20 Jan 2019

Legislative Commentary on the UAE Law regarding the Central Bank & the Organisation of Financial Institutions and Activities

Authored by: Sundus Khan

Legislation Number Federal Law No. 14 of 2018
Date of publication in the Official Gazette 30 September 2018
Jurisdiction United Arab Emirates
Related Legislation
  1. Federal Law No. 10 of 1980 Regarding the Central Bank, the Monetary System and Organisation of Banking and amendments thereto,
  2. Federal Law No. 6 of 1985, Regarding Islamic Banks, Financial Institutions and Investment Companies

 

Abstract

After the formation of the UAE in 1971, a Currency Board was established in May 1973, mandated simply to issue the UAE Dirham to replace existing currencies in use at the time. This Currency Board did not possess any real central bank powers. As the UAE’s economy developed, it became evident that the UAE needed a Central Bank to govern its economic development and its growing network of local and foreign banks. On 10 December 1980, the Currency Board became the Central Bank of the UAE. The Central Bank was tasked with the organisation of the UAE’s monetary, credit, and banking policy.

With the issuance of Federal Law No 14 of 2018 (the new Law) after almost three decades, the UAE has enhanced the authority and role of its Central Bank over the licensing and regulation of all financial institutions and financial activities within its borders.

This commentary highlights some of the changes introduced by the new Law with emphasis on how this law reins in the wide range of financial and banking practices in accordance with international standards along with tackling emerging financial activities and financial products not governed by previous legislation.

Analysis

The new Law repeals the old Central Bank Law (Federal Law No. 10 of 1980) and the law governing Islamic financial institutions (Federal Law No 6 of 1985) that has not been updated or amended to address developments in the financial industry since 1980.

 

The new Law reinforces and strengthens the role of the Central Bank to direct monetary credit and banking policy within the UAE. Under the new Law, the Central Bank is broadly tasked to:

  1. Exercise exclusive control over currency issue in accordance with the provisions of the new Law;
  1. Support the UAE currency and maintain its internal and external stability to ensure that its convertibility into foreign currency;
  1. Direct credit policy in a manner that achieves steady growth of the UAE economy;
  1. Supervise the effectiveness of the banking system in the UAE;
  1. Advise the UAE government on financial/monetary issues; and
  1. Maintain the UAE government’s gold and foreign currency reserves.

To achieve these broad objectives, the Central Bank:

  • Will act as the licensing authority for a range of designated licensed financial activities (LFAs) carried out in or from the UAE by Licensed Financial Institutions (LFIs), which now expressly include marketing of stored values services, electronic retail payments, digital money services and virtual banking services;
  • Will oversee the compilation, exchange and processing of credit information received from reporting LFIs or any other party;
  • Will impose requirements on LFIs in relation to their activities as deposit takers to protect the interest of depositors;
  • May exercise discretionary powers to establish policies and issue regulations relating to the prudential supervision of LFIs;
  • May make provision for the liquidation of LFIs in financial difficulty;
  • Will act in conjunction with any other regulatory authority in the UAE to ensure payment and settlement finality for fund and other money transfer systems; and
  • May exercise a range of administrative and financial sanctions and penalties on non-conforming LFIs.

Territorial Limits

The new Law does not apply to financial free zones and financial institutions regulated by the authorities of those zones. The Central Bank may however, in accordance with Article 28 (2) of the new Law, exercise its powers over financial institutions outside the UAE or in financial free zones in consultation and coordination with the concerned regulatory authorities.

Any new regulations, decisions, and circulars issued pursuant to the new Law will have no retroactive effect and will not prevent the implementation of agreements between LFIs and their customers that have been concluded prior to their issuance. The Central Bank will determine the transitional period within which all LFIs will be required to reconcile their position with the new Law and any secondary legislation.

Licensing

The new Law focuses the Central Bank’s licensing and supervisory functions on the type of financial activities to be carried out by any financial institution, as opposed to licensing specific entities. This approach mirrors the licensing classification system adopted by the Dubai International Financial Centre (DIFC).

