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Consultation Paper No. 25 The Proposed Regime for Collective Investment Funds
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Feb 9 2006 onwards

Consultation Paper No. 25 The Proposed Regime for Collective Investment Funds



FEBRUARY 2006

THIS DRAFT REGULATIONS ARE PUBLISHED FOR CONSULTATION PURPOSES ONLY. THE DIFCA AND THE DFSA RESERVE THE RIGHT TO AMEND THIS DRAFT AT THEIR SOLE DISCRETION.

Download this Consultation Paper in PDF format.

•   Download a copy of Annex A — Draft of proposed Collective Investment Law 2006 in PDF format.
•   Download a copy of Annex B — Draft of proposed Collective Investment Rules in PDF format.
•   Download a copy of Annex C — Draft of proposed Regulatory Law Amendment in PDF format.
•   Download a copy of Annex D — Draft of proposed Consequential Amendments to the Rules in PDF format.
•   Download a copy of Annex E — IOSCO Principles 17–20 in relation to Collective Investment Schemes in PDF format.

The purpose and scope of this Consultation Paper

1. This Consultation Paper ("Paper) seeks public comments on the DFSA’s proposed regime for the regulation of Collective Investment Funds ("the Fund regime"). The Fund regime comprises:
•   the draft Collective investment Law (2006) (the "Law") (Annex A);
•   the draft Collective Investment Rules (2006) ("CIR Module") (Annex B); and
•   draft consequential amendments to the Regulatory Law 2004 (Annex C) and the DFSA Rulebook (Annex D) arising from the above (the "consequential amendments").
2. The proposals in the Fund regime have been developed taking into account:
•   the comments received in the initial round of consultation on the Law in October 2005. A summary of changes made to the Law as a result of the previous consultation is set out at the beginning of Annex A;
•   the other regulatory requirements that apply to Authorised Firms, including the Regulatory Law 2004, the Markets Law 2004 and the Law Regulating Islamic Financial Business 2004, Conduct of Business Rules ("COB") and Offered Securities Rules ("OSR"); and
•   the regulatory requirements which other well regulated foreign jurisdictions apply to regulate collective investment funds in those jurisdictions.
3. There are three other associated consultations taking place, relating to the type of investment vehicles for Collective Investment Funds ("Funds"). These are:
•   Consultation Paper 26, relating to Investment Companies Regulation;
•   Consultation Paper 23, relating to Limited Partnership Law; and
•   Consultation Paper 24, relating to Limited Partnership Regulations.
4. This paper is structured as follows:
•   Defined terms (paragraph 8);
•   Executive Summary (paragraphs 9–11);
•   Objectives of the Fund regime (paragraph 12);
•   Requirements for Domestic Funds (paragraphs 13–16);
•   Requirements for Foreign Funds (paragraphs 17–22);
•   Additional requirements for Hedge Funds (paragraphs 23 & 25);
•   Real Estate Investment Trusts (paragraph 26);
•   Consequential amendments (paragraphs 27 & 28);
•   Issues on which we seek your comments (paragraphs 29–39); and
•   Diagrammatic representation of the proposed regime.
5. The DFSA may at its sole discretion amend these proposals in any manner it considers appropriate in light of any public comments received or on its own initiative. Further, these proposals do not constitute legal advice or a final policy and hence should not be acted upon as such.

How to provide comments

6. There are specific issues we have raised on which we seek public comments (see paragraphs 29–39). You may also comment on any other aspect or issue relating to the Fund regime, both in relation to its content or drafting.
7. You must identify the organisation you represent in providing your comments. The DFSA reserves the right to publish including on its website any comments you provide, unless you expressly request otherwise at the time of making comments. All comments should be forwarded by 9th March 2006.

