DIFC Hedge Funds
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.
Why setup a DIFC hedge fund?
The DIFC is a leading financial hub in the region. Besides offering a wide range of financial service activities, the centre also provides an integrated environment and world-class standard of living. It is well regarded in the international community as well.
During 2022, a record number of hedge funds registered in the Centre, with more expected to open in 2023. It has been reported that over 60 hedge funds are in DIFC's pipeline.
The global hedge fund sector is still dominated by older, more established centres like London and New York, but the Middle East is a young market where Dubai offers all the necessary circumstances for expansion, especially in the aftermath of the Covid epidemic. Due to the government's successful management of the outbreak and the far less limitations there than in other centers, Dubai had a significant inflow of managers throughout the pandemic. This gave managers the chance to see firsthand the various benefits the emirate provides hedge funds contemplating establishing an office there.
The growing influx of private wealth
Hedge funds setting up shop in Dubai will have access to the growing institutional and retail wealth in the area. According to reports, the UAE saw the largest net influx of millionaires in 2022 and is becoming an increasingly attractive travel destination for high-net-worth individuals. Private wealth in the nation is thought to be around USD 966 billion, and by 2031, the number of HNWIs in the UAE is expected to increase by 40%.
The Global Family Business and Private Wealth Centre, the first such support center for the ultra-wealthy and family companies, was established by DIFC in March 2023. It is anticipated that this initiative would draw more family businesses and ultra-high-net-worth people to Dubai.
You can also read more about DIFC Investment Funds here:
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
What is a hedge fund?
Hedge funds got their name from investors in funds holding both long and short positions, to ensure that they made a profit despite market fluctuations. This practice is called hedging.
Hedge funds have moved on to many different kinds of structures with different assets and securities, and nowadays mean that the fund manager uses a combination of complex investment strategies and leverage to aim for higher returns. Contrast that to a equity fund or a property fund, which, as the name suggests, invests in listed equities or property assets.
As the first money manager to combine short selling, the use of leverage shared risk through a partnership with other investors and a compensation system based on investment performance, Alfred Winslow Jones earned his place in investing history as the father of the hedge fund.
Typical hedge funds have some or all of the following characteristics:
- They are available to professional investors only;
- They have a wide range of investments;
- They employ leverage;
- They have a 2/20 structure, with 2% management fee and 20% performance fee.
What is a 2/20 structure?
This represents the fixed management fee of 2%, and a variable fee of 20% based on performance. For example, if a hedge fund manager set up a professional fund with an AUM of US$10 million, the fund manager would get 2% of that amount ($200,000) as a fixed fee for managing the portfolio. In addition, if the fund did well and the AUM got doubled to US$20 million, the fund manager would get a performance fee of US$ 2 million, based on the US$ 10 million additional gains generated.
What is the DFSA Hedge Fund Code of Practice?
The DFSA implemented a code of practice for Hedge Fund Managers setup in the DIFC. This code serves as a standard for good practice and aim to address the risks inherent in the operations of DIFC hedge funds. The nine principles set out in the code cover skills and resources, investment strategies, systems and controls and ethical practices.
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.
Types of Funds
A DFSA Hedge fund can be a Public Fund, or a Professional Fund.
Public Funds are open to Retail Clients (as defined by the DIFC), and hence subject to higher levels of regulation. The other features of a Public Fund in the DIFC are:
- No minimum subscription limit;
- Units are offered to the general public;
- Can have any number of unit-holders; and
- Have to comply with IOSCO principles.
Exempt Funds are open only to Professional Clients (as defined by the DIFC). The other features of an EF are:
- Minimum subscription of US$ 50,000; and
- Units are offered to persons only by way of a Private Placement.
Qualified Investor Funds
Qualified Investor Funds are open only to Professional Clients (as defined by the DIFC). The other features of a QIF are:
- Minimum subscription of US$ 500,000; and
- Units are offered to persons only by way of a Private Placement.
Setting up a fund structure in the DIFC
Setting up a fund in the DIFC requires either a) setting up a Domestic Fund Manager or b) licensing an existing fund manager in a recognized jurisdiction, to act as the External Fund Manager of the DIFC fund.
DIFC Capital requirements
The base capital requirement for a Category 3C Fund Manager is US$ 70,000. Actual capital required will depend on the nature, quantum of business and forecasted annual expenditure, as per the financial model of the proposed firm.
Capital waivers may be available to the DIFC branch of a regulated financial institution having its head office in a recognized 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 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 Fund Management firms: 13/52 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.
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 fund management 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.
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.
The DIFC Application Process – fast tracked
The DIFC application process commences with formal introductions to the DIFC and the DFSA.
Following the introductory call, a 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 45 and 60 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 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.
Advising, arranging or managing Virtual Assets
The Dubai Financial Services Authority (DFSA) recently implemented a Digital Assets Regime, thus opening the gateway to a whole new world of exciting and cutting-edge fintech applications using the Distributed Ledger Technology (DLT).
The first part covers Security Tokens, and Part 2 of the DIFC Digital Assets Regime covers Crypto Tokens, Utility Tokens, Exchange Tokens and Stablecoins.
