DIFC – Commercial Arrangements and Collective Investment Funds: What is the difference?

1. Scope

This memorandum discusses how the Dubai Financial Services Authority (“DFSA”), in its’ capacity as the financial services regulator in the Dubai International Financial Centre (“DIFC”), distinguishes between:

• commercial arrangements or carrying on a commercial business (“Undertakings”), and
• collective investment funds (“Funds”).

2. The Law

   • What is a Fund?

The DFSA Collective Investment Law (the “CIL”) defines what a Fund is and then give examples of Undertakings that do not constitute a Fund.  The DFSA will deem any Undertaking to be a Fund if it has the following elements:

Definition:  A Fund is any arrangement with respect to property of any description, including money, where:

Objective: the objective is to enable investors to receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income;

Investors must be Passive:  investors in the arrangements do not have day-to-day control over the management of the property; and

Essential Elements:  the arrangements have either or both[1] of the following characteristics:

• the contributions of the Investors and the profits or income out of which payments are to be made to them are pooled; or
• the property is managed as a whole by or on behalf of the Fund Manager.

3. Examples where Commercial Arrangements will not be classified as a Fund[2]

   • Deposits

An arrangement does not constitute a Fund if the whole amount of each participant’s contribution is a Deposit which is accepted by an Authorised Firm authorised under its Licence to carry on the Financial Service of Accepting Deposits.

• Common accounts
• An arrangement does not constitute a Fund if:
  • the rights or interests of each participant in the arrangement are rights or interests in money held in a common account; and
  • the money is held in the account on the understanding that an amount representing the contribution of each participant is to be applied in making payments to him or in satisfaction of sums owed by him or in the acquisition of property for him or the provision of services to him.
• Commercial activities unrelated to Financial Services

An arrangement does not constitute a Fund if each of the participants in the arrangement:

• carries on a business which does not involve the carrying on of any of the activities specified under GEN Rule 2.2.2(d) to (k) (or (n) to (q)[3] or an activity which would be such an activity were it not for any applicable exclusion; and
• enters into the arrangement for commercial purposes related to that business where that participant carries on that business by virtue of being a participant in the arrangement.

• Group arrangements

An arrangement does not constitute a Fund if each of the participants is a Body Corporate in the same Group as the Person undertaking the fund management function in relation to the arrangement.

• Franchise arrangements

An arrangement does not constitute a Fund if the arrangement is a franchise arrangement.

• Clearing services

An arrangement does not constitute a Fund if the purpose of the arrangement is the provision of clearing services and the services are operated by an Authorised Market Institution[4].

• Certificates or Options

An arrangement does not constitute a Collective Investment Fund if the rights or interests of the participants in the arrangement are Investments of the kind specified under GEN Rule A2.2.1(d) or A2.3.1(a).

• Time-share and other ‘property-enjoyment’ related arrangements

An arrangement does not constitute a Collective Investment Fund:

• if the rights or interests of each of the participants in the arrangement are time share rights; or
• if:
  • the predominant purpose of the arrangement is to enable the participants to share in the use or enjoyment of property or to make its use or enjoyment available gratuitously to others; and
  • the property to which the arrangement relates does not consist of or include the currency of any country or territory or Investments, as defined in GEN Rule A2.1 or, which would be such Investments if not for any applicable exclusion.
• Commercial arrangements

An arrangement that consists of a company, partnership or trust does not constitute a Fund if the main purpose and effect of the arrangement is the carrying on of a commercial or other business unrelated to financial or investment activities.

The DFSA would generally not expect an Undertaking (whether it is structured as an ordinary company, partnership or trust) that carries on a general commercial business to be a Fund, and, therefore, regulated. An undertaking would be regarded as carrying on a general commercial business where it pursues a business strategy that involves activities such as:

• running a business involving the purchase, sale or exchange of goods and commodities;
• supplying services – such as maintenance, cleaning, electrical or plumbing, servicing appliances;
• providing non-financial professional services – such as legal or accounting;
• conducting media activities/business;
• operating an industrial activity, such as the production of goods or construction of property; or
• carrying on a combination of the above or similar activities.

