New UAE Funds Regulation and its Effect on Insurers
In June 2016, the UAE Securities and Commodities Authority (the “Authority”) issued Authority Chairman Resolution No. (9/R.M) of 2016 Concerning the Regulation of Mutual Funds (the “Regulation”), which will become effective upon publication in the Official Gazette. Authority Chairman Resolution No. (10/R.M) of 2016 has also been issued at the same time and concerns fees relating to mutual funds. The Regulation’s provisions impose a requirement to register mutual funds if they are offered in the United Arab Emirates (“UAE”, the “State”). This will not only impact the operations of financial services and investment companies that directly offer these funds, but will also create responsibilities for the secondary offerors of the funds, such as life insurers.
Part One- The New Regulation
Mutual funds, as defined by Article 1 of the Regulation, are financial vehicles that practice the activity of collecting money from investors for the purpose of investment in lieu of the issuance of investment units of equal value. The mutual funds discussed within the regulation require a license granted by the Authority to validate its registration. The extent of the Authority’s involvement extends past the licensing process, since Article 39 of the Regulation allows it to “take all procedures necessary for the supervision, control and inspection of the public or private mutual funds and the confirmation of the compliance with the law and regulations of the Authority or the resolutions, circulars or controls issued pursuant thereto.” Any violations would expose the fund management to penalties described in the Commercial Companies Law 2016 and/or suspension or cancellation of the license (Article 40).
Excluded from the scope of the Regulation’s provisions are funds incorporated by federal or local government authorities, reverse promotions by State investors seeking to purchase foreign mutual funds abroad, and accumulations of money for the purpose of investing in joint bank accounts, concluding group insurance contracts, employee incentive programmes, or participations in social security not directed towards investment in mutual funds. It is important to note that the scope of the Regulation has become much more specific in comparison to its predecessor, and this is evident through the definitions provided and the multiple categories mutual funds are separated into.
Open-end Public Mutual Fund (Emirates UCITS)
An open-end public mutual fund is made for all investors and is characterized by its variable capital, which increases with new units being issued and decreases with existing units being redeemed (Article 1). The application for licensing the mutual fund should be submitted to the Authority by the management company or the incorporators of the fund, accompanied by but not limited to the offer document and the Key Investor Information Document (KIID) in accordance with the provisions of the Regulation and an AED 10,000 non-refundable public mutual fund license application fee (Article 3).
The offer document should be drafted in Arabic, and contain data such as information of the management company/fund incorporator, name and duration of the mutual fund and the purpose of incorporation, name and obligations of the safe custodian as outlined in Article 32, the method of issuance of units and its categories and subscription and redemption thereof, a determined financial year with reports complying to International Financial Reporting Standards (Article 13), and the investment policy of the mutual fund. The investment policy requirements for an open-end public mutual fund are discussed in Article 8, and if the license is issued, there must be compliance with the percentages and controls of investment prescribed by the Authority. The investment of the fund’s property must also be in line with the investment nature of the fund and must be within the scope outlined in Article 8 of the regulation, an example being that negotiable (stocks, bonds and currency instruments), non-negotiable and immovable assets can only be invested in if they are of high liquidity. Subscription to such fund units by investors post-license approval must be made in accordance with the offer document, and if the minimum subscription is not covered by the management, it is possible to extend the subscription duration for a maximum of three months, or amend the value property to be invested to correspond to the covered shares, or abandon the incorporation of the mutual fund, all after obtaining the Authority’s approval (Article 10). Alternatively, if subscription units exceed the number of offered units, it is possible to either raise the par value of the fund or distribute the offered units to subscribers in a proportionate manner (Article 10). Redemption of the mutual fund units shall be done “in lieu of cash by the rate of the announced net asset value of the unit and in line with the offer document,” (Article 12). The KIID submitted during the license application procedure must also be drafted in Arabic and include information and data of the mutual fund and a description of the type of its management and unit categories, a summary of the fund’s objectives, the methods of calculating fees and payment, any outsourced activities, and information of the feeder fund, umbrella fund and its affiliate sub-funds (Article 7).