Any licensed firm that wishes to advise, arrange or manage crypto-assets, will have to apply for additional endorsements to their licenses. Get in touch with us to know more.
Setting up a DIFC Regulated Firm involves the following interactions:
Dubai Financial Services Authority (DFSA)
The DFSA is responsible for reviewing and approving all applications for financial services. Costs depend on the activities applied for, which puts the applicant in one of five categories.
Generally, there are two components of DFSA fees. One – an application processing fee, and the other, an annual licensing fee.
Application fee: US$ 10,000 for a Fund Manager license application.
License fee: US$ 10,000 for a Fund Manager license application.
The above figures are US$ 5,000 each in case of Fund Managers that manage Qualified Investor Funds.
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:
Application for reserving a name (2 working days): US$ 800
Application for Incorporation of a Private Company Limited by Shares (5 working days): US$ 8,000
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:
Registration - US$ 500
Annual renewal – US$ 250
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:
DIFC Business Centre – from a two-desk office at US$ 35,000.
DIFC Fitted Offices – from US$ 55 per square foot.
Other buildings – from US$ 32,000 per annum
Establishment Card Application – US$ 630
PSA Deposit – US$ 682
Visas (per visa) – from US$ 1,500
PSA Deposit (per visa) – US$ 682
A hedge fund in the DIFC will also need to appoint some service providers to carry out critical functions, such as fund administration and audits.
Third-party service providers
An investment fund in the DIFC requires a basic network of service providers, who carry out key outsourced functions, and help the fund conduct it’s activities.
A fund administrator carries out calculations of Net Asset Values (NAV) of the fund units, manages the investor onboarding process, including subscriptions & redemptions, and does all necessary due diligence on the investors. A fund administrator also prepares financials reports for the fund. In case of open-ended funds, a fund administrator also carries out trade and account processing, confirmation of trades & reconciliations, cash management, shareholder register management, investor document retention and overall investor communication on all reporting and corporate actions.
A Qualified Investor Fund in the DIFC does not have to appoint a fund administrator for closed-ended funds and this function can be handled in-house, if the fund manager has capabilities and qualified personnel. However, in most cases, a fund administrator brings to the table a lot of benefits that can be valuable especially to smaller funds who cannot carry out this function effectively in-house.
It is mandatory to appoint legal counsel for an investment fund. A typical fund setup involves at the very least, three main documents – a detailed private placement memorandum (PPM), an investment management agreement between the fund manager and the fund, and a fund constitution that serves as the Articles of Association of the fund and helps govern the internal matters of the fund. Other relevant documents include the information memorandum, which is usually a subset of the PPM, and subscription agreements that can be quite detailed in some cases.
Legal counsel help draft this extensive set of documentation, and review fund marketing material. They also play a role in investor dispute resolution & litigation.
Prime brokers function as the fund’s gateway to the financial markets, by offering services like execution & clearing, securities lending (shorting), and financing (leverage/margin trading). Additional services include financial reporting, operational and risk consulting and management, and these can also be offered by prime brokers. The fee structure for prime brokers tend to vary to other service providers. Fees are normally charged indirectly: Spreads on financing (by offering leverage and facilitating share borrowing for brief sales), trading commissions charged for execution & clearing and costs for custody & clearing services. While startup hedge funds may initially start with one prime broker, over time most hedge funds diversify and retain multiple prime brokers.
All funds require custodians, who safeguard fund assets by providing cash and securities custody services. Custodians offer the hedge fund & investors transparency over assets and ensure a further layer of operational scrutiny over the security and security of assets. Some prime brokers have custody services as a part of their offerings. However, large hedge funds may plan to use a custodian separate to their prime broker. Custodians may provide additional services, like calculating NAV of a fund, monitor local sub-custodians where region-specific regulatory constraints require institutions to carry assets within a selected jurisdiction and cash management & FX services.
Every fund requires a bank account, which serves as the cash custodian. Investors transfer subscription monies into this bank account, and redemptions are also processed from the fund’s bank account. A fund may open multiple bank accounts in many countries, to facilitate subscriptions. For smaller funds however, one bank account is sufficient.
The DFSA usually requires an external auditor to be appointed for investment funds. Auditors also work with the fund administrator and assess the valuation of the fund and verify the fund’s annual financial statements. In addition, they review the fund’s valuation methodology and its implementation. A consent letter from a suitably qualified external auditor is required as part of the DFSA regulatory process.
Other third-party service providers, which are not required but may be used by new hedge funds, are listed below.
An outside/part-time CFO could also be hired to advise on finance-related matter, as startup funds might not want to retain a full-time CFO given budgetary constraints. CFOs work with the auditor and administrator to organize financial statements, oversee income, budgeting & financial planning requirements, manage third-party service providers and supply in-house tax and compliance-related advice.
Hedge Fund Consultants
A third-party hedge fund consultancy is usually engaged to provide marketing services and investor relations. Most startup hedge funds have to present their value proposition to multiple potentials, and marketing documentation not only has to be visually appealing, but also has to convey the offering in an effective manner. Hedge Fund consultancies help in bridging this marketing and sales servicing gap.
