The United Arab Emirates (UAE), is one of the highly preferred international commercial hubs by entrepreneurs, investors, and businesses, because of its favorable economic policies and robust financial regulatory organizations. UAE’s legal framework has provided for the establishment of two major international financial free zones, which are, the Dubai International Financial Center (DIFC) located in the Emirate of Dubai and the Abu Dhabi Global Market (ADGM) located in the Emirate of the Abu Dhabi. DIFC and ADGM are regulated by their own set of regulations and rules and courts. DIFC has become a well-established and leading international financial hub, contributing to the effective growth of Dubai’s economy and the Middle East and North Africa (MENA) region. ADGM being a global financial hub has also successfully provided a progressive and robust financial ecosystem in a manner enriching the economy of Abu Dhabi. The UAE acknowledging the role of the start-ups and the Small and Medium Enterprises (SMEs) in contributing to the significant growth of the UAE’s economy, has taken adequate steps in establishing required and robust economic regulations and laws to cater to the financial needs of the private companies.
The concept of Private Financing Platforms (PFPS) has been introduced to provide an alternative financial source for start-ups and SMEs, as the bank systems have been rigid when it comes to lending to such small-scale private entities. In the year 2018, the Financial Services Regulatory Authority (FSRA), the financial regulator of the ADGM has passed a regulatory framework to regulate the PFPs, to mitigate the risks involved in such peer-to-peer investment. This article shall briefly lay down the regulations that govern the PFPs in the ADGM as per the regulatory guidance provided by the FSRA and other relevant laws.
Definition of PFPs & Who are considered as Operating PFPs
The Financial Services and Markets Regulations (FSMR) of 2018 (Amendment Number 4) provides provisions on who are considered as operating PFPs and the meaning of PFPs. Schedule 1, Chapter 17C, section 73E (3) (a), defines a PFP as an entity that intends to provide the financial source from one individual to another, either in the form of debt or equity on an electronic platform. Further, clause b of the same section defines an electronic platform as a website or any other kind of electronic media. Section 73E, 3 (c) of the schedule 1 of the FSMR interprets the word to provide (facilitate) as follows- Any person who is operating PFPs or by an arrangement with another person carries out the following actions shall be considered as facilitating financing from one person to another person:
- If conveys information to a person with regards to specified investment offered by another person, either directly or indirectly;
- If takes initiatives to recover the debts owed by one person to another person, either directly or indirectly;
- To exercise rights or carry out any obligations regarding the specified investment on behalf of another person.
The word ‘arrangement’ can also include a sale of shares or rights conferred by any investment vehicle, either established, owned, or managed by the person operating a PFP, by a person running PFPs to another person. However, if any person is only providing the medium through which one individual can connect or communicate directly with another individual of the same transaction shall not be deemed as a person who is operating a PFP.
Section 73E of Chapter 17C of the FSMR lays down as to who is considered as a person operating a PFP (Regulated Activity), as follows:
- Connects one individual (the creditor) to another (borrower) individual via electronic platforms for lending;
- Connects one person to another person through any form of electronic platforms to allow one of the persons to either directly or indirectly for purchasing or subscribing a specified investment that the other person issues;
- Connects one person to another person by any means of electronic platform, wherein, one person either directly or indirectly purchases an instrument that acknowledges the indebtedness arising from the delivery or supply of goods or services by the other person;
- If has entered into an arrangement with a person to facilitate the above-stated activities either through an intermediary investment vehicle or otherwise;
- Possesses control over the client’s money or arranges custody in line with an arrangement for the activities stated above;
- Runs an incidental facility on the PFP, for a person to transfer its rights in an arrangement to another person.