Once the aforementioned documents are submitted, “the management company or the fund’s board of directors shall be prohibited to practice duties related to the mutual fund, subject of the application, unless after the issuance of the Authority’s resolution on the licensing of the fund,” which will be issued within thirty working days as of the date of submission of the complete application (Article 3). If approved, the license duration of the fund will be for one year and expires on the thirty-first of December of each year, but can be renewed if an application verifying the fund’s compliance with the Regulation’s provisions is submitted one month prior to its expiry and an AED 3,000 license renewal fee is paid (Article 4). Moreover, upon approval, “the mutual fund shall have a corporate personality and independent financial liability,” (Article 5). This entails limiting the mutual fund’s liability to “obligations resulting from the practice of its activity” and guaranteeing the rights of mutual fund share owners by acknowledging that the units may not be mortgaged or lent to any third party, they may not be attached or disposed of for the fulfilment of any debts, and they may not be allocated to an owner’s inheritor or creditor. Although lending and borrowing is prohibited, owning debt instruments shall not be deemed as lending, and borrowing within no more than 10% of the fund’s assets for the purpose of purchasing immovable assets shall not be deemed as borrowing (Article 9).
Management of the mutual fund can take the form of either a management company or self-management. “The management company shall undertake practicing the activity of the incorporation and management of the mutual fund after obtaining license by the Authority, which is renewed annually.” Conditions of licensing are in Article 23 of the Regulation and specify the forms which the license applicant may take as long as its capital exceeds AED 5,000,000- a company licensed by the Authority and working in the domain of securities, a company incorporated in accordance with the Commercial Companies Law 2016, a local or foreign bank with the approval of the Central Bank, or a branch of a foreign company, all of which must have been licensed or established to practice the management and incorporation of mutual funds. The application for licensing the practice of the activity of the incorporation and management of mutual funds must be submitted to the Authority with the ad hoc application form, the legal form of the license applicant and its members, a statement indicating legal or judicial obligations or liabilities, and a statement indicating the proposed work procedures along with an AED 50,000 non-refundable license application fee (Article 24). The license renewal procedure is that of the renewal of mutual funds, along with an annual, non-refundable payment of AED 25,000 (Article 25). If approval is granted by the Authority, the management company must comply and be committed to the obligations and requirements imposed by Article 26 of the Regulation. Contrastingly, self-management (self-fund) requires a “mutual fund incorporated by a group of natural persons who are qualified and experienced. It is run by a board of directors,” (Article 28). The license and application procedure and fee for a self-managed fund is the same as that of a management company, with the primary difference being the board of directors that self-management requires to appoint (Article 29). It is possible to change the fund’s management once the license has been issued if a sixty working day notice is given and “upon approval of 75% of the owners of the fund’s units and after obtaining he approval of the Authority and in accordance with its procedures,” (Article 30). It is also possible to outsource the duties of fund management if in accordance with Article 31 of the Regulation.
Closed-end Public Mutual Fund
A closed-end public mutual fund is incorporated into the state and made for all investors, and is characterized by its fixed capital, with units only being redeemed upon the fund’s expiration, unless otherwise stipulated by the offer document (Article 1). With the exception of certain differences in provisions in the closed-end public mutual fund’s investment policy as per Article 15, the requirement to list and trade units at the Securities and Commodities Market, the ability to redeem units only according to the date specified by the offer document or upon expiry of the fund, and the ratio of the fund’s borrowing being capped at 30% of its net asset value, “the same conditions and provisions stipulated for the open-end public mutual fund shall apply to the closed-end public mutual fund,” (Article 16).
Special Provisions for certain Public Mutual Funds
The focal point of the other public mutual funds mentioned in the Regulation is the umbrella fund, which is “a public mutual fund whose investment policy is represented in establishing an affiliate sub-fund. It shall have a public offering document and each sub-fund shall have a separate offer document that refers to the public offering document. It shall be permissible for the umbrella fund to establish sub-funds for the purpose of decreasing costs after obtaining the Authority’s approval, and shall license each sub-fund in accordance with the conditions and requirements stipulated by the Regulation,” (Article 20). As part of an umbrella fund, a master fund can be established provided it has at least one feeder fund among its unit’s owners with approval given by the Authority, but cannot be a feeder fund by itself nor can it own units in a feeder fund (Article 17). A feeder fund is also part of a group of funds for an umbrella fund, but it is excluded from investing in negotiable securities- it must invest at least 85% of its assets in the units of a public master fund or foreign public fund, and invest the remaining percentage in either liquid assets, financial derivatives for the purpose of hedging, or movable and immovable properties necessary for the completion of direct business (Article 18). Feeder funds must also satisfy the conditions pertaining to the licensing of public mutual funds (Article 19). The related license application fees are a non-refundable AED 15,000 payment for the main fund and AED 5,000 for the sub-fund, with a license renewal fee of AED 5,000 and AED 1,000 for the main and sub-funds respectively.
