires a license from the Central Bank, ESCA or the MEP, as the case may be, to carry on such activities and would, in practice, be required to create a local establishment in accordance with the provisions of the UAE Company law.
The foreign ownership restrictions that apply in the wider UAE do not apply in the DIFC. There are no minimum thresholds on the proportion of a DIFC company's shares that must be owed by UAE nationals; this contrasts to the position in the rest of the UAE, where a minimum of 51% of a locally incorporated company's shares must be owned by UAE nationals. This means that foreign financial institutions can establish a business in the DIFC without finding a suitable local partner.
Companies wishing to access public capital through the DIFC may seek to make an initial public offering (IPO) of their shares through the DIFX. Alternatively, they may seek to make a secondary listing of their shares on the DIFX. Under the DIFX's Listing Rules, companies floating an IPO through the DIFX need generally only offer 25% of the issue to the public in order to demonstrate an adequate and open market in the relevant securities. Companies making an IPO in the UAE must, by comparison, offer at least 55% to the public. The DFSA also has an exempt offers regime, in respect of offers made to smaller numbers of experienced investors.
The restriction on dealing with wholesale clients in or from the DIFC does not mean that retail investors cannot invest in shares listed on the DIFX. In the context of primary market trading, it is possible for the DFSA-authorized sponsors of securities issues operating from the DIFC to employ brokers licensed outside the DIFC to place securities with retail investors, provided that the relevant broker is a regulated financial institution, that is a person who does not hold a DIFC Licence but who is authorized in a jurisdiction other than the DIFC to carry on any financial service by another financial services regulator (such as an ESCA-regulated broker) (COB 3.2.1(3)). In the context of secondary market trading, the DIFX is an electronic exchange with links to the world markets. This allows, for example, brokers resident in other financial centres such as London, Frankfurt and New York to access the exchange remotely and trade in the market on behalf of retail clients without establishing a local physical presence in the DIFC. Remote participants will, however, need to comply with DIFC laws (including the DIFC's market conduct provisions of the DIFC Markets Law) in respect of their activities in the DIFC.
Financial regulation in the wider UAE
In contrast to the DIFC, the wider UAE does not have a single financial services regulator. The Central Bank is the main body responsible for regulating banking and investment business, whilst certain categories of investment and securities business, such as exchange operations and brokerage business, is administered by ESCA. Insurance Business is regulated separately by the MEP.
The Central Bank The Central Bank's operations are governed by Union Law (10) of 1980 Concerning the Central Bank, the Monetary System and Organisation of Banking (the Banking Law). Under the Banking Law, the Central Bank is granted a general power to create rules governing all matters falling within its competence. The Central Bank has, in this context, promulgated a number of detailed regulations governing the operation of banking and securities businesses. However, it should be noted that, since the Central Bank does not have a policy of publishing all its rules and regulations, or else making such rules and regulations available to the public, any institution regulated by the Central Bank should request copies of all relevant regulations.
ESCA ESCA is responsible for, amongst other things, overseeing the operations of the wider UAE's two securities exchanges, namely the Abu Dhabi Securities Market (ADSM) and the Dubai Financial Market (DFM) and a commodities market, the Dubai Gold and Commodities Exchange (DGCX). Both the ADSM and the DFM have now established their own Central Securities Depositary (CSD) in compliance with the Trading and Settlement Regulations promulgated by ESCA. Each of the CSDs allows for the dematerialization of shares listed on the relevant exchange; and the transfer of such shares by book entry (in the terminology of ECSA, a computerized credit entry). Under Article 6 of the Trading and Settlement Regulations, securities settled through either the ADSM or the DFM may now only be settled in book entry form; therefore, before a trade in a security issued by a UAE company is settled through either the ADSM or the DFM, the existing paper share certificates must be surrendered to the relevant CSD and replaced with book entries in a securities account opened in the name of the investor held with the relevant CSD.
The Ministry of Economy Insurance business is regulated by the MEP under Federal Law (9) of 1984 on Insurance Companies and Agents (the Insurance Law). The Insurance Law contains a prohibition on carrying on "insurance activities" in the UAE without obtaining a licence from the MEP.
As noted above, there are restrictions on the extent to which foreign companies can open and operate financial services businesses in the UAE without the involvement of a local partner. Under Article 22 of the Federal Commercial Companies Law 1984 (as amended), at least 51% of any company registered in the UAE must be owned by UAE nationals. In respect of the opening of local branches of foreign financial institutions, whilst UAE federal law allows foreign entities to establish a branch office in the UAE with the right to carry on all the activities of the parent company, as things currently stand it is in practice rare for the MEP to issue branch office licences to foreign companies. The underlying policy behind this approach is to encourage foreign companies to enter into partnership with UAE nationals. In this context, however, it should be noted that the government of the UAE has plans to amend and update the Commercial Companies Law; and that one of the proposed amendments is a loosening of the restriction on foreign ownership in the UAE.
The financial regulations promulgated by the Central Bank, ESCA and the MEP are in many cases less detailed than the equivalent regulations promulgated by the DFSA. One area in particular in which this is evident is in relation to offers of securities in the UAE. Under Article 6 of Central Bank Resolution 164/8/94 Regarding the Regulation of Investment Companies and Banking, Financial and Investment Consultation Establishments or Companies, any person wishing to make an offer of securities to the public in the UAE must first, as a matter of strict law, make an application to the Central Bank to do so, lodging a draft prospectus with the Central Bank for its approval. In this context, there are no express Central Bank regulations providing a regime for the making of exempt offers to limited numbers of sophisticated investors.
As noted above, in the context of the restrictions on dealing with retail investors from the DIFC, it is possible for the DFSA-authorized sponsors of securities issues operating from the DIFC to employ brokers licensed outside the DIFC to place securities with retail investors, provided that the relevant broker is a "Regulated Financial Institution". ESCA-regulated brokers therefore have an important role to play in relation to potential UAE retail offers of DIFX-listed shares. Although ESCA reserves the right to refuse a local UAE broker permission to deal in DIFX securities, we are not aware of ESCA having refused to grant such permission to any particular broker.
One issue common to both the DIFC and the wider UAE is the absence of a dedicated financial promotions regime. This does not mean, however, that overseas financial institutions wishing to promote their services to new and existing customers in the UAE will fall outside the scope of local regulation. In relation to brokerage business specifically, ESCA regulations expressly provide that the soliciting of clients to deal in securities and commodities shall, in and of itself, be deemed brokerage business. In practice, it is likely that both the Central Bank of the UAE and ESCA may regard promotional activities carried on outside the UAE, but targeted at persons in the UAE outside the DIFC, as falling within the scope of regulated business, notwithstanding the absence of any general rules on promotions of the relevant services.
Lawyer, Financial Regulatory
Clifford Chance, Dubai
Telephone: +971 4 3620 687
Clifford Chance, Dubai
Telephone: +971 436 20695