INTRODUCTION
Abu Dhabi Global Market (ADGM) was inaugurated in late October 2015. It occupies an area of 14.38 million sq mt, making it the largest financial hub in the world. It has swiftly established its jurisdiction in financial institutions, fintech, corporations, asset management and especially in private equity and venture capital structures. It helps in selecting different legal structures, in the incorporation and registration of a company and also in dispute resolution.
ADGM is an independent regulatory authority and is built on English common law. It is a financial free zone with a business-friendly environment and no direct tax applicability. This upholds international standards while making way for the most efficient and cost-effective authorisation of financial services globally. ADGM has thus been the top choice for financial, non-financial, and retail businesses for seamless incorporation and operations. This article outlines one such specific type of company known as VC funds, the procedural steps to create and register from scratch in ADGM, especially a QIF (Qualified Investor Fund).
VENTURE CAPITAL RULE 4.1.6
Venture Capital invests only in the securities of companies at an early stage of development that are not listed or admitted to trading on an exchange directly or indirectly, are closed-ended, limits the total subscription to maximum $100 million or higher amount as approved by the Regulator and is either a domestic fund that is either an exempt or qualified investor fund or a foreign fund not available to retail clients.
RETAIL CLIENT (Conduct of Business (COB) Rule 2.3)
A person who cannot be classified as a professional client per the criteria falls under the category of a retail client. In simple words, if the person does not meet the required financial strength, the market experience of a professional client is known to be a retail client.
PROFESSIONAL CLIENT (COBS Rule 2.4.1)
There are two ways in which a person may be classified as a professional client:
Deemed Professional Clients
A ‘deemed’ professional client is a client who has prior experience, knowledge and expertise to make investment decisions and properly assess the risks that it holds. A person is considered a ‘deemed’ professional client based on their most recent financial statements, and they meet at least 2 conditions:a balance sheet total of $20 million;
a net annual turnover of $40 million; or
own funds or called up capital of at least $2 million
Assessed Professional Clients
An ‘assessed’ professional client does not have prior experience or knowledge in the market as compared to the deemed professional clients. A person may qualify as an ‘assessed’ professional client only if certain criteria are met.An individual has net assets of at least $1,000,000 excluding the value of the person’s primary residence, any rights qualifying under Contract of Insurance within the meaning of FSMR and any other benefits such as pensions.
The individual is or has been working in a professional role at a licensed financial firm (banks) or regulated financial institutions (stock exchange) within the past 12 months or 2 years, in the case of a passported fund (cross-border funds)
The individual must have sufficient experience and understanding of the financial markets and any associated risks.
GOVERNING REGULATIONS IN ADGM
The formation of funds and regulation in Abu Dhabi Global Market (ADGM) is monitored by an independent regulatory authority known as the Financial Services Regulatory Authority (FSRA). The legal framework that regulates fund structures includes the Financial Services and Markets Regulation 2015 (FSMR), which gives the foundation for the provisions of financial services. The FSMR was established by ADGM Directors in line with powers granted to them under Article 6(1) of Law Number 4 of 2013. The FSRA Fund Rulebook (FUND) provide specific rules for the governance of investment funds, and the Companies Regulations 2020 govern the incorporation of legal entities within ADGM. The Limited Liability Partnerships Regulations 2015 regulate the fund structuring of VC for the Limited Liability Partnerships (LLPs).
These rules and regulations, together, establish a transparent framework that ensures the smooth operation of funds, incorporating best practices internationally.
FUND CRITERIA
FOREIGN FUNDS
It is an investment fund that is established in another jurisdiction and not domiciled within the ADGM. These funds are not subject to the requirements of domestic funds but are permitted to market with the ADGM investors through cross-border regulatory requirements. A foreign fund manager must be appointed.