Specialized Mutual Funds
Subject to the Regulation’s provisions, specialized (private or foreign) mutual funds shall apply technical controls issued by the Authority (Article 33). A private mutual fund is one that is incorporate in the state, can be open or closed- ended, and is made for the qualified investor and his own account (Article 1). Although the application, procedure and fees for the licensing and renewal of private mutual funds is similar to that of public funds, it shall be conditional for the licensing of a private mutual fund that the incorporator is one that meets the efficiency and integrity issued by the Authority, and the minimum limit of subscription per investor is AED 180,000 (Article 34).
A foreign fund is a mutual fund incorporated abroad of the State or in a free zone or financial free zone in the State (Article 1). Regarding foreign mutual funds, “it shall not be permissible to promote any foreign fund in the State unless after it is registered at the Authority and making a contract with a local promoter licensed by the Authority,” (Article 35). The application to the Authority for the registration of a foreign mutual fund should be submitted by the legal representative, together with the offer document and its investment policy, with the application fee for registration set at a non-refundable AED 35,000 and annual registration renewal fees set at AED 7,500.
Part Two- Effects of the Regulation on Life Insurers
The Regulation passed is expected to heavily impact the State’s asset and wealth management space, moving towards a robust and sophisticated regime where no mutual fund may be established or promoted within the State prior to obtaining a license for establishment from the Authority, except if explicitly excluded in Article 2. Life insurance companies often offer variable unit linked (VUL) insurance policies, which are ultimately hybrid insurance-security products that allows for part of the premium paid by a client to be invested in any number of qualified investments such as stocks, bonds, and mutual funds in order to diversify the holdings and mitigate and minimize risk.
Previously, when an insurer offered a list of funds which policyholders could invest their money into, these funds did not have a registration requirement, the legal basis being that the financial product being promoted was deemed to be the life insurance product and not the units in the fund. However, the new Regulation embodies a material reversal of its previous position- now; a duty is imposed upon insurers offering single or bundled integrated fund products in the State to register these funds with the Authority. Interestingly, it is possible for large insurance companies to prefer the heavily regulated environment if registration costs are within their means, since the unprecedented shifts in consumer habits and painfully low interest rates have been a factor in decreasing profits from premiums and have increased the incentive to sell asset management products such as mutual funds to insurance clients as a steady source of additional cash flow and earnings. However, more probable than not, the administrative burden and increased cost due to registration fees may prove prohibitive from both an economic and practical perspective. This is because life insurers may simply choose to significantly reduce their offering to the State’s market rather than cope with the added cost and time involved with the registration process. Choosing to curtail the funds offered may be dangerous at a time where “life products” are under-represented in the State’s insurance market and growth is necessary to push this industry out of its early stages.
The specifics of the precise registration process are thus far vague, but ESCA is expected to treat insurers as “promoters” and thus liable to file their offerings. The Authority has informally advised that they intend on issuing implementing rules either later this year or early next year. It has further recommended that insurers should formally advise the Authority in written correspondence of any funds that they now offer, in lieu of there being a formal registration process. It is not anticipated that any fees will be payable until the implementing rules are issued, but this remains subject to change. It is also anticipated that the forthcoming rules will allow a fund manager to elect and register itself either solely on its own behalf, or file on behalf of the insurers that are offering the fund as part of a life product. The expectation is that many major fund managers will elect this option, at least on behalf of their current life insurer partners, and this will in turn lessen the burden on the insurers themselves. However, it is still undetermined whether the insurer that blends fund products will be required to register the blended product, notwithstanding that each separate fund may have been registered by its issuing manager. It is anticipated that the forthcoming enabling rules will shed some clarity on this issue.