Middle East and India: Right as Bahrain
It seems that barely a day passes without another Middle Eastern state announcing that it is to develop a centre devoted to the financial services industry and proclaiming its intention to be the 'financial services hub of the Middle East'. In a manner reminiscent of the fable of the tortoise and the hare, the Kingdom of Bahrain has, meanwhile, been quietly but methodically overhauling its legal and regulatory framework for financial services with a view to providing a comprehensive, straightforward and user-friendly platform upon which banks, funds, insurance companies and other participants in the financial services market can establish a presence in Bahrain and operate cost-effectively and competitively, while adhering to international best practice.
April 02, 2008 at 10:03 PM
7 minute read
It seems that barely a day passes without another Middle Eastern state announcing that it is to develop a centre devoted to the financial services industry and proclaiming its intention to be the 'financial services hub of the Middle East'.
In a manner reminiscent of the fable of the tortoise and the hare, the Kingdom of Bahrain has, meanwhile, been quietly but methodically overhauling its legal and regulatory framework for financial services with a view to providing a comprehensive, straightforward and user-friendly platform upon which banks, funds, insurance companies and other participants in the financial services market can establish a presence in Bahrain and operate cost-effectively and competitively, while adhering to international best practice.
In reality, despite there being no lack of healthy competition, each jurisdiction is pursuing a slightly different path and thus direct comparisons are somewhat invidious. Nevertheless, based upon published data, it would appear that the initiatives undertaken by the Kingdom of Bahrain and its central bank have borne (and continue to bear) fruit.
According to the Bahrain Financial Services Department (BFSD) – part of the Economic Development Board – Bahrain is now home to more than 400 licensed financial services institutions. The BFSD also notes that the financial sector is now the most important sector of the economy, accounting for more than 27% of GDP. In an era when – notwithstanding the arrival of the $100 (£50) barrel of oil – Middle East governments are attempting to diversify their economies away from oil revenue dependence, this is a significant statistic.
The first step in the process of financial services reform in Bahrain took place in 2002, when the then Bahrain Monetary Agency (BMA), like its UK counterpart the Financial Services Authority, assumed responsibility for regulating the entire financial services industry, including the insurance sector and the Bahrain Stock Exchange.
In September 2006, the Central Bank of Bahrain (CBB) and Financial Institutions Law established the CBB as the successor organisation to the BMA. The CBB law provided enhanced enforcement powers to the CBB as well as reinforcing its operational independence.
The CBB, in its capacity as the 'super-regulator', issues regulations with which licensees are legally obliged to comply. These regulations are contained in the CBB rulebook. The CBB rulebook currently covers five different areas of financial services activity, including: conventional banks (volume one), Islamic banks (volume two), insurance and reinsurance services, including takaful and retakaful – Islamic [re]insurance (volume three), regulated investment services (volume four), and collective investment undertakings (volume six). Volume five, which will deal with specialised providers of financial services is expected to be launched during the second quarter of 2008.
Bahrain has also instituted a number of specific initiatives with a view to establishing its credentials as the regional (if not the global) leader in Islamic finance. There are currently 24 Islamic banks and 11 Islamic insurance companies (takaful) operating in the Kingdom. The CBB has (in volume two of its rulebook) crafted a regulatory system for Islamic banks, which is tailored to regulating the specific products and services which they offer and the particular manner in which they manage their assets and liabilities.
Bahrain is also home to the Accounting & Auditing Organisation for Islamic Financial Institutions, the Islamic International Rating Agency and the International Islamic Financial Market, all of which are working together to draft and harmonise accounting and other standards underpinning the development of the Islamic financial, capital and money markets.
Following completion of a consultation process conducted in two stages in October 2005 and March 2006, the CBB issued the fourth volume of its rulebook for licensees in April 2006.
The regulations in volume four apply to investment firms and address both general issues relating to the conduct of investment business in Bahrain, as well as the specifics of receiving both initial and ongoing regulatory approval.
The growth of funds and other investment vehicles operating in the Gulf Co-operation Council and the development of the private equity and venture capital sectors had created significant opportunities for participants in the fund management, asset management, broking, advisory, custody and administration industries. The primary purpose of volume four was to clarify those investment business activities which require a licence from CBB. It also contains detailed provisions on the suitability and vetting of those persons who will perform certain 'controlled functions' within a licensee firm. Controlled functions include performing the roles of CEO, COO, CFO, compliance officer and money-laundering officer and, in the context of providing Sharia-compliant products, acting as a member of such a licensee's Sharia supervisory board.
In July 2006, the Bahrain Government, through the CBB, was also the first of its peers to introduce a formal trusts law. While many Islamic finance structures (notably mudaraba, musharaka and wakala) acknowledge the distinction between legal and beneficial title to assets and also impose duties on the relevant manager or agent analogous to fiduciary duties, the Bahrain trust law introduced the concept of a statutory trust, which can be formally registered with the CBB.
While this statutory trust has, thus far, perhaps been less enthusiastically embraced than might have been envisaged by the CBB, there are signs that lawyers and other advisers, together with banks and other financial institutions operating in the Bahrain market, have begun to appreciate the potential for using such a construct in the context of sukuk, securitisations, syndicated finance and in particular, funds and other collective investment schemes.
Finally, new regulations relating to collective investment undertakings (CIUs), which came into effect from 1 June, 2007, have reinforced Bahrain's reputation as the funds centre of the Gulf by allowing, for the first time, CIUs to be targeted at accredited investors and by broadening the range of products available, extending to hedge funds and derivatives.
The funds industry in Bahrain is currently the largest in the region. More than 2,600 funds are registered in Bahrain. Of these, 97 are Bahrain-domiciled schemes, and 80 Islamic. Total assets under management are some $9.3bn (£4.6bn) – up nearly 40% on the total for 2006).
The new regulations provide for three classes of funds: retail, expert and exempt funds. Only retail and expert funds attract supervisory oversight from the CBB, while exempt schemes essentially adopt the concept of caveat emptor, on the basis that their participants will be institutions and high net worth individuals.
In order to avoid supervisory duplication, the regulations also provide for a fast-track approval for overseas domiciled CIUs, which are already regulated in certain recognised jurisdictions, including the European Economic Area member states, the US, the Cayman Islands and certain British Crown dependencies.
In addition, the new rules make special provision for Shariah-compliant funds. The Bahraini Islamic fund industry is estimated to be growing at a rate of 20% a year, with Islamic funds currently representing $1bn (£500m) of $9bn (£4.5bn) of assets under management, in CBB-registered funds.
The introduction, over the last five years, of this package of new or revised legislative measures has created a steady flow of interesting and challenging work for lawyers and other professional advisers practising in Bahrain – particularly in the context of guiding and advising new participants entering the market. A number of 'heavyweights' have chosen to establish a presence in Bahrain to provide banking, insurance, reinsurance, asset/fund management and fund administration and custody services.
Accordingly, regardless of whether one jurisdiction or one regulator within the Middle East market ultimately establishes itself as the dominant force in the regional financial services arena, Bahrain will undoubtedly continue to be a respected and leading player and like the hare before them, its peers should guard to ensure that they are not caught napping.
Neale Downes is a partner and regional head of banking and finance at Trowers & Hamlins in Bahrain.
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