Abu Dhabi’s New Financial Free Zone Puts Regulation in the Spot Light
01 Jun 07:14 AMSector : Banking & Finance Country : UAE
By Andrew Cunningham
Abu Dhabi’s recent announcement that it will establish a financial free zone on Maryah Island provides further evidence of the Emirate’s increasing selfconfidence, and it will offer an additional point of entry to international financial institutions looking to access the lucrative UAE market.
The new free zone will also increase the fragmentation of financial regulation in the UAE by adding an additional regulatory body – responsible for the new free zone – to the four that already oversee financial sector activities in all or part of the UAE federation (see table below).
The Federal Decree that enacted the creation of the Abu Dhabi World Financial Market was issued on February 11 and it was published in the official gazette in April. In May, the Abu Dhabi authorities announced plans to create a legal infrastructure and court system for the Global Marketplace Abu Dhabi (GMAD).
Three Bodies Regulate Financial Activity
Three bodies currently regulate financial activity in the UAE at the federal level: the UAE Central Bank based in Abu Dhabi, the Insurance Authority, and the Securities and Commodities Authority (SCA). The regulatory scope of these three bodies extends throughout the seven Emirates that make up the UAE although it does not apply within the Dubai International Financial Center (DIFC). Firms operating within the DIFC are licensed and regulated by the Dubai Financial Services Authority (DSFA) and are not subject to federal laws and regulations other than the federation’s criminal law. Financial firms in the DIFC include banks, insurance companies and Nasdaq Dubai (formerly known as the Dubai International Financial Exchange).
The creation of the DIFC, with its own legal and regulatory structure, enabled Dubai to build a financial services industry physically situated in Dubai, even if legally distinct. Crucially, it enabled Dubai to attract and license a large number of financial firms far more quickly than if licensing had been in the hands of the federal authorities. For firms operating out of the DIFC, the limitations on their ability to conduct business with domestic firms is easily outweighed by the speed with which they gained a regional base from which to penetrate larger economies.
Abu Dhabi’s proposed GMAD builds on the existing development of Sowwah Square, a mixed-use commercial real estate project on Maryah Island (which was previously known as Sowwah Island).
Sowwah Square is situated in an area of Maryah Island that has been designated as Abu Dhabi’s new Central Business District. As with the DIFC, GMAD will enable licensed firms to operate within a regulatory and legal environment that has been carved out of federal law and regulations.
Abu Dhabi’s announcements about its GMAD immediately prompted comments that Abu Dhabi was seeking to compete with the DIFC and perhaps even draw business away from Dubai and into Abu Dhabi. A senior Abu Dhabi businessman who had been involved in planning the new center was quick to state that Abu Dhabi’s financial center would “complement” rather than compete with the DIFC.
The Federal vs. Free Zone Dilemma
But more fundamental than the issue of competition between free zones is the relationship between free zones and “on-shore” financial activity regulated by the federal authorities. Despite the attention that is given to off-shore free zones, the great majority of financial activity conducted by firms situated the UAE is regulated by the federal authorities.
For example, 23 banks are licensed by the UAE Central Bank. Together they held assets of $489 bn at the end of 2012, more than 80 percent of which were domestic. UAE residents account for more than 90 percent of these banks’ deposits.
In contrast, the DIFC contained 912 active companies at the end of 2012, of which 345 were “regulated firms,” comprising banks, insurers, and other financial service providers. At the end of 2011 (the latest year for which figures are available) active companies held $109 bn in financial assets.
Similarly, the value of shares traded on each of the two on-shore stock exchanges, the Abu Dhabi Exchange and the Dubai Financial Market, has been about 10 times the traded value on Nasdaq Dubai, which sits in the DIFC.
Federal Regulators are Seen as Slow to Act
Yet the federal regulators have often been seen as too slow to act and insufficiently attuned to the needs of market participants. Taking the oversight of mutual funds away from the Central Bank and putting it under the SCA took years to complete even though the move was long overdue and widely recognised as appropriate (the SCA assumed control of mutual funds in 2012.)
Earlier this year, the Central Bank’s proposals to place strict loan-to-value limits on mortgages extended by local banks ran into strong opposition from the Emirates Banks’ Association, resulting in weeks of delay and, when an accord was eventually reached, significant changes to the Central Bank’s original draft.
Perhaps most significantly, only two new banks have been licensed by the Central Bank in recent years despite a significant increase in the financial activity in the UAE, and in the Gulf states more broadly. The key shareholders of both these banks were either Dubai or Abu Dhabi based investors. In contrast to the DIFC, which has proved an effective gateway into the region for financial firms since its establishment in 2004, the federal regulators have appeared reluctant to take advantage of the increase in financial sector activity in the region by licensing more firms to operate within the UAE.
But the UAE Central Bank is far from alone in the GCC in its conservatism when it comes to licensing new institutions. Saudi Arabia has licensed only two new commercial banks in the last 25 years (although the Kingdom has opened up to investment banks and branches) and Kuwait has licensed only two in the last 30 years (although the Emirate has also allowed some overseas banks to open branches).
Qatar has been a little more open, with four new banks being licensed by the Central Bank in the last 10 years, although the real growth in financial services has occurred in the Qatar Financial Center (QFC), which was established in 2005.
Capital market regulation has been more forwardlooking throughout the region, reflecting the rise of sukuk issuance and the slow but steady deepening of equity markets. The UAE has followed this trend, with the SCA modernizing existing regulations, for example in areas such a corporate governance standards, and adding new requirements in areas of increasing importance, such as compliance.
Yet, as the planned creation of GMAD on Maryah Island demonstrates, Abu Dhabi is intent on attracting financial sector firms that want access to the Emirate’s wealth and to use its facilities and infrastructure as a springboard into the wider Gulf region. How these firms will be regulated will determine not only the success of Maryah Island, but also the development of the financial industry in the federation as a whole.