• Similarly, an Undertaking that pursues a charitable purpose (such as a charitable trust) would not be regarded as a Fund.
• Further indicators which can be used to identify if an Undertaking is a commercial business include:
  • the particular structure of the Undertaking – i.e., if it is open-ended^[5], then the structure is generally regarded as more suited for collective investment, rather than a commercial operation (because a commercial business does not lend itself to having parts of it sold off to meet redemption rights of investors and, also, investors in commercial businesses do not expect the business to do so);
  • the distribution mechanism used by the Undertaking – if it is closed-ended^[6] and has a specified period at the end of which it will be wound up and proceeds from realising assets will be distributed to investors, then generally such an undertaking is a Fund, rather than an Undertaking;
  • how it conducts its business – for example:
    1. if the business has a large number of employees engaging in its business activities, this is a possible indicator it is an Undertaking. This is because many investment companies delegate or outsource their investment and administration activities to third party service providers, and have limited staff;
    2. if the business merely holds the property to take advantage of changing market prices or the income stream, it is an indicator of conducting collective investment business (i.e., a Fund), rather than undertaking any construction or development activities, which are commercial activities (i.e., an Undertaking);

• if the business is designed to expand any existing commercial business of investors, this is a pointer that it is an Undertaking, as opposed to a scheme that would achieve gains or benefits by realisation of the underlying assets – which is a pointer that it is a Fund; and

1. if the business itself creates the property or assets it manages (e.g., by constructing a building), it indicates that such a business is more likely to be a property development business, which is an Undertaking, rather than a Fund.

• Alternatively, if a business promotes itself based on its investment mandate and the investment skills of the person carrying out the investment and risk management function in the business, is likely to be a Fund rather than an Undertaking.

• When Property Arrangements Are Classified as an Undertaking and not a Fund

A Fund is a Property Fund if its main purpose is investment in Real Property and in securities issued by companies whose main activities are investing in, dealing in, developing or redeveloping real property. Whether an arrangement, particularly if it is a closed-ended company which invests in Real Property, is a Fund or a commercial company is not always an easy question to answer and a meeting with the DFSA will be required.

The DFSA considers the following type of closed-ended property companies to be commercial companies, rather than Funds:

• a property developer or a property construction company which is in the business of developing and constructing (i.e., creating) the property;
• a real estate company that operates a business of selling or leasing real estate for its customers;
• a property management or maintenance company – which generates profits through fees charged for those services; and
• a property valuation service provider – which is a property related service provider.

In contrast, there are certain types of closed-ended companies which directly or indirectly invest in real property and, therefore, are clearly Funds. For example, a company which:

• raises capital from investors to invest in real estate, on the basis that the real estate will be selected or bought and sold on the basis of specified criteria, and profits generated are distributed as specified; or
• invests in securities (such as shares, debentures or units) of other real estate companies or property developers to generate profits through returns on such investments.

• Debentures and Warrants of a single issuer
  • An arrangement does not constitute a Fund if the rights or interests of the participants in the arrangement are represented by a Debenture or Warrant:
    • where the issuer of the Debenture or Warrant is a single issuer, and if that issuer is:
      • a company, it is neither an open-ended investment company nor a closed-ended company the intent or purpose of which is investment management as specified as a commercial arrangement in clause 3.10 above; or
      • not a company, the rights and interests of the Debenture or Warrant holder are guaranteed by the government of any country or territory; and
    • which, if it is a convertible security, the underlying securities to which the Debenture or Warrant holder is entitled are shares or debentures issued, or to be issued, by the same issuer as the issuer of the Debenture or Warrant or single other issuer.
  • An arrangement that does not constitute a Fund by virtue of clause 3.11(a) above does not become a Fund merely because one of the participants in the arrangement is a person:
    • whose ordinary business involves him engaging in an activity that is a Financial Services activity as defined as a “Financial Service” in GEN chapter 2 or that would fall within an applicable exclusion from a Financial Services activity; and
    • whose rights or interests in the arrangement are, or include, rights or interests in a swap arrangement under which he facilitates the making of payments to participants whether in a particular amount or currency or at a particular time or rate of interest or all or any combination of those things in settlement of the rights and interests of the other participants in the arrangement.
  • Insurance

An arrangement does not constitute a Fund if it is a contract of insurance.

• Profit Sharing Investment Accounts

An arrangement does not constitute a Fund if it is an account or portfolio which is a Profit Sharing Investment Account.

• Discretionary Portfolio Accounts

An arrangement does not constitute a Fund if it is a portfolio or account managed under a Discretionary Portfolio Management Agreement.

• Close Relative accounts

An arrangement does not constitute a Fund if every participant in the arrangement is a Close Relative. For the purposes of this Rule, the defined term “Close Relative” includes grandchildren.

