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Freshfields Transactions

| 4 minutes read

Revitalising the Credit Landscape: Regulatory Frameworks for Credit Funds in the Dubai International Financial Centre and Abu Dhabi Global Market

Over the past decade, the global private credit market has nearly tripled in value, estimated to have grown from around USD 300 billion to almost USD 900 billion. Capitalising on this growth, the Dubai Financial Services Authority (DFSA) has introduced a new regulatory framework for credit funds operating in the Dubai International Financial Centre (DIFC). Not to be outdone, the Abu Dhabi Global Market (ADGM)’s Financial Services Regulatory Authority (FSRA) has proposed a similar framework for credit funds in the ADGM.

Both the DFSA’s new framework and the FSRA’s proposed framework aim to encourage investment in the region’s private credit market by providing clear and transparent rules for credit fund managers operating within the DIFC and ADGM, respectively. At the same time, these frameworks also impose appropriate restrictions and requirements on fund managers investing in private credit assets, which are inherently considered a riskier asset class for investors.

Here are some of the key features of these regulatory frameworks, as well as the potential direction they could lead the DIFC and ADGM in the private credit market.

DFSA’s New Framework: Empowering Credit Funds in the DIFC

The DIFC has ushered in a new era for credit funds with the implementation of the new DIFC credit regime, which came into effect on 1 June 2022 and is governed by the DFSA Rulebook (Collective Investment Rules). Under this framework, credit funds are now required to register with the DFSA, appoint a licensed and regulated fund manager, and adhere to a set of regulatory standards.

The regulatory standards encompass various aspects, including governance, risk management, and marketing and disclosure. Credit funds are mandated to have robust policies and procedures in place for credit origination, acquisition, monitoring, and management. Risk management measures entail borrowing limits and comprehensive stress-testing, with results to be reported to the governing body of the credit fund on an annual basis or as requested by the DFSA. Marketing and disclosure requirements mandate the production of prospectuses and detailed reports to investors, covering information related to credit provided and loans acquired by funds.

In addition, the DFSA’s rules impose certain restrictions on the type of facilities that credit funds may provide. Specifically, letter of credit facilities, financial guarantees, and cross-border trade finances are prohibited, while trade finances within a country are permitted as they are deemed less complex and lower in risk.

The rules apply to both domestic and foreign funds whose investment objective includes providing credit (with a broader test to discern which foreign funds the rules apply to). However, certain rules are disapplied for funds that meet the criteria of an “Exempt Fund” under the rules.

For detailed information on the DFSA’s new rules regarding credit funds, please refer to chapter 13.12 of the DFSA Rulebook (Collective Investment Rules), available here.

FSRA’s Proposed Framework: Paving the Way for Credit Funds in the ADGM

The FSRA issued a consultation paper on 12 December 2022, outlining its proposed regulatory framework for credit funds in the ADGM. The public was invited to provide feedback and comments on the proposal by 27 January 2023. As of now, there have been no updates on the FSRA’s website regarding the proposal or feedback received. However, it is expected that in 2023, the FSRA will make amendments to the ADGM Financial Services and Markets Regulations 2015 and its various rulebooks to reflect the new ADGM credit regime.

The proposed regulatory standards for credit funds in the FSRA’s consultation paper include requirements for appropriate policies and procedures for investing in, monitoring and managing credit; stress-testing with regular reporting; and producing prospectuses with a focus on disclosing risks associated with credit investments. Compared to the DFSA’s framework, the FSRA’s proposed framework allows fund managers more flexibility in making investment decisions based on investors’ appetite.

There are some key differences between the FSRA’s proposed framework and the DFSA’s framework. The FSRA’s framework applies only to domestic funds that have limited operations to investing in credit facilities or special investments that acknowledge indebtedness, any activities related to the foregoing (including equity investments), and holding financial instruments for treasury cash management and hedging. It does not restrict credit funds from providing letter of credit facilities, financial guarantees, or cross-border trade finances. Additionally, the FSRA’s proposed framework imposes less restrictive capital requirements, with a leverage cap of 100% of a fund’s net asset value (equivalent to 50% loan-to-value of the fund’s portfolio), compared to the DFSA’s borrowing limitations of no more than 10% of the net asset value of the fund property.

The FSRA’s consultation paper and suggested amendments to the ADGM Financial Services and Markets Regulations 2015 and its various rulebooks can be found here.

Looking ahead

The DIFC and ADGM have long been regarded as premier financial centres in the Middle East, drawing significant interest from global investors and financial institutions. Their competitiveness though, even between themselves, is highly dependent on regulatory frameworks, since they affect the ease of doing business, attractiveness to investors and overall market activity.

With the FSRA’s proposed framework potentially offering more flexibility and leniency in regulations for credit funds, it could pave the way for the ADGM to gain a competitive edge over the DIFC. Credit funds could be drawn to the ADGM due to its regulatory framework, which offers greater ease of doing business and less red tape. The FSRA, however, has indicated that it will take a “risk proportionate, wait and see” approach to imposing constraints, considering the development of the private credit market in the region. It is possible that the two regimes will become more aligned in the future, either through the FSRA tightening its regime for additional investor protections or the DFSA loosening its rules to remain competitive.

In summary, the new and proposed regulatory frameworks for credit funds in the DIFC and ADGM are expected to have significant implications for the private credit market in the region. The introduction of clearer rules for managers and enhanced investor protections is likely to attract more private credit investors to the region. However, it is important to acknowledge that some funds may face challenges in meeting the new regulatory requirements due to operational limitations and increased compliance costs.

As the DFSA’s new framework and the FSRA’s proposed framework continue to evolve, it will be crucial to closely monitor their implications on the DIFC and ADGM, as these developments could shape the landscape of the private credit market in the Middle East. Financial institutions, investors, and market participants should keep a keen eye on these regulatory changes and their potential impact on the competitiveness of the DIFC and ADGM in the private credit market, and, of course, between themselves.