The new Law puts on paper the full list of financial activities that may be carried out by LFIs and which require mandatory licensing by the Central Bank. The new provisions simplify the previous position, under which both the Central Bank and the Securities and Commodities Authority (SCA) have exercised their respective powers for licensing of day-to–day activities of financial institutions within the UAE. To the extent that a LFI intends to carry on activities other than LFAs, licensed by other regulatory authorities in the UAE or in other jurisdictions, such LFIs are required to obtain approval of the Central Bank prior to obtaining licensing from the concerned regulatory authority which appears to signify concurrent jurisdiction.

The list of financial activities in the new Law also includes new activities of providing and marketing stored values services, electronic retail payments, digital money services and virtual banking services. The inclusion of these financial activities indicates the Central Bank’s willingness to respond to market demands and developments while ensuring consumer protection and financial stability.

The new Law grants the Central Bank wide discretionary powers to issue licenses, and impose conditions and restrictions, suspend, withdraw or revoke licenses. Additionally, the promotion of any LFA or financial product can only be carried out in accordance with the new Law and related rules and regulations. For the purposes of this new Law, promotion includes any form of communication by any means, aimed at inviting or offering to enter into any transaction or offering to conclude any agreement related to an LFA.

The Central Bank has wide discretionary powers to exempt any activities or practices, or exempt the prohibition to carry on or promote LFAs.

Financial Activities Committee

Any financial activity not expressly listed under the new Law is to be determined by a technical committee named the “Financial Activities Committee” (Committee). The Committee is intended to be established by the Ministry of Finance and will include in its membership a representative of each of the regulatory authorities in the UAE.

Representation of all regulatory authorities in the Committee is likely to streamline assessment and consideration of new financial activities not listed in the Law.

Regulatory Framework and Responsibilities for Deposit Taking Financial Institutions

The Board of Directors of the Central Bank is empowered to establish a resolution framework for deposit taking LFIs in order to minimise the effect that a deficiency in their financial position may have on the UAE’s financial system.

In order to protect concerned institutions and their respective depositors, the Central Bank may, among other measures, undertake direct management of a financial institution and form an interim committee to manage the concerned institution, which may impose a moratorium on all or some of the activities of the financial institutions.

The running theme of the new Law is consumer protection and financial stability. In order to achieve both objectives, the new Law emphasises by way of numerous provisions, responsibilities and obligations of LFIs. The most notable of these are:

Controlling Interest

All LFIs are required to ensure they do not allow any person (term not defined) from holding or increasing controlling interest in LFIs without the express prior approval of the Central Bank.

Designated Functions

No LFI individuals may undertake “Designated Functions” without the prior approval of the Central Bank. Designated Functions include all functions for the benefit of a LFI or of an influential nature on the LFIs’ activities.

The Central Bank has the express authority to either: (i) prohibit an individual from carrying out a Designated Function; (ii) authorise the individual to carry out the Designated Function; (iii) impose conditions and restrictions on the authorisation granted; and (iv) suspend, withdraw or revoke any authorisation granted.

Reporting Requirements

All LFIs are required to provide information to the Central Bank in accordance with the reporting obligations as detailed in the new Law, and as further supplemented by secondary legislation issued by the Central Bank from time to time.

The Central Bank may authorise its staff to visit, examine and seek information from LFIs or their owned companies and subsidiaries to ensure soundness of their financial positions. In the event the companies and subsidiaries are regulated by other regulatory authorities in the state or in other jurisdictions the Central Bank will coordinate with the concerned regulatory authorities in this regard.

Establishment of the Higher Shariah Authority

The UAE has always been one of the largest Islamic banking markets in the world; however, it has been without a regulatory body tasked with standardising financial activities within the State.

Currently, Islamic LFIs are required to establish internal Shariah boards to ensure their financial activities and products are in compliance with the requirements and principles of Shariah.

The establishment of the Higher Shariah Authority, in accordance with the new Law, as a sole reference for fatwas will ensure alignment of all fatwas across all Islamic LFIs. This is a welcome change that will aim to provide clarity in respect of Islamic financial services and products to customers and internal Shariah boards of LFIs.

