A Trending Hedge Fund Hub: Key Aspects of ADGM Hedge Funds

The Abu Dhabi Global Market (ADGM) is fast becoming an international financial hub in the MENA region for global hedge fund managers that are drawn to the quality of the ADGM’s independent regulator, the Financial Services Regulatory Authority (FSRA), prevailing common law framework, excellent infrastructure, and tax efficiencies.

The last few years have seen a significant rise in the number of alternative investment funds and hedge funds more specifically migrating to the United Arab Emirates (UAE), with some of the biggest names in the industry among those setting up shop in the ADGM.

Increasingly relevant for mobile, remote, or dual-location investment and service professionals, the ADGM is conveniently located geographically at the intersection of Europe, Asia, and Africa, with 80% of the world’s population living within an eight-hour flight of the UAE. For hedge fund managers wishing to specifically target the Abu Dhabi sovereign wealth funds and family offices, the ADGM is uniquely positioned for this purpose.

Below we outline six key aspects of the ADGM hedge fund regime that make the ADGM an attractive destination for institutional investors.

ADGM Funds Regulation

There are three regulatory categories for funds established in the ADGM as specified by the Funds Rules (Funds Rules) issued by the FSRA. From least regulated to most regulated, these categories are as follows: (1) qualified investor funds (QIFs), (2) exempt funds, and (3) public funds (these are offered to investors by way of a public offer—or target retail clients—and thus are not outlined below).

While some investment funds may additionally be classified as a “specialist fund” by the FSRA, such as venture capital funds and credit funds, hedge funds do not fall within a specialist class of funds in the ADGM and as such are not subject to distinct additional regulation under the Funds Rules.

Qualified Investor Funds

QIFs in the ADGM may only be offered by way of private placement and may only be subscribed to by professional clients. In addition, the initial subscription to be paid by each investor in a QIF must be at least $500,000. To establish a QIF, a fund manager must notify the FSRA at least 14 days prior to the initial offer of interests in the QIF.

The FSRA generally will acknowledge the notification within five business days, after which the manager can proceed to offer and accept subscriptions. QIFs are not required to undertake reporting as frequently, are subject to fewer requirements relating to the content of their offering documents, and are not subject to specific requirements relating to conflicts of interest, investor meeting procedures, or FSRA approval of amendments to fund documents.

Exempt Funds

Similar to QIFs, exempt funds in the ADGM may only be offered by way of private placement and may only be subscribed to by professional clients. However, unlike QIFs, the initial subscription to be paid by each investor in an exempt fund must be at least $50,000.

Exempt funds are subject to the same applicable FSRA processes as QIFs. Unlike QIFs, exempt funds are subject to nearly all of the same Funds Rules as apply to public funds, with the principal exception that oversight requirements and regulatory investment and borrowing limits do not apply to exempt funds.

Hedge Funds

The ADGM does not recognize hedge funds as a specialist class of fund; instead, they are subject to the same regulatory framework as other types of funds not falling within a specialist class.

ADGM Asset Manager Licences

Managing a Collective Investment Fund

This regulated financial service activity is where an asset manager (1) is legally accountable to the investors in a collective investment fund for management of the property held for or within such fund or (2) establishes, manages, or otherwise operates or winds up a collective investment fund.

For these purposes, a collective investment fund requires the pooling of multiple investors’ contributions with the management of such pooled capital being undertaken by a third party (i.e., the fund manager).

Single-investor arrangements will therefore fall outside the scope of this regulated financial service activity, as will commercial businesses or joint ventures where each investor has an active, rather than a passive, role in the venture.

The collective investment fund manager licence is generally limited to managing QIFs and exempt funds, in which case the regulatory capital requirement is the higher of $50,000 and three months of the fund manager’s annual audited expenditure.

Managing Assets

This regulated financial service activity is where a person manages, on a discretionary basis, assets belonging to another person. This license is relevant for those asset managers who operate single-investor products, such as separately managed accounts or funds-of-one, where the asset manager retains investment discretion. In addition, this is the license used by ADGM asset managers operating foreign (non-ADGM) funds.

The regulatory capital requirement for this license is the higher of $250,000 and three months of the asset manager’s annual audited expenditure.

Arranging Deals in Investments

“Arranging” means making arrangements with a view toward another person (whether as principal or agent) buying, selling, subscribing for, or underwriting an investment or financial instrument. This is often used in cross-border structures where the hedge fund and the fund/asset manager are established outside of the ADGM, and the ADGM entity only arranges deals in investments, with investment discretion for the hedge fund resting elsewhere. The regulatory capital requirement is the higher of $10,000 and six weeks of the adviser’s annual audited expenditure.

