Five Key Trends Shaping the Middle East Fund Landscape

Paced by the UAE, the private fund sector in the Middle East is experiencing rapid growth, along with some profound challenges – chief among them regulatory demands and increasing operational complexity. This article examines the five key trends shaping the fund industry in the Middle East today and discusses what’s needed to both address the challenges and capitalize on the opportunities in this dynamic region.

Recent years have seen rapid growth in the private fund sector in the United Arab Emirates and surrounding regions, most notably in venture capital, real estate, private equity and private credit. This in itself is not surprising. Though economic growth has cooled somewhat after a banner year in 2022, the Arab world’s second-largest economy remains fundamentally buoyed by its oil and gas exports. The UAE government, meanwhile, has introduced initiatives to buffer the economy against fluctuations in oil and gas prices, output and global demand, and to encourage investment into such sectors as manufacturing, mining, construction, transportation, tourism and technology.

The Dubai International Financial Center (DIFC) and the Abu Dhabi Global Market (ADGM), special business zones governed by their own legal and regulatory framework, are models of the effort to diversify the economy, stimulate innovation and attract investment capital. What may be surprising, though, is the accelerating pace of change and the resulting pressure on fund managers to keep up. With rapid growth come “growing pains” fund managers in the region have run up against operational constraints that may impair their ability to fully capitalize on opportunities in the region. Meanwhile, a wave of regulation is putting pressure on managers to elevate their operational standards to improve the quality of their reporting and increase transparency.

Five Key Trends Impacting UAE and Arab Funds

1. Increasingly Complex Regulation

Regulatory compliance and reporting are arguably the biggest operational challenges facing Middle Eastern fund managers today. As funds grow and attract international capital, their exposure to global regulatory regimes grows in parallel. For example, funds that have US investors must comply with that country’s Foreign Account Tax Compliance Act or FATCA, while funds with investors from any of more than 100 participating jurisdictions must meet the OECD’s Common Reporting Standard or CRS. The intent of these laws is to ensure that citizens of those countries are properly reporting income earned from overseas investments to their respective tax authorities. The effect on fund managers in the UAE and elsewhere is that they must perform extensive due diligence and reporting on the accounts of foreign investors in their funds. The formats and filing requirements of these reports is dictated by the Automatic (or Annual) Exchange of Information or AEOI, the mechanism for compliance reporting under both FATCA and CRS. In a similar vein, UAE fund managers must comply with anti-money laundering (AML) and know-your-client (KYC) regulations as set forth by Central Bank of UAE, as well as the Abu Dhabi Global Market’s Financial Services Regulatory Authority (FSRA) and the Dubai Financial Services Authority (DFSA). This entails initial due diligence on investor’s backgrounds in the onboarding process, as well as ongoing monitoring and screening to ensure no investor is taking advantage of the fund to conceal financial crimes. Managers need automated solutions to perform these tasks at scale, which are too often bogged down in manual processes.

Most recently, the Abu Dhabi Securities Exchange and Dubai Financial Market, along with other exchanges in the region, have issued guidelines for funds to report on their environmental, social and governance (ESG) practices. And funds investing in European markets must comply with the EU’s Sustainable Financial Disclosure Requirement (SFDR). (ESG in investment strategies is a nascent trend in itself in the Mideast, discussed next in this document.) A sound regulatory framework is critical to the fair and efficient functioning of the investment marketplace. However, these mounting regulatory hurdles are putting enormous pressure on funds, straining both human resources and reporting systems. Finding ways to alleviate these burdens while mitigating compliance risks and lapses is a top priority for many managers.

