Setting up an Alternative Trading System in the DIFC
Why setup a financial services firm in the DIFC?
DIFC is one of the world’s top eight onshore financial centers and offers a secure and efficient platform for businesses and financial institutions to reach into and out of the emerging markets of the region. The quality and independence of DIFC’s regulator, the prevailing common law framework, excellent infrastructure and tax efficiencies make it the perfect base to take advantage of the rapidly growing demand for financial and business services in the MENASA region.
DIFC fills the time-zone gap for a global financial centre between the leading financial centres of London and New York in the West and Hong Kong and Tokyo in the East.
What is an Alternative Trading System?
An ATS is a platform that is more loosely regulated than an exchange. It is used to match large orders mainly from institutional clients, and hence work as broker-dealers rather than exchange houses. They are also referred to as Multilateral Trading Facilities in Europe.
The DFSA recognizes two types of ATS platforms – Multilateral Trading Facilities that operate on non-discretionary rules, and Organised Trading Facilities that operate on discretionary rules.
MTF operators allow for trading of a wide variety of equity and non-equity securities, including shares, warrants, options, derivatives, futures, CFDs, fund units and crypto assets. Contracts between buyers and sellers are formed according to a set of transparent rules that do not discriminate between members or their clients (non-discretionary basis).
Organised Trading Facilities on the other hand, are facilities where contracts for the exchange of non-equities such as bonds, structured finance products, emission allowances or derivatives are formed, on a discretionary basis. An MTF is usually operated by a regulated investment firm or an operator, whereas an OTF can only be operated by a regulated investment firm.
Why are Alternate Trading Systems of interest in the DIFC?
While the DIFC has provisions for ATS facilities, there are none registered at present. This is set to change however, with the introduction of the DIFC Digital Assets Regime. It is expected that there will be interest from ATS operators to register and get regulated in the centre, primarily to engage in Security Token Offers and secondary trading of crypto assets.
What does DIFC consider to be a token, or a crypto-asset?
The DFSA defines a token as a digital representation of value, rights and obligations that are created, stored and transferred electronically, using distributed ledger technology (DLT) or similar technology.
Generally, crypto-assets depend on cryptography and distributed ledger as part of their perceived or inherent value. They are created, stored and transferred using a DLT application, using:
- An address,
- a public key corresponding to that address, and
- a private key, also corresponding to that address.
What does the DFSA consider to be a Security Token?
In addition, a Security Token is defined as a token that confers rights and obligations that are:
(i) the same as those conferred by a share, debenture or futures contract (Investments); or (ii) substantially similar in nature, purpose or effect, to those conferred by Investments.
In effect, a Security Token is a token that behaves as a security (equity, debenture, convertible, future, option etc.) and is hence considered by the DFSA as a specified investment.
What is a security?
The DFSA has a list of instruments that they consider a security. In general, a transaction is considered a security if a) there is an investment of money, b) there is an expectation of profit, c) the investment of money is in a common enterprise and d) any profit comes from the efforts of a promoter or third party. This is also commonly known as the Howey Test.
How would the DFSA determine whether a particular Security Token is an Investment or not?
The DFSA aims to take a hybrid approach, where they will make their own assessment of whether the proposed token is a Security Token, based on a self-assessment submitted by the applicant.
Can an ATS operator conduct a Security Token Offering (STO)?
Security Tokens can be listed and traded on DFSA-regulated exchanges or Alternate Trading Systems, with both facilities being able to host initial token offerings and secondary trading.
The current admission criteria will also be applied to such Security Tokens, in a way that tokens trading elsewhere will also be tradable in such facilities.
In cases where the ATS is exclusively dedicated to trading only in Security Tokens, it would be labeled a Security Token Market (or Derivative Token Market).
Is direct access allowed in case of DFSA-regulated ATS operators?
Earlier, only persons who met certain criteria were allowed access to DFSA-regulated exchanges, clearing houses and ATS platforms. Direct access models are now allowed under the DIFC Digital Assets Regime.
Accordingly, this article is focused on the requirements for licensing an ATS operator who wishes to allow listing and secondary trading of Security Tokens from the DIFC.
Can a DFSA-regulated ATS operator allow for trading of all kinds of tokens?
The DIFC Digital Assets Regime currently covers Security Tokens only. It is anticipated that the second part of the Regime will cover Stablecoins, Utility Tokens and Exchange Tokens. Until then, only Security Tokens can be admitted for primary and secondary trading on the ATS.
Firms interested in carrying out financial services from the DIFC are required to submit applications to the Dubai Financial Services Authority, or DFSA.
The type of business that the applicant wishes to engage in defines the category of License that is required. For example, a firm undertaking low risk activities such as advising or arranging will require a Category 4 License, while a discretionary portfolio manager will require a Category 3C License. A STP broker, dealing on a matched principal basis will require a Category 3A License, whereas a market maker or provider of credit provider will require a Category 2 License. Full-fledged banks, that accept deposits, will come under a Category 1 License.