Advising on Investments or Credit

Broadly speaking, “advising” means providing advice to an individual on the merits of buying, selling, subscribing for, or underwriting an investment or financial instrument, and can include advising on financial products (which covers most debt and equity securities, including convertible and derivative instruments).

This is often used in cross-border structures where the hedge fund and the fund/asset manager are established outside of the ADGM, and the ADGM entity only provides investment advice. The regulatory capital requirement is the higher of $10,000 and six weeks of the adviser’s annual audited expenditure.

Legal Structures

The ADGM offers the following vehicles for purposes of establishing a domestic fund: (1) investment companies (including protected cell companies and incorporated cell companies), (2) limited partnerships, and (3) investment trusts.

Investment Companies

An investment company may be either a public or private company and may take the form of a company limited by shares or a cell company (as discussed below). Further, an investment company may be open-ended, allowing for operation of a fund with regular subscription and redemption processes, or closed-ended.

An investment company may either have a sole corporate director acting as its fund manager, with such director being licensed directly by the applicable regulator as a fund manager, or may have an external fund manager appointed as such pursuant to a management agreement. The corporate hedge fund construct of a “participating, non-voting” investor share class and a “non-participating, voting” management share class is commonly used.

Cell Companies

A protected cell company (PCC) is a corporate structure in which a single legal entity is composed of a core and several cells that have separate assets and liabilities. A cell of a PCC is not a body corporate and has no legal identity separate from that of its cell company, but it is treated as a company.

As such, a cell of a PCC may enter into an agreement with its cell company or with another cell of the company that shall be enforceable as if each cell of the company were a body corporate that had a legal identity separate from that of its cell company.

An incorporated cell company (ICC), while similar to a PCC, adopts a fundamentally different approach to cells: each cell is incorporated as a separate legal entity (with a separate legal personality), and the cell company need not have any shareholder relationship with the relevant cell.

PCCs and ICCs are useful structures that enable fund managers operating multiple strategies to legally separate assets and liabilities of each strategy (on a per-cell basis) while operating under common management.

Limited Partnerships

A limited partnership is a body corporate (which as a default does not, but which may elect at the time of formation to, have a legal personality separate from that of its partners) in which one or more general partners have unlimited liability for the debts and obligations of the limited partnership and exclusive authority to operate the limited partnership, and one or more limited partners each have liability limited to the amount of their capital contributions to the limited partnership but may not participate in the management of the limited partnership.

Investment Trusts

Investment trusts are not separate legal vehicles but instead contractual arrangements whereby legal and beneficial ownership of the trust (or fund) property are separated as between the trustee and investors, respectively. This structure is not commonly used for hedge fund structures in the ADGM.

Tax Considerations

The UAE currently imposes a 5% value-added tax (VAT) on most goods and services, and this VAT would generally apply to any management fees. As a matter of market practice, this VAT expense is typically passed on to investors.

The UAE has also recently enacted a corporate income tax, which generally applies to any business income earned whether from a corporation, partnership, or business conducted as a sole proprietorship.

The general UAE corporate income tax rate is 9%; however, there is also a 0% rate for certain qualifying income earned by companies formed in a free zone such as the ADGM. Because the UAE corporate income tax law is new, many details of its application, including what income will be treated as “qualifying income,” remain uncertain.

In addition, a separate exemption is available for certain qualifying investment funds. This exemption generally requires that

• the investment fund or the investment fund’s manager be subject to regulatory oversight by an approved authority,
• interests in the investment fund be either traded on a recognized stock exchange or marketed and made available sufficiently widely to investors,
• the main or principal purpose of the investment fund not be to avoid corporate tax, and
• the investment fund comply with any under future decisions issued by the government.

Forming an investment fund in the ADGM may also result in other tax benefits. In particular, investment funds may be able to benefit from the UAE’s broad tax treaty network or otherwise receive preferential tax treatment, such as any special treatment provided under the domestic law of other Gulf Cooperation Council (GCC) states that afford special treatment to fellow GCC states for Zakat taxation purposes.

While the UAE does not impose a personal income tax, as noted above, certain business income earned by individuals may be subject to the UAE corporate income tax.

Cross-Border Arrangements

It is possible for an ADGM asset manager to operate or advise a foreign fund, and in this case the foreign fund is not required to be classified as or meet the requirements relating to the ADGM fund categories. In addition, fund managers established and licensed outside of the ADGM (but in a “recognized jurisdiction”) may be approved by the FSRA to operate ADGM funds. The FSRA is currently taking a restrictive view of approving the latter category unless there is a clear strategic reason for the foreign fund manager to be managing an ADGM-based fund.

Fees

As of the date of this LawFlash, the fees payable to the two ADGM authorities—the FSRA and the Registration Authority (RA)—in connection with forming a hedge fund manager and a hedge fund structured as an open-ended investment company are as follows: