United Arab Emirates: Are Client Assets safe in the DIFC?

"Client Assets" is defined in the Dubai Financial Services Authority (DFSA) rules, as "Client Money and Client Investments". "Client Money" and "Client investments", are money¹ and investments², held or controlled by an authorised firm³ on behalf of a client in the course of, or in connection with the carrying on of investment business in or from the Dubai International Financial Centre (DIFC).

An authorised firm may, depending on the scope of its license, act as an investment intermediary who holds or controls, or provides or arranges custody, in respect of Client Assets. Such authorised firm must comply with the applicable provisions in the DFSA rules relating to Client Assets. The key requirement⁴ is that an authorised firm must have systems and controls to ensure that Client Assets are identifiable and secure at all times. Client Assets must be properly segregated from those of the authorised firm and that client account must be established to hold the Client Assets.
This article intends to discuss the treatment of Client Assets held by an authorised firm in the occurrence of a Distribution Event. A Distribution Event, according to the DFSA rules is:

• The appointment of a liquidator, receiver or administrator, or trustee in bankruptcy, over the authorised firm or its nominee company;
• The appointment of a liquidator, receiver or administrator, or trustee in bankruptcy, over a third party agent of the authorised firm or its nominee company; or
• The coming into force of a direction by the DFSA in respect of all Client Assets held by the authorised firm.

The laws and regulations of the DIFC⁵ and DFSA relevant for the discussion of the topic at hand, include the following :

• DIFC Insolvency Law (DIFC Law No. 3 of 2009)("Insolvency Law")
• DIFC Insolvency Regulations ("Insolvency Rules")
• DIFC Personal Property Laws (DIFC Law No. 9 of 2005) ("Personal Property Laws")
• DFSA Conduct of Business Rule ("COB Rule").

Rule A5.13⁶ of the COB Rule provides that on the occurrence of a Distribution Event, an authorised firm must distribute money in the following order of priorities:

• "Firstly, in relation to Client Money held in a client account, this must be paid to the segregated client⁷ in full (or, where insufficient funds are held by the authorised firm, proportionately, in accordance with each segregated client's valid claim over that money);
• Secondly, where the amount of Client Money in a client account is insufficient to satisfy the claims of the segregated client, or not being immediately available to satisfy such claims, all other money held by the authorised firm must be used to satisfy any outstanding amounts remaining payable to the segregated client but not satisfied per (a) above;
• Thirdly, upon resolution of claims in relation to the segregated clients, any money remaining with the authorised firm must be paid to each client in full (or, where insufficient funds are held by the authorised firm, proportionately, in accordance with each client's valid claim over that money); and
• Fourthly, upon satisfaction of all claims in (a), (b) and (c) above, in the event of:

- The appointment of a liquidator, receiver or administrator, or trustee in bankruptcy over the authorised firm, payment must be made accordance with the Insolvency Law; or
- All other distribution events, payment must be made in accordance with the direction of the DFSA".

Based on the above, not only is the authorised firm obliged to pay the client in full from all the money held in the client account, the authorised firm must also pay any shortfall amount, in case the client account has insufficient money to satisfy the client's rightful claims. As noted in COB Rule A5.13(d), the Insolvency Law must also be taken into account in the distribution of Client Assets. The Insolvency Law and Insolvency Rules set out the manner and procedures of an insolvency process, which includes the roles of the liquidator and the types of assets for distribution. Under Article 5.1.1 of the Insolvency Rules, creditor's winding up proceedings are initiated by the creditor by the service of the "statutory demand". The statutory demand must state the amount of the debt and claim for the payment of the same. The failure to pay the debt on the part of the company⁸ will entitle the creditor to institute the winding up proceedings.

Article 5.16.1 of the Insolvency Rules stipulates that, in the case where the company is wound up by the court, the person (creditor) must submit his claim to the liquidator through a "proof of debt" form which essentially states the total amount of his claim and the particular of the debt.

What then constitutes "debt", and does "assets for distribution" include Client Assets? Under Article 1.1.3(a) of the Insolvency Rules, the term "Debt" specifically excludes any obligation of a company under or in respect of "Excluded Property". "Excluded Property", is defined, in relation to a company which is an investment intermediary⁹, as:

• Property which is subject to Article 36¹⁰ of the Personal Property Law; or
• Money claims specified in the DFSA¹¹ rules relating to the holding by investment intermediaries of money belonging to third party.

Clients having investments with an authorised firm are treated as an account holder¹² in the context of the Personal Property Law. Article 35(1) of the Personal Property Law, clearly provides that investments and money held by an investment intermediary shall be allocated to the rights of the account holders. Article 35(2) further sets out that the investments will not form part of the property of the investment intermediary available for distribution among or realisation for the benefit of its creditors in the event of insolvency. Such investments will also not be subject to claims of the creditors of the investment intermediaries.

Additionally, in terms of the liquidator's duties in this case (ie where Excluded Property forms part of the assets or liabilities), Article 5.45.3 of the Insolvency Rules stipulates that the liquidator must comply with the requirements set out in the Personal Property Law or DFSA laws with respect to the Excluded Property.

In summary, the DFSA laws give utmost importance to the protection of Client Assets held or controlled by an authorised firm. Obligations are imposed on authorised firms to ensure that appropriate handling of Client Assets is in place at all times, so that any risks of loss or diminution of Client Assets can be avoided or mitigated. The laws go further to provide protection in the case of insolvency of the authorised firm by excluding the Client Assets from the authorised firm's estate and claims by its creditors.

Footnotes
1 Any form of money, including cheques and other payable orders.
2 Investments under the DFSA General Module are categorised as "Security" and "Derivative". "Security" includes share, debenture, warrant, certificate, unit or structured product and "Derivatives", include options or future. Investment also includes right or interest in the relevant "Security" or "Derivative".
3 Authorised firm is a licensed and regulated by the DFSA and registered or incorporated in the DIFC under the laws of the DIFC.
4 As set out in Rule 6.11 of the DFSA Conduct of Business Rule.
5 Dubai International Financial Centre.
6 This rule has to be read together with the Insolvency Regulations, and will prevail in case of inconsistencies.
7 Client who receives the protection conferred by the Client Money provisions in the COB Rule.
8 This can refer either to an authorised firm or a non regulated firm, namely a firm incorporated in the DIFC, but not licensed by the DFSA.
9 Defined in the Personal Property Law as "a person who, in the ordinary course of business, transacts investments or holds investments by way of custody or security".
10 This article talks about the effect of insufficiency on account holder's rights, whereby the authorised firm must pay any shortfall in the amount of the investments that should be rightfully allocated to the account holder.
11 Under COB Rule 6.12.1, this refers to all money held or controlled on behalf of a client in the course of, or in connection with, the carrying on of investment business in or from the DIFC.
12 A person in whose name, an investment intermediary maintains an investment account, whether that person is acting for his own account or for others.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.