DOMESTIC FUNDS
A fund is a domestic fund when it is established or domiciled within the ADGM. ADGM’s Fund Rulebook (Rule 3.2) categorises domestic funds into three types:
Exempt Funds
Public Funds
Qualified Investor Funds
EXEMPT FUND (Fund Rule 3.3.3)
An exempt fund is a private credit fund limited only to persons who meet the criteria of professional clients and requires a minimum subscription of $50,000 per investor to become a unit-holder. They are not formally registered with the FSRA, but for the fund launch, the fund manager needs to inform the FSRA at least 14 days prior, as per Section 112 of FSMR. The fund manager must ensure that the fund meets the criteria both at the inception and during the operation of the fund. The offer must be made via private placement and not by public advertising. The exempt fund may also convert to a qualified investor fund if it meets the criteria of a qualified investor fund.
PUBLIC FUNDS (Fund Rule 3.3.1)
It is a retail fund and can be offered via a public offer to any investors, including retail investors. There is no minimum investment, but it goes through the highest regulatory scrutiny. It has to be registered with the FSRA, requires prior approval of a detailed prospectus and is subject to the appointment of a fund manager to provide an oversight function for a fund and to protect the investors, especially the retail investors.
QUALIFIED INVESTOR FUNDS (QIF) (Fund Rules 3.3.4)
These investor funds are intended only for high-standard or institutional investors. QIFs can only be offered to professional clients or Market counterparties, typically institutions or individuals with high-net-worth, in compliance with the FSRA’s criteria, only based on private placement. The initial commitment of an investor must be at least $500,000 as per Rule 15.1. Similar to Exempt Funds, QIFs are required to notify the FSRA at least 14 days prior rather than going through the full registration process. The notification is acknowledged by the FSRA usually within 5 business days, after which the fund may be available to accept subscriptions. QIFs are not subject to any particular rules that apply to other funds, like detailed requirements of documents, investor meeting procedures, or the authority’s approval to amend documents; hence, they benefit from minimum regulatory requirements. There is no limit on the number of investors in an Exempt fund or QIF.
In brief, a QIF in ADGM is a regulated private fund for qualified investors, making it an ideal structure for venture capital, private equity, and other funds targeting high-standard investors.
SETTING UP A VENTURE CAPITAL FUND AS A QIF IN ADGM
Selecting an appropriate legal structure:
ADGM allows funds to be structured as investment companies, limited partnerships, or investment trusts, depending on the investor’s objectives. Each of them has its advantages, like the investment company incorporated under ADGM, which can issue shares to its investors and is often used for funds that might be listed on an exchange or simply a corporate form. Another choice for venture capital and private equity funds is a Limited Investment Partnership, which comprises at least one general partner (GP) and limited partners.
The Partnership law under the ADGM permits flexible partnership agreements, and a General Partner SPV (Special purpose vehicle) (company created specifically to act as the General Partner (GP) in a Limited Partnership) can be used to act as the GP for structuring convenience. In addition to this, an Investment Trust structure is accessible, where a licensed trustee holds the fund’s assets on trust for investors. Moreover, ADGM also allows umbrella fund structures using Protected Cell Companies (PCCs) or Incorporated Cell Companies (ICCs) to separate assets of sub-funds.Fund Manager License:
A collective investment fund must be managed by an FSRA-authorised Fund Manager until and unless an eligible foreign manager is performing the duties. The ADGM recognises foreign asset managers of certain jurisdictions to manage the ADGM Fund.
The FSRA has introduced the Venture Capital Fund Manager (VCFM) framework to encourage start-up venture capital managers with proper requirements. Within this framework, the manager applies for a Financial Service Permission (FSP) to carry out the task of managing a Collective Investment Fund (only restricted to managing Exempt and QIF Funds). There is an eligibility criterion that the framework has laid:The fund must be a closed-end fund investing especially in the early stage,
Unlisted companies, offered to only professional clients and
Fund sizes typically not exceeding $100 million as per Section 3.1 of Guidance - Regulatory Framework for Fund Managers of Venture Capital Funds, unless the FSRA approves a higher capital amount.