A common misinterpretation is that a firm applies for a DIFC Category 3C or a DIFC Category 4 license. As described above, the activity defines the category, i.e. a company that wishes to engage in Asset Management, advisory and arranging activities falls in the Category 3C, by virtue of the highest activity of Managing Assets, even though advisory activities fall in category 4.
ATS operators will have to apply for the activity of Operating an Alternative Trading System, which comes under the Category 4 licensed activities.
Category 4 – Operating an Alternative Trading System
Base Capital – US$ 140,000
The DFSA expects that the ATS Operator have transparent and non-discriminatory rules and procedures to ensure fair and orderly trading of investments, and objective criteria governing access to its facility. The regulator also requires the ATS operator to have objective and transparent criteria for admitting securities that will be traded on the platform, adequate technology resources and procedures for proper market conduct.
An ATS Operator may only trade investments that reference to an underlying benchmark or index provided by a Price Information Provider, which is usually a price reporting agency or an index provider like Refinitiv.
The ATS operator is also required to provide adequate pre-trade and post-trade transparency to its market participants. Since an ATS Operator is not authorised to provide clearing and settlement services, it will have to make arrangements for clearing and settling trades from an existing clearing house in the DIFC (Nasdaq Dubai is the only such institution at present).
Technology and governance requirements for ATS operators that deal in Security Tokens
ATS operators that allow primary listing and secondary trading of Security Tokens will have to ensure that the DLT applications used by the facility operate on permissioned access. Privacy tokens and anynomous trading are not allowed.
The DFSA would be interested in reviewing the criteria for market participants who access and update records on the platform, network security and ongoing compliances. They would also review the IT design of the DLT implementation adopted by the facility that trades security tokens, and whether it is able to address how the rights and obligations relating to the tokens are properly discharged.
Technology governance mechanisms would also be reviewed, including IT architecture, storage and transmission of data, procedures to address soft and hard forks, cyber-security measures,
decision-making protocols and interfaces with providers of digital wallets.
A comprehensive IT audit, conducted by an independent third-party IT expert would be required to be submitted to the DFSA annually.
The DFSA expects that the ATS operator be adequately staffed depending on the scale, scope and nature of the product portfolio that is proposed to be offered from the DIFC. At a minimum, the DFSA would like to see the following appointments:
Board of Directors – a well-organized Board with robust governance policies. The Chair would have to be a non-executive Director.
Senior Executive Officer (SEO) – Senior banking professional with over 10 years of experience, ordinarily resident in the UAE.
Finance Officer (FO) – Senior and suitably-qualified finance professional. In case of a group, the FO can be from the parent company and does not have to be resident in the UAE. This role can also be outsourced.
Risk Officer – This position is usually outsourced, and not mandatory.
Chief Technology Officer – suitably qualified and experienced IT expert.
Compliance Officer (CO) - Senior compliance professional with over 10 years of experience, ordinarily resident in the UAE.
Money-Laundering Reporting Officer – Senior AML professional with over 10 years of experience, ordinarily resident in the UAE. This function can be combined with Compliance and one individual can carry out both responsibilities.
The CO and MLRO roles can also be outsourced.
Internal Auditor - Senior and suitably qualified internal audit professional. Usually outsourced to a professional firm.
External Auditor – DFSA-recognised auditor.
Independent IT Auditor – Suitably qualified IT expert (e.g CISA, CISM, ISACA, CISSP qualified)
DIFC Capital requirements
The category of license will determine the amount of capital required. The base capital requirement for a Category 4 firm is $10,000. This rises to $500,000 for a Category 3 firm, $2 million for a Category 2 firm and $10m for a Category 1 firm.
Capital waivers may be available to the DIFC branch of a regulated financial institution having its head office in a recognised regulatory jurisdiction.
Actually, there are three components of capital - base capital, risk-based capital and expense-based capital. The higher of the three is set to be the capital requirement. These figures are calculated using the financial models that we make for the Regulatory Business Plan during the application process, and so are mostly unique to the company that applies for the license.
The figures given above are for base capital only, and actual capital may vary depending on the business model and the associated expenses and risks.
In general, for ATS operators that hold Client Assets - 18/52 of the projected annual expenses of the firm.
Calculation of capital is a detailed process and involves many factors. We recommend that you contact us for more details on the application process and capital calculations.
Can DIFC firms service clients outside the centre, and in the greater UAE?
Yes, they can. Sheikh Mohammed bin Rashid Al Maktoum issued Law No. (5) of 2021 relating to the DIFC, which brought further clarity to the rules governing the promotion and supply of services and products for firms registered in the centre.
The revised law confirms that DIFC-registered entities can supply services and products outside the DIFC, as long as they are primarily provided out of the firm’s premises in the DIFC area. Marketing and promotional activities are also allowed outside the centre.
There may be additional rules to follow, for instance, when actively marketing funds from the DIFC. A passporting regime exists in this case, where the fund manager can register for a passport for the fund to be marketed in the UAE and the ADGM. Do get in touch for more information on this.
Here are some specific advantages of establishing in the Dubai International Financial Centre.
