While fund managers are permitted to carry out a variety of investment activities using investors’ money (i.e., Fund Property) under the current DFSA Funds regime, direct loan origination or the purchase of loan portfolios are prohibited. Loan-related activities add a distinct new dimension to Fund Management, necessitating new standards of conduct and prudential oversight, the details of which are outlined in this blog.

The purpose of this Consultation Paper is to get comprehensive feedback from regulated fund managers related to the proposed introduction of a credit fund regime and its regulations. This blog outlines the main proposals for the Credit Fund regime and the full consultation paper can be viewed here. Regulated Fund Managers can send their comments online here, by January 19, 2022. They will have to identify the organization they represent in the comments. Unless they expressly request at the time of making comments, the DFSA reserves the right to publish any comments on its website. 

Following this public consultation, the DFSA expects to proceed with making the necessary changes to its Rulebook, which will be amended to reflect the points raised in the consultation. As such, Fund Managers are advised not to act on the proposals highlighted in this consultation paper until DFSA officialize the amendments via an official notice on their website. 

What are Credit Funds under the current DFSA Rulebook? 

Credit funds are collective investment funds that use fund property (i.e., investors’ money) to originate, purchase or both originate and purchase loans. Since the 2008/2009 financial crisis, there has been a significant increase in the number and variety of funds active in this market, with fund managers employing a wide range of different investment strategies. This is partly due to the withdrawal of traditional bank lending in certain markets.

While banks have reduced lending in specific markets such as SME lending, fund managers have seized the opportunity to provide private credit. Many investors view credit funds as a potentially valuable asset class, particularly in the low-interest rate environment that has persisted in many jurisdictions since the financial crisis.

Fund managers have been able to obtain dependable deal flow directly from targeted market segments by utilizing underlying collateral (receivables and inventory). They also gained access to lending transactions with banks (co-lending and syndication), as well as the purchase of loan portfolios from banks and other loan originators. To properly manage the risks associated with this business, fund managers have developed expertise in credit assessment and lending transaction pricing.

This, and other developments in credit provisions, have prompted global regulatory organizations to consider the risks posed by such “shadow banking.” The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) have both examined the potential impact of these activities from different perspectives.

The FSB has specifically examined the potential risks to financial stability that could arise from the introduction of new players and new channels of contagion to the credit markets. The DFSA recognizes that such risks exist, but they also see benefits in broadening the pool of potential credit providers, particularly in underserved areas of the market. As credit funds are not currently permitted in the Dubai International Financial Centre, it will take some time and significant growth before this sector poses systemic risks. The DFSA proposes putting in place appropriate monitoring tools to help understand the sector’s development. 

Proposed Amendments to the DFSA Rulebook  

DFSA proposes that Fund Managers be permitted to use Fund Property for direct loan origination of the purchase of loan portfolios. Although the DFSA does not suggest regulating this activity in the same way that banks’ lending activities are, the proposals in this consultation paper are generally conservative. This is a deliberate policy choice that reflects the novelty of the proposed activity in the UAE, and the region as a whole. The DFSA will revisit this initial approach as the activity progresses.

The DFSA believes that this activity should not be made available to a wide range of fund classes. Instead, the organization suggests creating a new class of Funds called Credit Funds that can originate loans and/or purchase loan portfolios. These Credit Funds would be subject to the restrictions and controls outlined in this Consultation Paper.

In addition, the DFSA recommends that Credit Funds must use at least 90% of the Fund Property for either loan origination, as will be defined under the rules of the organization, or loan portfolio acquisition. The DFSA does not intend to impose any specific requirements as to the other types of investments that may be made by the Credit Fund, as long as it does not exceed 10% of its investment portfolio.

The DFSA proposes that the Credit Funds be either an investment company or an investment partnership, that it has a closed-ended legal structure with a specific end date, and that it be managed using either the internal or external model.

The prudential requirements will differ from the banking industry, including limiting the risk of loans made by the Credit Funds, the complexity of the lending products, and the permissible borrowers. Moreover, the DFSA proposes that the Credit Funds should not be able to issue letters of credit or give financial guarantees and they should not be able to undertake financial leasing.

The DFSA recommends prohibiting the Credit Funds to grant loans to natural persons, fund managers, other funds, financial institutions and their related parties, persons intending to trade in equities and other tradable investments, commodities, and digital assets, and persons whose business is credit provision.

You can read the full Consultation Paper here.

How Valsen Can help

The experienced staff of Valsen Fiduciaries Group and our global network allow us to provide high-quality services in several jurisdictions across the world. We are at your disposal to assist you with understanding the different proposals related to the introduction of the Credit Fund and how they can be to your advantage. Please get in touch with us through [email protected] or + 248 2525 217.