Setting up a Tokenised Real Estate Crowdfunding Platform in the DIFC
The DIFC came out with their Crowdfunding regulations in 2018, and this year they released the first part of their Digital Assets Regime covering security tokens. A combination of tokenization and crowdfunding may be non-existent in this part of the world, but we have seen keen interest in tokenization, crowdfunding and a combination of both.
We currently advise a number of upcoming crowdfunding platforms in the region, many of them undergoing the process of DFSA authorisations, and have received many enquiries on tokenization. Here is a look at tokenised real estate crowdfunding platforms in the DIFC.
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 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.
Benefits of tokenization
Tokenisation has the potential to significantly change real estate investment. Currently,
Trading in real estate involves comprehensive paperwork, high costs and compliance checks, besides a steep entry point and additional payments on exit. Tokenisation now allows investors to buy smaller stakes in multiple properties without the inefficiency of the current processes, and with much greater ease.
The main benefits of tokenization include:
1. Fractionalisation leading to unlocking liquidity – Real Estate is traditionally a fixed, illiquid asset. Through tokenization, it can be broken down and represented as tokens, thereby fractionalising the underlying asset and offering new investment opportunities and nearly eliminating illiquidity discounts.
2. Access to global markets – Investors can buy tokens representing a shares in assets in any part of the world, thus adding more depth to liquidity, and more diversified investment portfolios. An example would be of an investor in Bengaluru holding tokens of underlying real estate in Dubai, or an investor in Ghana holding tokenised debentures of an SME in Sharjah, all within a few clicks.
3. Operational efficiency - Smart contracts are programmable actions on the blockchain that facilitate the automation of processes such as compliance checks, investor on-boarding, and post-issuance matters including dividend distribution and exit. For example, a tokenised crowdfunding platform can automatically release dividends on a pre-determined basis and assign voting rights based on tenure of holding of the token.
4. Reduced settlement times – Tokenised products are settled in almost real-time, as compared to T+2 or T+3 settlement times in conventional markets. Platforms that deal in tokenised offerings operate 24/7, unlike conventional markets that are closed on the weekend.
5. Potential interoperability of assets – As Stephen McKeon explains – one can hold ownership claims to a commercial building, early-stage equity, corporate bonds, family residences and a DLT application on a single platform.
6. Data Transparency and Security – DLT-based applications are known to be resilient to cyber-attacks, as opposed to data on centralized servers. Transaction information is trackable and publicly visible on the blockchain.
7. Automated compliance – KYC/AML measures can be baked into the token itself, using smart contracts. A case in point being Polymath working in tandem with tZERO and other exchanges.
8. Flexibility – Tokenisation assists in construction of flexible portfolios and deeper diversification, and more insightful analyses to make better investment decisions.
What is crowdfunding?
The past few years has seen disruptive innovation in financial technology and the financial services sector is changing access to finance in more ways than one. Crowdfunding, as the name suggests, involves sourcing finance from the ‘crowd’, or a large pool of individual investors (mostly retail), as opposed to obtaining finance from a bank or other financial institutions.
At the core of the crowdfunding business is a platform, based on innovative technology, that can be a combination of a website and an app. This platform offers an online marketplace for seekers of finance, and sources of finance (the crowd). Consequently, the DIFC licenses three main types of regulated crowdfunding businesses:
- Investment-based crowdfunding - where businesses offer equity in return for finance;
- Loan-based crowdfunding - where issuers offer an interest on monies borrowed under a loan agreement with lenders on the platform; and
- Property-based crowdfunding - where the platform lists properties in which investors can take fractional ownership.
The DFSA currently does not regulate charity-based crowdfunding platforms, and hence there is no such license available at the DIFC.
Crowdfunding platforms pioneered fractionalization by offering access to smaller bits of real assets, securities and debt. Tokenisation takes this to a new level by offering interoperability across local and international markets. Imagine the scenario of a token of a real estate asset in Dubai being traded in Europe or the States. This will open new markets and give access to new investors who would have traditionally not found any way of investing in assets so far away from home.
DIFC Crowdfunding License
Firms interested in carrying out crowdfunding activities from the DIFC are required to submit applications to the Dubai Financial Services Authority, or DFSA.
The DFSA, for the purposes of authorisation and supervision, categorises the crowdfunding business as a Category 4 entity, with the primary activity of “Operating a Crowdfunding Platform”. The base capital required for a DIFC Crowdfunding license is US$ 140,000.
The DFSA offers three types of crowdfunding licenses:
(i.)Investment-based Crowdfunding Platform.
(ii.)Loan-based Crowdfunding Platform.
(iii.)Property-based Crowdfunding Platform.
DIFC Crowdfunding Platforms are able to cater to retail clients, with certain additional requirements to ensure retail client protection. For instance, retail investors will only be allowed to invest upto US$ 50,000 in a single calendar year.
Due to the nature of the license, and the recent issuance of crowdfunding regulations, the DFSA places slightly higher entry-level requirements and restrictions on the license itself.
You can also setup in the DIFC with a DIFC Innovation License, which is for non-regulated technology startups. Such a license encourages startups to establish a presence in the region, employ staff and prepare for regulation by then applying to the DFSA for regulatory approvals. You cannot however, carry out regulated activities until a Financial Services Permission has been obtained.
This will be an additional step. The property, once funded, will have to be transferred to an SPV, whose shares can then be tokenised and released to the investors (akin to an initial offering of tokens).
Given that the DFSA currently does not encourage a secondary market for crowdfunding shares, it may be that the tokens will have to be listed with a regulated ATS in the DFSA (or equivalent jurisdiction).
The DFSA mandates that firms that market, promote, manage or undertake any other financial services in relation to Security Tokens will be required to provide to their clients a Key Features Document, with relevant disclosures. We anticipate that this requirement will also hold for tokenised crowdfunding platforms.
A comprehensive IT audit, conducted by an independent third-party IT expert may also be required to be submitted to the DFSA annually.
We would approach this on a case-to-case basis.
The DFSA expects that the firm 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 - Senior and suitably qualified external audit firm. The DFSA maintains a list of recognised auditors, and there are 15 such firms at present.
Independent IT Auditor – Suitably qualified IT expert (e.g CISA, CISM, ISACA, CISSP qualified)
DIFC Capital requirements
The base capital requirement for a Category 4 Crowdfunding Business license US$ 140,000. Actual capital required will depend on the nature, quantum of business and forecasted annual expenditure, as per the financial model of the proposed firm.
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 Planduring the application process, and so are mostly unique to the company that applies for the license.
The figures given below are for base capital only, and actual capital may vary depending on the business model and the associated expenses and risks.
In general, for Crowdfunding Licenses, since they hold Client Money - 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.
The DIFC 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 60 and 90 days to complete.
A critical part of this process is the detailed demo of the crowdfunding platform during which the applicant would be expected to demonstrate the crowdfunding solution for review. This is a live demo and takes around an hour, following which the DFSA sends in their comments and asks for additional clarifications.
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 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.
The tokenization will happen in stage 2, after a particular investment in an underlying property has been closed and the related SPV has been formed, with the real asset being transferred to it.
Setting up a DIFC Regulated Firm to operate a crowdfunding platform involves the following interactions:
Dubai Financial Services Authority (DFSA)
The DFSA is responsible for reviewing and approving all applications for financial services.
Generally, there are two components of DFSA fees. One – an application processing fee, and the other, an annual licensing fee.
1. Application fee: US$ 5,000
2. Retail Endorsement fee: US$ 20,000
3. License fee: US$ 10,000 per annum.
Registrar of Companies (DIFC ROC)
The ROC helps to set up the legal structure of the DIFC Regulated Firm. Shareholders can be individual, or corporate. There are many options available, such as ‘Private Company Limited by Shares’ and ‘Limited Liability Partnerships’. In case of Private Company Limited by Shares, the costs for setting up include:
1. Application for reserving a name (2 working days): US$ 800
2. Application for Incorporation of a Private Company Limited by Shares (5 working days): US$ 8,000
3. Commercial License on Incorporation (5 working days): US$ 12,000 (annual fee)
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 Fintech business centre – from US$ 19,000
2. DIFC Business Centre – from a two-desk office at US$ 35,000.
3. DIFC Fitted Offices – from US$ 55 per square foot.
4. Other buildings – from US$ 32,000 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
Visas are issued based on office space availed, and are usually calculated at 80 sq.ft. per visa.
We provide turnkey services for DIFC Crowdfunding business license applications. From fintech consulting, 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;
- 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 Information On Tokenised Real Estate Crowdfunding Platform In The DIFC, Contact us here