LEGAL AND REGULATORY FRAMEWORK
- Legal framework supports cross-border activities
- 100% foreign ownership permitted
- No restriction on foreign talent or employees
- No restrictions on capital repatriation
- Zero tax for 50 years on profits, capital or assets from 2004
- Zero tax on employee income
- Highly regarded, independent regulator
- Independent, English-speaking, common law judicial system
- Distinct from the UAE legal system
- Risk-based regulatory approach
- Central to regional deal making
- High concentration of international firms, investment funds, wealth management firms, banks, and financial institutions
- World-class regional and international law and auditing firms, and other professional services
- The largest fund domicile in the region
- Management offices, holding companies and family offices are located closer to the assets they own or manage
- The Middle East, Africa and South Asia (MEASA) is increasingly the centre of gravity for the global economy
- Dubai plays a central role in the growing South-South trade, principally between Asia and Africa
- Well-positioned to harness the potential of emerging markets
The Application Process
The DIFC application process commences with formal introductions to the DIFC and the DFSA.
Following the introductory call, a detailed Regulatory Business Plan (RBP) is prepared, along with financial projections, for a quick review by the regulator.
The comments of the regulator are incorporated into the RBP, and a comprehensive application is compiled, comprising policies, processes and other related documentation. The KYC and associated forms of all key individuals are also prepared for submissions.
The formal application is then sent across to the DFSA, who reviews the pack over a period of 7-10 business days, and then accepts it. The detailed review process then commences, and this can take anywhere between 90-120 days to complete.
The regulator maintains communication with the applicant at all times during the review, reverting with an initial review 2 weeks into the application, and then follow-up reviews thereafter. The DFSA also meets with the SEO, FO, Technology Head and CO/MLRO designates, and conducts a detailed interview with them.
An in-principle approval is issued in case the application is successful. The applicant then proceeds to satisfy the in-principle conditions, and this involves the setting up of a legal structure, opening a bank account, and depositing the share capital in the account. Other tasks include finalization of auditors and obtaining professional indemnity insurance for the firm.
Once done, a final submission is made to the DFSA, following which the regulator issues the Financial Service Permissions and the process is then complete. The firm is now open for business.
Setting up an Alternative Trading System in the DIFC involves the following interactions:
Dubai Financial Services Authority (DFSA)
1. Application fee –US$ 150,000
2. Annual fee –US$ 100,000
3. ATS operators who allow Direct Access – US$ 10,000 additionally per annum
4. Retail Endorsements – US$ 20,000 (one-time).
Registrar of Companies (ROC)
The DIFC ROC helps to set up the legal structure of the DIFC Firm. In most cases, this would be a Private Company Limited by Shares. Shareholders can be individual, or corporate. The costs for setting up such a fintech company are:
1. Application for reserving a name: US$ 8,000
2. Application for Incorporation of a Private Company Limited by Shares: US$ 12,000
The data protection notification is part of the process of registering a new entity in the DIFC. The costs involved are as follows:
1. Registration - US$ 1,250
2. Annual renewal – US$ 500
Every entity registered in the DIFC is required to lease a physical office. You can choose from the Gate and surrounding buildings, or other buildings within the DIFC, such as Emirates Financial Towers, Central Park, Park Avenue, Burj Daman and Currency House.
Prices vary, depending on the space availed and the building. Here is an indication of the prevailing rates:
1. DIFC Business Centre – from a two-desk office at US$ 35,000.
2. DIFC Fitted Offices – from US$ 55 per square foot.
3. Other buildings – from US$ 35,000 per annum
1. Establishment Card Application – US$ 630
2. PSA Deposit – US$ 682
3. Visas (per visa) – from US$ 1,500
4. PSA Deposit (per visa) – US$ 682
5. Visa allocation is calculated as 80 square feet per visa.
We provide turnkey services for DIFC ATS Operator Licenses. From inital consultations, to assistance in authorisations, to assistance in preparation of the legal documentation, 10 Leaves helps you navigate the DFSA Rulebook and submit an application that is comprehensive, complete and compliant.
Our services include assistance in:
- Reviewing the business model and advice on the applicable regulatory framework;
- Preparation of the Regulatory Business Plan and comprehensive financial projections;
- Preparation of all policies, processes and manuals required;
- Assistance in retaining the services of the Internal, External and IT auditors;
- Provision of Outsourced Compliance Officer and Outsourced Finance Officer services;
- Finalising the legal structure, including holding company setup and customisation of Memorandums; and
- Finalisation of leased space, bank account opening and obtaining Financial Services Permissions.
We also assist with corporate and commercial documentation through our legal consultancy - 10 Leaves Legability. We assist in the drafting of:
- Crypto-asset Purchase Agreements
- Crypto-asset Terms and Conditions
- Key Features Documents for Security Tokens
- Private Placement Memorandums for Tokenised Funds
- STO Prospectuses
- Simple Agreement for Future Tokens (SAFT)
- Privacy Notices
- Founder agreements
- Shareholder agreements
- Investor agreements
- Share vesting/ESOP plans
- Client/Supplier/Distributor agreements
- Employment agreements
We also provide services in Luxembourg, Saudi Arabia and Mauritius, For More Details Contact us here.