* Financial regulator proposes new fund class
* Aims to attract private equity and hedge funds
* Less stringent regulation, higher minimum investment
* Cost and 'human infrastructure' issues persist
DUBAI, March 16 (Reuters) - Dubai is considering regulatory reforms to persuade more funds to base themselves in its financial centre, though industry experts believe that other parts of its investment environment may also need to change for the emirate to compete globally.
The proposed rules would create a new class of funds in the Dubai International Financial Centre (DIFC) in an effort to attract asset managers, such as hedge funds and private equity funds, serving the richest and most risk-tolerant investors.
The DIFC has boomed since it was set up as a financial free zone in 2004, becoming the Middle East's top banking hub. The number of registered firms operating in the DIFC jumped 14 percent to 1,039 last year, but it has not come close to competing with the likes of Luxembourg, Dublin and the Cayman Islands as a top domicile for funds.
Only nine funds have been domiciled in the DIFC since its current funds regime was introduced in 2010, compared with hundreds established in the leading centres, industry sources said. The DIFC declined to comment.
The Dubai Financial Services Authority (DFSA), the regulatory body for the DIFC, is now moving to narrow that gap with its new fund class, which would impose less stringent regulation - and therefore lower costs - on asset managers.
Rapidly expanding financial markets and rising incomes in the Gulf suggest there is room for a fund management hub to develop in the region.
"You need an option now for a Middle East domicile," said Chris Harran, a national partner at law firm Dechert LLP, which has worked extensively on setting up funds in Dubai.
But he added that elements outside the DFSA's control - such as the way in which investment funds are incorporated and registered - would also need to be considered to maximise Dubai's attractiveness.
Anthony Mallis, chief executive of asset management firm Securities & Investment Co in Bahrain, said the DIFC would succeed in the long run if it could accommodate investors such as family offices from around the Gulf.
A growing number of these offices, which help the region's wealthy families and business dynasties to manage their money, have been establishing a presence in Dubai, he noted.
For now, however, Dubai needs to develop its "human infrastructure" of financial lawyers, custodians and other professionals to sustain growth as a fund centre, Mallis said.
"The volumes of money flowing through must be large enough to sustain the infrastructure. They haven't got that yet."
At present, DFSA rules permit two types of funds: public funds and exempt funds.
Public funds serve the mass of retail investors, who can afford relatively little risk, with extensive regulation in line with International Organization of Securities Commissions standards.
Exempt funds, meanwhile, serve professional, experienced clients more able to cope with risk. Regulation is less stringent but subscriptions to exempt funds start at $50,000.
The DFSA's proposal would create a third category: qualified investor exempt funds (QIEFs). Rules would be relaxed further - for example, fund managers would have more flexibility in the appointment of custodians and the filing of reports on funds. The minimum subscription would be much higher at $1 million.
The proposal was made after a review of other fund jurisdictions, including Bahrain, Luxembourg, Dublin, the Cayman Islands and Singapore, the DFSA said. A public consultation ended last month and the rules could be introduced this year.
Dubai has strengths as a fund centre. Tax and investment treaties between the United Arab Emirates and other countries, as well as the legal treatment of land ownership, can make it advantageous for foreign investors in Gulf assets - or Gulf-based investors in overseas assets - to have their funds domiciled in the DIFC. In effect, Dubai can act as a contact point for the Gulf and Western financial systems.
Dubai's move comes after the European Union introduced its Alternative Investment Fund Managers Directive, tightening the EU's regulation of hedge funds and private equity funds in the wake of the global financial crisis.
While the DFSA emphasises that it is not sacrificing responsible regulation with its proposal, it has a chance to appear attractively lenient to European fund managers saddled with heavier regulation at home.
It is not yet clear, however, whether the DFSA's efforts will bear fruit. Harran said the proposed $1 million minimum subscription could be considered too high by some fund managers. Regulations in Ireland and Luxembourg suggest that a figure of $500,000 might be more appropriate for QIEF, he said.
Some other QIEF requirements look potentially problematic, depending on how they are applied, he said. For example, while private equity funds do not have to appoint custodians for assets in certain circumstances, they do need to have independent oversight committees, which could prove burdensome.
And though the QIEF proposal aims to streamline registration for funds, DIFC companies law and its requirements would still apply. Standalone investment fund incorporation rules may be needed to resolve this issue, Harran said.
Other obstacles to the QIEF regime involve wider aspects of Dubai's investment environment.
John Sfakianakis, chief investment strategist at Saudi Arabian investment firm MASIC, said that the decade-old DIFC would initially find it hard to compete with more established fund domiciles.
"Others are more attractive in terms of experience, legacy and cost," he said. "The last point is very crucial as fund competitiveness is partly due to the set-up cost."
Jacques Visser, another national partner at law firm Dechert, argues that more policy changes at local and federal government levels might be necessary to give the DIFC a unique selling point for funds.
For example, a Dubai government decree allows one fund, Emirates REIT, to buy property anywhere in the emirate, not only in designated zones for foreigners. Extending that right to all DIFC funds, provided that most investors were from Gulf Cooperation Council countries, could ignite interest in DIFC funds as a way into Dubai's booming property market.
Similarly, there are ceilings or bans on foreign investment in individual UAE stocks such as telecoms giant Etisalat , and Visser says that federal rules could be eased to make the DIFC a channel for such investment.
"The moment one takes steps like that, DIFC-based funds may be able to reach critical mass to fuel further, exponential growth," he said.
"But one needs that spark from a policy-related perspective rather than just focusing on pure regulatory change."