2. The Rising Importance of ESG in Investment Strategies

ESG consciousness has begun to rise in the Middle East. Companies are hiring sustainability officers and voluntarily reporting on their environmental impact and initiatives. In its 2023 Social and Governance Report, PwC reported that 64% of companies surveyed have adopted formal ESG strategies – motivated mainly by regulatory mandates in the region. On the fund front, ESG has been slower to take hold in investment strategies. In a 2022 survey of private equity and venture capital funds in the Middle East and Africa, S&P Global found that 31% of respondents did not factor ESG into their investment strategies, 17% were just starting to and 41% are trying to improve their ESG posture. Nearly one-third are seeking companies with good ESG track records for their portfolios.

The UAE has declared 2023 the “Year of Sustainability,” giving some measure of hope to proponents of sound environmental practices in a region that is especially vulnerable to hotter temperatures, rising seas and water scarcity. Fund managers are likely to feel public and government pressure to elevate ESG in their decision-making. They need a means of sifting through the voluminous and often contradictory research on ESG performance in order to identify responsible investment opportunities.

3. The Surge in Family Wealth

The Middle East is experiencing a surge in private wealth. Consider just a couple of indicators, the ultra-high net worth population in the Middle East is expected to rise by nearly 25% in the five-year span from 2021 to 2026. And Arabian Business reports that Saudi Arabia is home to 71 billionaires and the UAE 42 billionaires, (WealthX 2023 Billionaire Census). As a result, the number of family offices in the region is on the rise – so much so that the DIFC has enacted regulations to establish certification and accreditation programs to incentivize qualified firms to locate in its Global Family Business and Private Wealth Centre. So far, more than 460 entities or some 10% of companies in the DIFC reportedly operate under a “family structure.” Family offices have become major players in the fund sector, either through wealth advisors, private equity and venture capital funds, or through their own funds that invest directly in real estate, real assets or venture-backed projects. As their portfolios become more diversified and complex, they need tools and professional support to help them track and accurately account for the deployment of their wealth.

4. Start-Ups and Venture Capital

The Middle East has become a hotbed of start-up activity – and the money has followed. Startups in the region attracted a record US$3.94 billion in funding in 2022, most of which happened in the UAE, Saudi Arabia and Egypt. The Abu Dhabi Global Market exemplifies the start-up mentality taking root in the region. Its venture-backed Hub-71 is an incubator and collaborative workspace housing over 100 start-ups from around the world, reportedly ranked among the top 10 start-up ecosystems in the world. Led by the UAE, the Middle East is “emerging as a bright spot for venture capital investments,” says Gulf Business. The Emirates accounted for nearly 50% of total venture funding between 2018 and 2022. While oil underpins the region’s financial strength, venture capital is reportedly flowing into other emerging sectors, such as technology and finance.

5. Emerging Technologies

Efforts to diversify the economy, modernize the infrastructure and nurture start-up companies are among the factors driving growth in the technology sector in the UAE and surrounding region. Another is timing – the boom coincides with the mainstreaming of artificial intelligence, which stands to accelerate the pace of technology adoption in the region. “The UAE, Saudi Arabia and Qatar, in particular, have demonstrated strong commitment towards the development and implementation of AI technologies,” says a report from PwC. “Businesses in these parts of the region have been investing heavily in new technology, supported by governments as early consumers of the technology.” The study projects that AI could contribute as much as $96 billion to the UAE’s GDP, or roughly 14% of total GDP, by 2030.

Signalling the importance of AI development to the region, the DIFC instituted the UAE’s first “Artificial Intelligence and Coding License” in 2022, with the goal of attracting AI coders to set up shop in the centre’ss Innovation hub. AI represents both an opportunity and a challenge to fund managers in the region. The investment opportunity is readily apparent. The challenge, however, is the fund industry’s readiness to be adopters of emerging technologies and not get left behind by the AI-powered transformation taking place around them.

Conclusion:

The Middle East's fund industry is at a crossroads, offering unprecedented opportunities for growth and innovation. As we navigate the five key trends shaping this dynamic landscape, it becomes evident that the region's resilience and determination are driving it towards a prosperous future. To stay informed and make the most of these opportunities, we invite you to explore further insights and resources on our website. www.bridgesbiz.llc