• Sukuks

An arrangement does not constitute a Fund if the rights or interests of the participants are evidenced by sukuk certificates where the holders of the certificates are entitled to rely on the credit worthiness of:

• the issuer of the sukuk certificates; or
• any other Person who has assumed obligations under the sukuk certificates, for obtaining their rights and benefits arising under the certificates.

• Employee reward schemes

An arrangement does not constitute a Fund if the arrangement is for the purposes of enabling or facilitating the operation of an employee compensation or reward scheme where the arrangement:

• makes securities available only to:
  • an Employee or former employee of the Issuer or of another member of the same Group as the Issuer; or
  • a Close Relative of any such employee; and
• is operated by the Issuer or by a member of the same group as the issuer or by a trustee who, in pursuance of the arrangements, holds the securities issued by the Issuer for the benefit of any eligible persons referred to in this clause 3.17 (a) (i) or (ii).

• Crowdfunding

An arrangement does not constitute a Fund if all of the following conditions are met:

• the arrangement is entered into using a Property Investment Crowdfunding Platform, operated by a Crowdfunding Operator;
• the arrangement involves multiple investors investing in an individual apartment, house or building that has a single discrete title deed;
• all of the investors are Clients of the Crowdfunding Operator; and
• the total consideration paid by all investors in the apartment, house or building is not more than $5 million or an equivalent amount in another currency.

An Investment made through an Investment Crowdfunding Platform (i.e., a platform that facilitates an investment in a business or a project rather than a property) is likely to fall within the exclusion of a commercial arrangement in clause 3.9 above.

An arrangement does not constitute a Fund if all of the following conditions are met:

• the arrangement is entered into using a Loan Crowdfunding Platform, operated by a Crowdfunding Operator;
• the arrangement involves multiple lenders providing a loan to a borrower for a business or project;
• all of the lenders are Clients of the Crowdfunding Operator;
• the amount of the loan, the rate of return and the repayment period are fixed when the loan agreement is entered into; and
• the total funding provided by all lenders to the borrower is not more than $5 million or an equivalent amount in another currency.

• Employee Money Purchase Scheme

An arrangement does not constitute a Fund if all of the following conditions are met:

• the arrangement is an Employee Money Purchase Scheme and the DFSA has approved that Scheme under COB Rule 12.2.2;
• the Scheme is operated by an Authorised Firm that is authorised to Operate an Employee Money Purchase Scheme; and
• the Scheme is administered by an Authorised Firm that is authorised to Act as the Administrator of an Employee Money Purchase Scheme.

By Dennis S. Woloshyn (Ryan)
DSW Investment Fund Consultancy

[1] Though the DFSA maintains that they will keep the Essential Elements as arrangements that have “either or both” of the characteristics set out above (which is the wording used in the UK FSMA 2000 s. 235(3)), the DIFC regulator will nevertheless, by policy, require collective investment funds to have both elements; (i) pooling, and (ii) engagement of a Fund Manager.  We note that the same definition of a fund by the Financial Services and Regulatory Authority (the “FSRA”) in the Abu Dhabi Global Market (“ADGM”) was amended in January 2020 to change this provision to specifically require “both” elements to be present in any collective investment fund. forwarded this inconsistency in law and policy to the Policy Committee of the DFSA and will revert on delivery of their response.

[2] The information contained in this memorandum was substantially extracted from or summarised from the CIL and the DFSA Rulebook Modules.

[3]GEN 2.2.2 (d) Dealing in Investments as Principal; (e) Dealing in Investments as Agent; (f) Arranging Deals in Investments; (g) Managing Assets; (h) Advising on Financial Products; (i) Managing a Collective Investment Fund; (j) Providing Custody; (k) Arranging Custody; (n) Operating an Exchange; (o) Operating a Clearing House; (p) Insurance Intermediation; (q) Insurance Management;

[4] Glossary Rulebook: Authorised Market Institution:  A Person who is Licensed by the DFSA in relation to the carrying on either or both of the Financial Services prescribed in GEN Rule 2.17.1 (Operating an Exchange) and 2.18.1 (Operating a Clearing House).

[5] An Open-ended Fund means a Fund where investors have a right (generally, on request, or at a specified frequency) to have their Units redeemed or repurchased at a value calculated based on the net asset value of the Fund Property.)

[6] A Closed-ended Fund means a Fund where investors have no right of redemption or repurchase of their Units.