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March 2, 2024

The UAE as the new alternative investment hub

In a globalised financial environment, managing risk has become a paramount focus for Alternative Investment Fund Managers (AIFMs). Regulatory landscapes significantly impact risk management, with rules varying across jurisdictions.

While Europe has long been recognised as a hub for AIFs, with Luxembourg as one of the top respected investment destinations, the UAE has emerged as a strong contender. In recent years, it is attracting increasing attention from investors worldwide with its tax-friendly policies and favourable business environment.

As the UAE makes its mark in the AIF industry, it would help to understand the country’s risk management frameworks as well as forecast the future trends.

Regulatory landscapes: The UAE and EU

The risk management requirements for both UAE and EU markets aim to hold strong management norms and require enhanced transparency with extensive reporting guidelines.

The UAE has empowered the Securities and Commodities Authority (SCA) to oversee risk management in the field of AIF. It introduced substantial regulatory changes in 2022, including enhanced risk management protocols and stricter reporting norms.

Meanwhile, in the EU, the regulatory environment for alternative investment funds is governed by the Alternative Investment Fund Managers Directive (AIFMD). Under the AIFMD, the EU expanded risk management requirements with AIFMD II in the future, focusing on transparency, liquidity risk and robust supervision.

However, in addition to EU compliance, funds operating in Europe must consider regulatory supervision at national levels as well. The UAE regulatory framework for AIFMs, on the other hand, is designed to streamline the operating process, making it more efficient and less bureaucratic compared to the often time-consuming EU regulations.

UAE attracts smaller alternative investment funds

While comparing financial markets, it is to be noted that the UAE’s framework offers flexibility in structuring and operating, appealing to smaller AIFMs, due to its lower compliance and operational costs. It attracts international investors with high economic diversification and rapid growth in the fintech, renewable energy, and real estate sectors.

The strategic geographical location of UAE likewise makes it an appealing destination for a hub between the East and West. However, it is highly recommended to engage local experts as a fundamental market entry strategy, given local customs and business etiquette and potential changes in the regulatory framework.

Contrarily, with its mature market and robust regulatory regime, the EU’s framework enjoys access to one of the world’s largest single markets. However, it brings increased compliance costs and complex operational demands. As for economic diversification, the EU market shows slower growth in the financial services sector, with a high level of competition among well-established funds. It is likewise recommended to engage local experts on a market entry-level, given the size and diversity of EU markets and national laws, market conditions, and sanction policies.

It is important to highlight that the UAE offers a favourable tax environment for AIFMs and their investors, as certain jurisdictions provide zero corporate and income taxes. This tax-friendly environment and supportive business environment foster a conducive climate for emerging fund establishment and growth.

Outlook for risk management

Over the next three years, it is anticipated that regulatory standards are likely to converge, particularly with the UAE likely to adopt stricter norms aligned with international standards. Though this may elevate risk management costs in the UAE, it will potentially improve its attractiveness to international investors.

In the upcoming years, risk management and the role of the chief risk officer (CRO) will likely gain increased prominence in both the UAE and EU alternative investment fund industries. When global financial markets become increasingly interconnected, risk management continues to be a vital function in these industries, requiring the expertise of a dedicated CRO.

As cyber, geopolitical, and climate change-related risks gain attention and are seen as top risk priorities for the next 12 months, the CRO’s job will grow in complexity and rapidly expand remit. This trend is likely to continue, with the SCA necessitating independent risk management functions in line with global standards and the EU regulators emphasising the importance of effective risk management.

Lastly, technology is expected to play a vital role in risk management in the next three years, with advancements in data analytics, predictive modelling, and AI. While these improvements will enhance risk management efficiency, they may also present new risk types, particularly around data security and privacy.

Evidently, despite differences in the risk management regulations for the alternative investment fund industry in the UAE and EU, both regions recognise the crucial role of risk management. However, the UAE’s favourable business environment and rapid growth of certain high-tech sectors, together with larger flexibility and lower compliance and operational costs, provide an exceptional appeal to small-sized and emerging AIFMs.

Meanwhile, the role of a CRO role will continue to gain importance as international regulatory bodies increase their focus on risk management. The next three years will be crucial for the evolution of risk management in both regions, with increased compliance and more sophisticated risk management practices becoming the norm.