Risk & Compliance
An outsourced compliance firm has to be engaged advise on DFSA-compliance-related matters, draft internal AML/KYC policies, procedures and controls, develop appropriate employee training and review existing AML/KYC processes, examine risk-related procedures and methodologies utilized in the hedge fund. Usually, the fund manager’s compliance function is extended to the Fund as well.
Corporate tax is now a reality in the UAE and will be implemented from June 2023. VAT already exists. Also, Investment funds in the DIFC are able to source clients from multiple countries. These clients may come in through ancillary structures, for tax benefits. An external tax advisor consults on the suitability of fund structures, corporate tax compliance matters and on individual tax-related matters, if applicable.
Technology & Operations Consultants
Capital markets consulting firms could also be employed by startup investment funds to line up both physical and digital infrastructure for the hedge fund. Consultants may help integrate technology with data feed suppliers and other third-party software platforms, manage document management solutions and style and maintain hedge fund’s public-facing & investor-facing website.
Technology Vendors & Research Boutiques
Investment funds that engage in active trading, usually enter into agreements with data providers like Thompson Reuters, trading terminals such as Bloomberg, news platforms and research boutiques, to make sure that the fund analysts are well equipped for their roles in researching and advising on securities.
DIFC Investment funds may outsource the human resource and recruitment functions to an HR specialist. The role of an HR specialist ranges from sourcing new candidates and graduate recruitment to managing internal training programs, liaising with the CFO and the Finance department for employee payroll and incentive calculation, DEWS registrations and processing, and handling employee disputes.
With the increased use of technology in finance, along with the prevalence of associated risks, cyber risk management requirements for regulated firms have been detailed in a new consultation paper issued by the DFSA. All financial firms would be expected to put in place detailed IT and Cyber Risk Management processes, and good practice would also mean conducting regular IT audits.
Starting an investment fund not only requires deep understanding what investment strategies, but also of the various structures available and the documents required for these structures. Broadly speaking, there are two main categories of hedge fund structures in the DIFC – partnerships and investment companies. Let’s take a closer look at the statutory documents required to setup partnerships and investment company-related structures in the DIFC.
For DIFC-investment companies:
- Private Placement Memorandum.
- Subscription Agreement (for investors).
- Investment Management Agreement.
- Fund Constitution.
For DIFC Partnerships:
- Private Placement Memorandum.
- Limited Partnership Agreement.
- Subscription Agreement (for investors).
- Investment Management Agreement.
Private Placement Memorandum
A Private Placement Memorandum, or PPM, is the key document for DIFC Investment funds. The PPM details material information on the fund and serves as the backbone of the legal documentation involved.
A PPM contains specific information about the terms of the offering, the structure of the investment, the background of the fund manager and related professionals, service providers, statutory and commercial disclosures. Prospective investors make a choice about whether to subscribe to the fund, based on this PPM and other supplementary documentation provided by the investment manager. A condensed form of the PPM, called the term sheet, is usually used as a teaser to gauge interest in the fund. This term sheet mentions specific information and refers to the more detailed PPM.
A typical PPM contains:
- A summary of the offering.
- Investment objectives and strategies.
- Investment methodologies.
- Risk factors
- Background of the promoters.
- Details on the Investment Manager and advisors.
- NAV calculation methods.
- Legal background and rules & regulations that the Fund is subject to.
- Service providers involved in servicing the fund.
The subscription agreement sets out the terms under which an investor subscribes to the fund and holds non-voting participating shares within the fund structure.
In addition to the terms, the investor will make representations and warranties within the subscription agreement, which can include his/her compliance with the suitability tests (status as a ‘professional investor’ as required by the DFSA).
In most cases, a subscription agreement forms part of the annexure of the fund PPM. Some subscription agreements mention a specific rate of return that will be paid to the investor, such as a particular percentage of company net income or lump sum dividend payouts, and related payment dates.
Investment Management Agreement
An investment manager is contracted by the fund, to manage it’s assets. In case of DIFC funds, they can be managed by a Domestic Fund Manager (setup in the DIFC) or an external fund manager (setup in a recognised jurisdiction). This arrangement is governed by an Investment Management Agreement, that managed the contractual relationship between the two parties. It grants the investment manager power of attorney over the assets of the fund and gives the investment manager the authority to manage the fund’s investments.
The investment management agreement usually contains:
- Power of attorney to the investment manager.
- Details on the discretionary powers granted.
- Management and performance fee structure
- Disclosure of potential conflicts of interests, and mitigation.
- Representations and warranties.
- Liability limitation and indemnities.
- Other Agreements.
We provide turnkey services for Hedge Fund license applications. From initial 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:
1. Reviewing the business model and advice on the applicable regulatory framework;
2. Preparation of the Regulatory Business Plan and comprehensive financial projections;
3. Preparation of all policies, processes and manuals required;
4. Provision of Outsourced Compliance Officer, Outsourced Risk Officer and Outsourced Finance Officer services;
5. Finalising the legal structure, including holding company setup and customisation of Memorandums; and
6. Finalisation of leased space, bank account opening and obtaining Financial Services Permissions.
Get in touch today to more information on hedge funds in the difc.