Mr Nicholas Alves
Legal Counsel
DFSA
PO Box 75850
Dubai, UAE

or e-mailed to nalves@dfsa.ae

Defined Terms

8. The terms used in this Paper have the same meaning as in the Law and the Rulebook Glossary. For convenience of reference, in this Paper:
•   "Fund" means a Collective Investment Fund, as defined, subject to Article 19, in Article 18 of the Law;
•   "Domestic Fund" means a Fund which is established or domiciled in the DIFC;
•   "Financial Service" has the same meaning as in GEN 2.2.2;
•   "Foreign Fund" means a Fund that is established or domiciled in a jurisdiction other than the DIFC;
•   "Operator" means the person described under Article 12(3) of the Law, who is responsible for the management of the property held for or within a fund and otherwise, operating the fund and, in relation to a Domestic Fund, is authorised under a licence granted by the DFSA to operate that fund;
•   "Private Fund" means a Domestic Fund where participation is limited to 100 or fewer Qualified Investors and participation is achieved by means of private placement;
•   "Prospectus" means a document containing the information about a Fund, by whatever name called and includes any supplementary documents
•   "Public Fund" means a Domestic Fund where participation is not limited and therefore may have any number of Qualified Investors;
•   "Qualified Investor" means a person who is defined as such in the CIR Module;
•   "Unit" means a Unit or share representing the rights or interests of Participants in a Fund.

Executive Summary

9. The Fund regime has the following key features:
•   The Operator is responsible for the establishment and operation of Domestic Funds. The Operator must, among other things, be an Authorised Firm whose licence authorises it to carry on Financial Services relevant to the operation of the Fund. The Operator must also be domiciled in the DIFC and register the Fund with the DFSA if it is a Public Fund;
•   Authorised Firms can market Units in both Domestic Funds and Foreign Funds. Authorised Firms must meet additional requirements in COB when marketing in or from the DIFC Units in Foreign Funds;
•   Operators can also market Units in other Funds including Foreign Funds subject to the relevant COB requirements ;
•   The Fund regime retains the wholesale nature of the DIFC as participation is limited to Qualified Investors;
•   The safety of Fund Property of Domestic Funds is ensured through the use of Eligible Custodians; and
•   Different regulatory requirements apply under the proposed regime depending on the nature and domicile of the Fund, i.e., whether it is
i. a Domestic Fund, which can be a Public Fund or a Private Fund; or
ii. a Foreign Fund.
10. In general, Domestic Funds that are Public Funds attract a greater level of regulation than Domestic Funds which are Private Funds. For example, Public Funds attract more detailed Prospectus disclosure requirements and require independent oversight requirements. This is because Public Funds can be offered publicly to any number of Qualified Investors, whereas participation in Private Funds is limited to 100 or fewer Qualified Investors.
11. The proposed regime for marketing (i.e. Offering and selling the Units) of Foreign Funds by Authorised Firms applies differently depending on whether or not the Foreign Fund is established and operated in a Recognised Jurisdiction, i.e. a jurisdiction which is included in the DFSA’s Recognised Jurisdictions list. The DFSA will have this list ready at the time of implementing the Fund regime.

Objectives of the Fund regime

12. These proposals strive to achieve the regulatory objectives of the financial services regime the DFSA administers, in particular:
•   to provide flexibility for persons intending to operate Funds in the DIFC, in particular:
i. by making available a number of internationally recognised vehicles to operate collective investments; and
ii. by allowing delegation of functions subject to requirements that ensure such delegations do not result in any dilution of accountability or minimisation of the level of protection intended by the Fund regime;
•   to allow Authorised Firms operating in the DIFC the ability to market not only Units of Domestic Funds but also Units of Foreign Funds, provided those Foreign Funds are subject to a comparable level of regulation as applicable to Domestic Funds. This promotes the DIFC internationally as a well regulated and competitive regulatory environment; and
•   to promote the integrity and soundness of the DIFC as a financial market by applying an appropriate level of product regulation and oversight arrangements through requirements that apply to certain types of Domestic Funds. The proposed requirements for Public Funds also meet IOSCO requirements applicable to collective investment schemes (See Annex E). Therefore, the registration of Public Funds has the added advantage of permitting the promotion of these Public Funds as a permissible investment vehicle for institutional investors such as pension, insurance and retail funds which may be prohibited from or have restrictions relating to investing in unregulated Funds. Further, it may be possible for Public Funds to be passported to other well regulated jurisdictions.