As per section 15 (2), Financial Services and Markets Regulations of 2015, the regulatory guidance on the PFPs has been introduced (the Regulatory Guidance on PFP). The Regulatory Guidance on PFP shall be read in line with the FSMR and the relevant rulebooks and the guidance & policies manuals of the FSRA. As per the Regulatory Guidance on PFP, the objectives of the PFPs are as follows:
- The PFPs are virtual platforms that provide the private entities like the start-ups and SMEs to obtain funds from private and institutional investors to establish and scale up their businesses;
- PFPs act to enhance the economic growth in the MENA region by providing an alternative source of obtaining finance for start-ups and SMEs. The PFP shall encompass invoice financing platforms, equity funding, a private placement to come up with new approaches to raise money for small businesses from potential and professional investors like individuals of high net worth, or private equity, venture capital, family offices, accelerators/incubators, and angel investors, by leveraging data and using technology.
The Clients as per the Regulatory Guidance on PFP
As per the Regulatory Guidance on PFP, the word client represents the creditors and investors on the purchasing side in a transaction facilitated through a PFP. Due to the high risk involved in the transactions done via PFP, the FSRA has restricted the clients who are eligible to participate in the transactions to professional clients. The professional clients are deemed to have sufficient experience and are more sophisticated, to make apt decisions on the prospective debt and equity instruments provided through the PFP, after thoroughly assessing the risks involved in such transactions. The PFP operators will not offer any financial advice to clients. The clients are responsible for making their due diligence before entering into any PFP transactions but the client can take legal advice from finance lawyers. In certain circumstances, the PFP operators make also cater to the financial needs of the clients who fail to meet the required criteria set for professional clients with relevant permissions (the retail clients). Further, a PFP prospect shall be a corporate body. The clients are required to be pre-screened and on-boarded by the PFP operator, in line with the chapter 2 of Conduct of Business Rulebook (COBS), before permitting to have access to the PFP.
The Regulatory Guidance on PFP has set certain threshold conditions and criteria for a PFP applicant as follows:
While assessing an application seeking a Financial Service Permission (FSP) for operating a PFP, the FSRA shall check if the PFP applicant has met the threshold conditions set out in the FSMR and chapter 5 of the General Rulebook and the matters laid down in chapter 2 of the Guidance & Policies Manual (GPM). As per the Rule 5.2.7 specified in the General Rulebook, a PFP applicant shall be able to establish the below states threshold conditions to the satisfaction of the FSRA:
- Possess sufficient and appropriate resources, which includes financial resources as well;
- Is suitable and proper;
- Shall be fit for being supervised;
- Shall has satisfactory compliance arrangements, including the policies and procedures that will allow the PFP operators to observe all the relevant and applicable legal requisites and requirements.
Such thresholds stated above shall be evaluated by assessing the following aspects of the PFP applicant as set out by chapter 2 of GPM:
- Type of Business Model Proposed: The FSRA will check the following aspects of the PFP applicant, like structure and type of products offered, target clients, duties of the PFP applicant, any perceived conflicts if authorized, any possible arrangements with third-party service providers, any proposal as to carrying out any other regulated activity ( such as providing advice on credit or investment or managing a collective investment fund), preserving of the client assets in the case where the applicant prefers to hold.
- Track Record: The PFP applicant must establish that they hold at least a minimum of five (5) years of experience in corporate finance or any such similar business, under the jurisdictions which contain similar legislative and regulatory framework as that of the FSRA. In cases, where the PFP applicant lacks such a track record as stated above, the decision for approval shall be based on the track record of the PFP applicant’s potential shareholders; and the experience and qualifications of the key individuals of the PFP applicants
- Governing Body: The partners and the directors of the PFP applicant is required to be established and incorporated in the ADGM, and further they shall be registered with the FSRA in line with the General Rulebook, rule 5.5.4 and 5.5.5. However, if the applicants are the legal entities situated outside the ADGM, such an appointment is not required. Further, the PFP applicant shall establish that they possess all the skills necessary to oversee the firm’s operation.
- Mandatory Appointments: As per the rule 5.5.1 of the General Rulebook, the following individuals are required to be appointed by the PFP applicants:
- Senior Executive Officer (SE0): who shall assume the role of running and operating and supervising the firm’s operation. The SEO shall possess at least a minimum of five (5) years of experience as relevant to the position.
