Regulatory & Investigations
In this article we summarise the recent changes to the Dubai Financial Services Authority's (DFSA) suitability rules, and look at their application to corporate finance activities.
On 1 January 2020 the DFSA implemented changes to its suitability rules and guidance. The DFSA consulted on the new rules and guidance in Consultation Paper No. 127, and while these changes were referred to as "miscellaneous changes" in the Consultation Paper, in fact they represent a significant change in the way in which the DFSA expects regulated firms to deal with Professional Clients.
We understand that there are further changes to the DFSA's suitability rules in the pipeline as the DFSA aims to bring the regime in the DIFC in line with the equivalent EU regime. We will provide further updates when the DFSA consults on these additional changes.
The current changes affect Investment Firms and firms conducting Insurance or Insurance Intermediation activities.
The changes to the suitability rules, and the accompanying updated guidance, are set out in section 3.4 of the Conduct of Business Module (COB) of the DFSA's Rulebook and focus on the suitability assessments.
The amended rules and guidance apply to investment firms who recommend financial products and services, and undertake transactions on a discretionary basis for or on behalf of Professional Clients. In summary, the changes:
The changes to the suitability rules and guidance will impact on firms conducting any Insurance or Insurance Intermediation business with or for a Retail Client in respect of Direct Long-Term Insurance. In summary, the new guidance:
Whether the DFSA's suitability rules apply to "corporate finance" business will depend on the facts in question. Corporate finance business is not defined under DFSA rules. However, it typically involves advice to companies on capital structure, corporate or industrial strategy, and advice and services relating to mergers and acquisitions. There may be circumstances where a firm conducting corporate finance business with a client (who is not Market Counterparty) may be required to consider suitability for that client if the firm "recommends to a Client a financial product or financial service" in conducting corporate finance business.
In corporate finance business, the situations in which a firm may recommend to a Client a financial product are likely to be limited. "Recommending a financial product" must be read in light of the DFSA definition of "advising on financial products" which is:
"Advising on Financial Products means giving advice to a Person in his capacity as an investor or potential investor […] on the merits of his buying, selling, holding, subscribing for or underwriting a particular financial product (whether as principal or agent)." (see DFSA General Module Rule 2.11)
It is generally unlikely that in conducting corporate finance business a firm would give advice on financial products to a Person in his capacity as an investor. A company seeking corporate finance advice is generally doing so for strategic purposes, for example, by buying a competitor out or divesting of a non-core asset. The advice sought is not advice on whether a particular financial product should be bought but whether a particular company or asset should be bought or divested.
Therefore, unless it is clear that in conducting corporate finance business a firm is making a recommendation on a particular financial product to a person in his or her capacity as an "investor", the suitability rules would not apply to the relevant transaction. We set out in the table below some examples of circumstances where the suitability rules do and do not apply to firms conducting corporate finance business.
|Activity||Application of suitability rules|
|Pre-engagement, generic discussions and advice with a Client on a corporate finance transaction as part of the beauty-parade.||No|
|Advising a Client on changes to a company's capital structure.||No|
|Advising a Client on potential merger or acquisition targets.||No|
|Advising a Client on a particular industry sector or companies within that sector.||No|
|Recommending to a company's director which industry competitor would be the optimum acquisition target.||No|
|Advising a company to make a strategic acquisition in another company by buying shares or debt in the company.||Potentially yes – if the advice is given to the company in its capacity as an "investor".|
|Advising senior management and other shareholders on whether to sell their shares at a particular price - when acting for a target in a takeover context.||Yes – such advice would amount to a recommendation to the shareholders in their capacity as investors to sell their shares.|
Even where the DFSA suitability rules do apply to in whole or in part to a firm conducting corporate finance business, complying with the rules is likely to be relatively straightforward and is unlikely to require material or indeed any changes to a firm's processes. This is because typically, in the course of winning and undertaking a corporate finance mandate, a firm is likely to have acquired more than enough information about the Client’s needs and objectives and financial situation to have a reasonable basis for considering a recommendation or transaction to be suitable for that particular Client. In addition, the Client's risk tolerance, knowledge, experience and understanding of the risks involved in a transaction, if not set out in the RFP, can be ascertained from publicly-available information or may reasonably be inferred from the firm's knowledge of the Client.
The changes to the Suitability Rules are not retrospective, however:
If you require any advice or assistance on the DFSA's new suitability rules and guidance, please contact a member of our specialist team.