Under the Venture Capital framework, the manager must appoint a minimum of 2 approved persons, i.e. a Senior Executive Officer (resident of UAE), and a licensed director or partner (one person can fit in both the roles if experienced). A Compliance Officer and Money Laundering Reporting Officer are also required. (It can be outsourced or combined with FSRA approval.)
The venture capital manager regime’s financial requirements often capital base of $50,000 for a Category 3C fund manager, and FSRA fees are about $10,000 for the application and an additional USD $10,000 annual supervision fees as per Section 3.2 of Guidance - Regulatory Framework for Fund Managers of Venture Capital Funds.
The FSRA’s review process usually involves an initial meeting and is then followed by a 4-6 week complete in-depth review of the application. Once the FSRA is satisfied with the application, it issues an In-Principle Approval, only after which the manager entity must be incorporated formally, capitalised and insured before the final approval and the grant of the FSP License. For a foreign fund manager, an ADGM license is not necessary, but the manager would have to inform the FSRA and comply with the QIF requirements.Investor’s eligibility:
The qualified investor’s fund can only be accepted by the qualified investors who meet the required definition of a Professional client under the FSRA Conduct of Business Rules. The net worth to qualify for an investor is usually a minimum of $500,000, and must commit the minimum amount to the fund. The fund manager conducts thorough scrutiny to verify that the investors are eligible. The QIF units are offered through private placements and, hence, no public offering is permitted. Before establishing the fund, the manager should notify the FSRA and convey its intention to offer QIF. The notification form must be filled out at least 14 days before the initial offering. The FSRA acknowledges the notification within 5 business days, and once the notification period lapses and no objections are raised by the FSRA, the fund may proceed with admitting investors.Prepare documentation:
The primary document to establish the fund is the Fund Constitution. The exact format of the document depends on the legal structure of the company or business. In a limited partnership, the Limited Partnership Agreement (LPA) is the fund’s constitution, in a corporate fund, the Articles of Association, and in the case of a trust, a Trust Deed is used. The main matters that a constitution covers are investment objectives, strategy, and the term of the fund, management fees, and redemption/exit provisions for a closed-end venture capital fund. The second most important document is the Offering Memorandum or Private Placement Memorandum (PPM), which is provided to prospective investors. The investment strategy, fund’s structure and terms, fees and expenses, risk factors, etc., are all described in the PPM. The fund manager, if newly formed, will need a Compliance Manual and a set of procedures that cover anti-money laundering (AML), risk management, and valuation policy for the fund’s assets. These documents are usually prepared during the manager’s licensing process and will control the operation of the fund in compliance with the FSRA rules. Various other documents include the Subscription Agreement for committing capital and to make representations regarding eligibility, any other Investment Management Agreement if only the manager is appointed by contract and not in cases where the role is already set by regulation or by the constitution. In cases of QIF documentation, FSRA approval is not needed, but any material changes should be communicated to investors and, if needed, updated to the FSRA via filing for transparency.Appointment of third-party service providers:
The appointment of service providers can be based in ADGM if they are properly regulated. A fund Administrator may be appointed to handle and manage tasks like capital calls, investor records and financial reporting. In cases of venture capital funds, which usually hold private, illiquid shares, the ADGM allows alternative safekeeping arrangements for QIF, but the fund manager must make sure these arrangements meet the FSRA requirements. Other important service providers include tax advisors for cross-border investments or for investors’ tax reporting, bank for managing capital contributions. All the key service providers must be appointed before submitting the QIF notification to the FSRA.Establishment of Fund:
After the fund manager’s license is received and all the documentation and service provider agreements are ready, the fund can officially be established. The incorporation and registration of the fund vehicle is done with the ADGM Registration Authority (RA). It involves submitting constitutional documents, prescribed forms to the RA. For incorporating a standard private company limited by shares in ADGM, it usually takes about 5 business days; for a limited partnership or a trust, it usually takes a similar number of days as the standard private company. If the general partner is a special purpose vehicle (SPV), then that SPV would be incorporated as well. After the FSRA recognises and approves the QIF notification and all the licensing conditions are met, the fund is added to the FSRA fund register and can hold its first closing, i.e. accepting investor commitments and calling of initial capital. The complete setup of a venture capital firm in ADGM from the start to establishing a fund may vary, but it is usually 3 – 4 months, with 2 – 3 months for the manager’s license and then a few weeks to launch the fund. In the case of a foreign manager, the process can be completed within a month. Once the fund is established, it can start making investments in portfolio companies as per the strategy.Budgeting and the costs incurred:
The regulatory fees in ADGM are pretty competitive compared to those in other jurisdictions. The FSRA charges $10,000 for a fund manager license and USD $10,000 as an annual authorisation fee for a venture capital fund manager. For the incorporation of a private or a partnership company, the ADGM Registration Authority charges a fee of $1,500, and the ADGM annual commercial license fee is around $4,000 for most entities. For a venture capital fund in ADGM, it incurs various costs like $9,000 for the fund manager license, $200 for name reservation and around $300 initial and $100 annual for data protection registration. Legal setup and licensing with ongoing compliance and audit fees usually cost around $10,000 to $20,000 per year. In ADGM, there is no corporate tax, but 5% VAT may apply to some services. Overall, annual regulatory and operating costs usually range from $20,000 to $30,000.
COMPLIANCE OBLIGATION UNDER FSRA RULES
Establishing the fund is the initial step of setting it up. During the ongoing process, the fund managers and the funds themselves should comply with the ADGM’s requirements. The FSRA, while being lenient on the QIF setup, also expects compliance with the obligations to ensure smooth and transparent operations and protect the investors.
Anti-money Laundering (AML)/Counter-terrorism Financing (CFT) Laws.
The ADGM fund managers are obliged to comply with the UAE’s Anti-money Laundering and Counter-terrorism Financing laws and also the FSRA’s AML Rulebook. The fund managers must implement appropriate and strict internal policies for all investors to assess money laundering risk and to monitor and report any suspicious transactions. A designated Money Laundering Officer must be appointed to oversee the compliance. The duty is to conduct a thorough study on each investor’s identity, source of funds at onboarding and also update it periodically. The AML audits should be done periodically to ensure complete adherence to the laws and AML Rulebook.Financial Reporting and Annual Audits
A QIF or any ADGM fund is usually required to prepare an annual audited financial statement. The funds must be audited by the approved auditor and must be provided to the investors within a specified timeframe, usually within 6 months of the financial year's end. To fulfil reporting obligations, the fund manager also submits the audited accounts and a brief annual report to the FSRA. As QIFs are exempt from frequent reporting, all material events should be updated as needed, and the FSRA must be informed. For FSRA inspection, the fund manager should maintain appropriate books and records as and when requested.Governance
ADGM does not require independent directors or a formal oversight committee for QIF, but the fund managers still must uphold high governance standards. They have a fiduciary duty to act in the interests of the fund investors, manage conflict fairly and maintain proper risk management. Formation of an investor advisory committee is encouraged. The duty of the manager also involves meeting the capital requirements at all times, renewing the license annually. The strict compliance with rules is essential, including the AML, anti-bribery and sanctions policies. Professional conduct is expected by the FSRA.
CONCLUSION
Establishing a venture capital fund as a qualified investor fund in ADGM has the benefits of a high-standardised international fund regime with a realistic regulatory approach. The ADGM offers fund investors an organised exposure path to the market from the QIF notification process to a venture capital manager license, and also the safeguard of an investor. Startup fund managers and established institutions can establish venture capital funds efficiently by accessing regional capital pools and operating under globally recognised legal standards. A fund investor can successfully position the venture fund for long-term success in ADGM by understanding the framework and meeting the requirements set out by the Abu Dhabi Global Market.