- Finance Officer (FO): to regulate and prepare the financial reports;
- Compliance Officer (CO): to oversee the firm’s compliance;
- Money Laundering Reporting Officer (MLRO): who assumes the responsibility of ensuring the implementation of the Anti-Money Laundering rules and guidance.
Further, the SEO, CO, and MLRO shall be residents of UAE, the functions of CO and MLRO can be carried out by the same person, and the FO, CO, and MLRO may be carried out in-house or can be taken from any group entity or service provider. The FSRA will also evaluate the capability of the other staff of the PFP applicant to determine if they have the essential skills and knowledge and experience to carry out the firm’s operation effectively.
- Systems and Controls: The FSRA shall also take into consideration the governance and control requirements of the PFP applicant, such as:
- If the applicant has established a Risk Management system to mitigate possible risks;
- The applicant shall maintain compliance arrangements, to endure that all the relevant regulations and rules are observed;
- The PFP’s operator internal audit shall be sufficient enough to be at par with the scale, nature, and complexity of the firm’s operation;
- The PFP operator shall have the resources to effectively manage the conflicts of interest that may arise during the transaction.
- Capital Requirements: A PFP operator must always have the capital resources more than the capital requirements.
- Professional Indemnity Insurance (PII): The PFP is required also to have a PII that would be at par with the nature, size, and risk profile of its business. Further, the FSRA shall also check if the PFP operator’s technology is at a reasonably advanced stage for the PFP applicant to establish the platform to be in compliance with the PFP regulations.
- Risk Warning: The PFP operator is required to adopt the principal conduct rules as set out in chapter 18 of the COBS, such as Risk Warning. The PFP operator is required to publish the risks involved in the PFP transactions, at least should mention the risks set out in the Regulatory Guidance on the PFP. The risks include but are not limited to capital loss, lack of liquidity, insufficient information, failure of the platform, or possible conflicts of interest between the clients and the PFP operators.
- Due Diligence: The PFP Operator is required to carry forth a sufficient and reasonable amount of due diligence as per the aspects specified in section 18.4 of the COBS. Further, the PFP operators must provide the clients with all the relevant and essential information for the clients to make an informed decision.
- Forums or Message Boards: The PFP operator is not obligated to disclose all the relevant information in cases where it is just ascertaining the client’s interest on a potential PFP transaction, in cases where the relevant start-ups or SMEs are not yet identified. Therefore, the PFP operator shall monitor the forums and the message used to determine the client’s interest in a potential PFP transaction in order to detect fraudulent actions.
- Marketing: The PFP operators are not allowed to participate in mass solicitation, or advertising as access to the PFP is restricted to only registered clients.
- Disclosure: The PFP operator is required to disclose the following information to the clients, either in a written form or electronic:
- The operation aspect of the PFP (like what it offers, how are the client assets held, the structure of the transactions etc.);
- The remuneration model of the PFP operators;
- The role and duties of the PFP operators;
- The other remedies or recourse options available in case the PFP operators fail;
- In cases where there is a drastic material change in the circumstances of the PFP transaction, then the role of the PFP operator which may also include the arrangements to retrieve the client’s assets; and
- The general disclosure of the obligations is set in the COBS.
- Exit Facility: The PFP operator shall also provide for an option of exit facility whereby the clients can exit the PFP transactions and allow them to find potential buyers, who are also the clients of the PFP operators, to transfer their rights and obligations under the loan or arrangement agreements
- Intermediate Entities: In cases where the PFP operators have made PFP transactions using a special purpose vehicle, such vehicles must be established in the ADGM for administration ease.
Thus, the ADGM by establishing a robust regulatory framework for the PFP intends to mitigate the risks involved in such transactions and at the same time bolsters the economic growth of the MENA region by facilitating the financial source for start-ups and SMEs.