Regulatory requirements for Domestic Funds

A. Requirements for Domestic Funds (both Public and Private Funds)

13. The Operator of a Domestic Fund is responsible for due compliance with the following key requirements:
•   The Operator must be:
i. a body corporate; and
ii. an Authorised Firm with appropriate authorisations for the Financial Services involved in the operation of the Fund, i.e.:
(a) it must have authorisations for Operating a Collective Investment Fund and Managing Investments; and
(b) it must also have additional authorisations for other Financial Services involved in the operation of a Fund, such as Fund Administration Services, Providing and Arranging Custody, Dealing in Investments as an Agent or Principal, and Arranging Deals in Investments, unless these functions are delegated to another Authorised Firm which has the relevant authorisations;
•   The investment vehicle used for the Domestic Fund must be established and operated in the DIFC;
•   Certain core functions relating to the operation of a Domestic Fund must be carried out in the DIFC, ie:
i. the issue and redemption of the Units in the Fund;
ii. the valuation and pricing; and
iii. maintaining the Fund register and records;
•   The Fund Property must be safeguarded by registering the legal title with an Eligible Custodian;
•   A registered auditor must be appointed;
•   Annual and interim reporting requirements must be met; and
•   Only persons who are Qualified Investors must be allowed to participate in a Domestic Fund.

B. Additional requirements for Public Funds

14. If the Domestic Fund is a Public Fund, in addition to the requirements under "A" above, the Operator must also comply with the following key requirements:
•   The investment vehicle used must either be an Investment Company or an Investment Partnership under the relevant DIFC laws. These entities can be open ended or closed ended investment vehicles;
•   The Operator must register the Fund with the DFSA. The DFSA will only register a Fund where it is satisfied, among other things, that:
i. the compliance arrangements are not only adequate but also meet the independent oversight arrangements specified in the CIR Module; and
ii. there are adequate systems and controls put in place in relation to the Fund for due compliance with all the applicable laws;
•   The Operator must prepare and lodge with the DFSA a full Prospectus that complies with the disclosure requirements for Public Funds but will not be vetted by the DFSA; and
•   The Operator must have adequate systems and controls to ensure that the restrictions relating to investments and borrowings are complied with.

C. Additional requirements for Private Funds

15. Domestic Funds which are Private Funds are subject to a much lighter regime of regulation than Public Funds. The Operator of a Private Fund can use:
•   any type of an investment vehicle or contractual arrangement, such as a company, partnership or a trust, provided it is established in the DIFC and is not a Protected Cell Company; and
•   a short form Prospectus, which does not require the detailed level of disclosure as a Prospectus for a Public Fund or, the lodgement of it with the DFSA.
16. However, an Operator of a Domestic Fund:
•   must issue Units only pursuant to private placements, i.e. not publicly offer the Units of the Fund;
•   must ensure that participation in the Fund is restricted to fewer than 100 Qualified Investors at any given time; and
•   may be subject to some additional controls imposed by the DFSA such as custodial and administration arrangements and investment management requirements where the Fund has more than 30 Qualified Investors.

Regulatory requirements for marketing of Foreign Funds

17. Foreign Funds are subject to the Fund regime only if their Units are marketed in or from the DIFC to potential investors. Authorised Firms with appropriate authorisations can market Units in Foreign Funds subject to the proposed requirements. These requirements vary depending on whether the Foreign Fund:
•   is located in a Recognised Jurisdiction; and
•   has the characteristics of a Public Fund or a Private Fund.

D. Recognised Jurisdictions

18. The DFSA will publish a list of Recognised Jurisdictions at the time of implementing the Fund regime. We expect to include in that list foreign jurisdictions that have a regulatory regime that is comparable to what we propose for Domestic Funds. Generally, if the regulatory regime applicable to the Foreign Fund meets the IOSCO requirements for collective investment schemes (see Annex E) and a regulatory agency in that jurisdiction is a signatory to the IOSCO Multilateral Memorandum of Understanding, we expect to treat such a jurisdiction as a Recognised Jurisdiction. We will finalise the list after taking into account public comments.

E. Requirements for marketing Foreign Funds with Public Fund features

19. An Authorised Firm can market Units in a Foreign Fund, to any number of Qualified investors where:
•   the Fund is located in a Recognised Jurisdiction;
•   the Fund is authorised or otherwise approved by the relevant regulator in the Recognised Jurisdiction as a Fund the Units of which can be offered to the general public;
•   the Fund and its Prospectus are in compliance with the applicable requirements in the relevant Recognised Jurisdiction; and
•   the Authorised Firm obtains from its legal advisers written certification of such compliance before marketing of the Units (which must be available for DFSA inspection at its business place).
20. An Authorised Firm can also market Units in a Foreign Fund which is not located in a Recognised Jurisdiction to any number of Qualified Investors where:
•   the Operator of the Fund is licensed or otherwise authorised in the jurisdiction in which the Fund is located (i.e. in the home jurisdiction);
•   the Fund is of a kind that has no restrictions relating to the offer of its Units to the general public in its home jurisdiction;
•   the regulatory requirements applicable to the Fund in the home jurisdiction are broadly equivalent to the requirements that apply to Domestic Funds which are Public Funds; and
•   the Authorised Firm, before marketing the Units of the Fund, obtains from its legal advisers written certification (which must be available for DFSA inspection at its business place) that:
i. the regulatory requirements in the home jurisdiction are broadly equivalent to those applying to Domestic Funds which are Public Funds; and
ii. the Fund’s prospectus is also in compliance with the requirements that apply to Domestic Funds which are Public Funds.

F. Requirements marketing Foreign Funds with Private Fund features

21. An Authorised Firm can market Units in a Foreign Fund to Qualified investors where:
•   the Fund is located in a Recognised Jurisdiction (ie in its home jurisdiction);
•   the Fund and its Prospectus are in compliance with the applicable requirements in its home jurisdiction; and
•   the Authorised Firm:
i. obtains from its legal advisers written certification of such compliance before marketing of the Units (which must be available for DFSA inspection at its business place); and
ii. reasonably believes that the number of participants in the Fund:
(a) will not breach any home jurisdiction limitations relating to the number of participants in the Fund; and
(b) in any case, will not have 100 participants including those who become participants as a result of its marketing of the Fund.
22. An Authorised Firm can also market Units in a Foreign Fund which is not located in a Recognised Jurisdiction to Qualified Investors where:
•   the Operator of the Fund is licensed or otherwise authorised in the jurisdiction in which the Fund is located (i.e. in its home jurisdiction);
•   the Authorised Firm, before marketing the Units of the Fund, obtains from its legal advisers written certification (which must be available for DFSA inspection at its business place) that:
i. the regulatory requirements in the home jurisdiction are broadly equivalent to those applying to Domestic Funds which are Private Funds; and
ii. the Fund’s prospectus is also in compliance with the requirements that apply to Domestic Funds which are Private Funds; and
•   the Authorised Firm reasonably believes that the number of participants in the Fund:
i. will not breach any home jurisdiction limitations relating to the number of participants in the Fund; and
ii. in any case, will not have 100 participants including those who become participants as a result of its marketing of the Fund.

Hedge Funds

23. The DFSA will consider as a Hedge Fund, a Fund whose investment strategy is aimed at achieving absolute returns rather than returns relative to the market and in so doing, employs elements of the following techniques or other techniques with similar characteristics:
•   the use of short selling;
•   the use of derivatives for investment purposes;
•   use of economic or debt leverage as well as leverage embedded in financial instruments such as derivatives;
•   the pursuit of absolute returns or alpha rather than measuring their investment performance relative to the market;
•   charging performance-based fees in addition to a management fee based solely on assets under management; and
•   having a broad mandate which gives the Fund Operator or manager more flexibility to shift strategy and more flexibility within each strategy.
24. We have considered it appropriate to have a few additional controls relating to Funds that are Hedge Funds due to the specific nature of these investments. There are three types of mandatory controls designed to address these concerns:
•   An Operator of a Hedge Fund must ensure that the risks inherent in the operation of a Hedge Fund are adequately addressed, with due regard to the nature of strategies and investment process employed by the Operator and the role of Fund Administrators and Custodians;
•   An Operator must ensure adequate segregation of duties in the Net Asset Value determination process. The Net Asset Value of the Fund must be produced by parties who are not involved in the investment process of the investment management entity; and
•   An Operator must provide a warning in prescribed form to potential investors in Hedge Funds alerting them to the high risk nature of Hedge Funds. Authorised Firms marketing Foreign Hedge Funds will also be required to provide a similar warning.
25. The DFSA expects Operators and other Authorised Firms marketing Hedge Funds to have proper regard to guidance and best practice standards issued by the DFSA as well as any leading industry bodies. The DFSA intends to develop a Code of Practice for Hedge Funds in consultation with the industry within one year of the proposed Fund regime coming into operation.

Real Estate Investment Trusts

26. Real Estate Investment Trusts (REITs) may be set up under the Fund regime by using the Investment Company structure. We are currently considering whether to allow the use of trust structure for Public Funds.

Consequential amendments

27. The consequential amendments will be made to the current DFSA Rulebooks to give effect to the proposed Fund regime. The Temporary prohibitions relating to the operation of a Fund in the DFSA Rulebook will be removed when the Fund regime is implemented. The other main consequential change is the proposed addition of a new Financial Service called "Providing Fund Administration".
28. Fund Administration is a function which can either be undertaken by the Operator of a Fund as an in-house activity or can be undertaken by a separate Authorised Firm with an authorisation for Providing Fund Administration.

Specific issues on which we seek your comments

29. Do you think that the proposed Fund regime provides an adequate and appropriate level of regulation of Domestic Funds? If not, how could the proposed regime be improved?
30. Do you think the proposed Fund regime provides an adequate level of regulation relating to the marketing of Foreign Funds in and from the DIFC? If not, what changes should be made to the proposed regime?
31. In particular, do you think that the criteria we propose for including in the Recognised Jurisdictions list to be appropriate? If not, what should be the relevant criteria?
32. Do you think it is appropriate to permit the use of unit trust structure as an additional vehicle available for Public Funds?
33. Do you think the proposed Fund regime contains an adequate attraction for Foreign Fund Operators to set up Domestic Funds?
34. Do you think that the proposed controls are appropriate for Private Funds? For example, do you think that participation in Private Funds should be limited to a lower number of Qualified Investors than 100? If so, what number is appropriate and why?
35. Do you think that additional controls proposed for Private Funds which have 30 or more qualified Investors should apply where the Private Fund has a higher number of Qualified Investors, e.g. 50 participants? If so why?
36. Do you think the proposed additional requirements for Hedge Funds adequately address risks inherent in Hedge Funds? If not, what additional requirements should be imposed?
37. Do you think it is appropriate not to have any minimum initial subscription limits for both Public and Private Funds? If so what should those limits be?
38. Are there any specific comments relating to the proposed new Financial Service of "Providing Fund Administration"?
39. Are there other issues relating to the proposed Fund regime which we have not identified? If so, what are they and how should they be addressed?
Proposed DIFC Regime for Operators of Domestic Funds

Proposed DIFC Regulatory Regime for Marketing of Foreign Collective Investment Funds