The new Law appears to formalise and expand on the mandate of the already existing Higher Shariah Authority which has been active since early 2018. Fatwas of the Higher Shariah Authority will now be binding on internal Shariah supervision boards of all Islamic LFIs.

Compound Interest

In the UAE, principles of Shariah law prohibit the payment of both compound and simple interest. Under UAE law, payment of interest is addressed by Federal Law 5 of 1985 (UAE Civil Code) that expressly prohibits an increase in the amount of money loaned by way of interest.

However, Federal Law No 18 of 1993 (UAE Commercial Code), which takes precedence over the UAE Civil Code in respect of commercial matters,  allows interest to be charged on commercial loans as agreed to between the parties. If such rate is not stated in the contract, it shall be calculated according to the rate of interest in the market at the time of dealing provided; it does not exceed 12%. The Commercial Code does not clearly specify whether compound interest is allowed to be charged or not.

Article 121 of the new Law clarifies the position in respect of compound interest and expressly prohibits LFI’s from charging any compound interest on any credit or funding facilities granted to customers. It is however, unclear whether capitalisation of interest would still be permitted.

Protection of Customers and Financial Inclusion

A fast paced digital transformation is taking place in the financial services industry globally. These advances in regulation and infrastructure are geared towards increased provision of financial services from both traditional and non-traditional institutes, but face challenges of serving the mass market. The Central Bank under the new Law is encouraging LFIs to make available financial services and products they offer, as far and wide to the general public as possible.  It intends to further this initiative by issuing necessary secondary legislation, to pave the way for increased accessibility to financial services and products.

On the heels of financial inclusion, the new Law also indicates that the Central Bank shall work towards customer protection by raising awareness of the types of banking services and their inherent risks and by issuing necessary regulations in this respect.

Minimum Capital Requirement for LFIs

In contrast with the old law, the new Law does not expressly specify the minimum capital requirement for LFIs - however, it states that the Board of Directors of the Central Bank are empowered to establish regulations on the minimum capital requirement, increase or decrease these capital requirements, determine risk-based capital requirements and the necessary actions to be taken in case of capital shortfall.

Penalties

The new Law also strengthens the Central Bank’s enforcement powers to impose a range of administrative and financial sanctions and penalties on LFAs that are in violation of the provisions of the new Law. These range from issuance of a caution, to requiring the financial institution to take corrective measures, to imposing fines and suspending or revoking the licenses of the concerned financial institution.

These broad enforcement powers will allow the Central Bank to exercise greater regulatory control over market participants ensuring financial infrastructure oversight and the enforcement of consumer protection.

Grievances & Appeals Committee

LFIs will be able to challenge the enforcement powers granted of the Central Bank by the introduction of a Grievances & Appeals Committee to be established under the chairmanship of a Court of Appeal Judge, two judges from the same court, and two experts nominated by the Board of Directors of the Central Bank of UAE.

The Committee has the sole and exclusive jurisdiction to decide on all grievances and appeals against any decisions of the Central Bank related to licensing, authorisations of individuals and licensing and designation of Financial Infrastructure Systems.

Confidentiality

Confidentiality of customer information held by banks was not specifically provided for under the old law. The new Law contains specific provisions aimed to ensure consumer protection, including the confidentiality, and protection of customer financial information.

The new Law specifically imposes a duty on LFIs to maintain confidentiality of all customer information and breaches to be penalised by imprisonment and/or a fine.

Financial Infrastructure Systems

Financial Infrastructure Systems play an important role in enhancing financial stability by enabling safe transfer of funds.

The new Law sets out, specific provisions for the establishment, development and operation of Financial Infrastructure Systems for clearing and settlement systems.

The Central Bank is now also responsible for the oversight of Financial Infrastructure Systems that have the potential to pose systemic or payments system risks. The Central Bank may designate any Financial Infrastructure System for clearing and settlement as systemically important if it considers that any malfunction or inefficiency in the operation of such a system shall effect daily operations of LFIs or the stability of the financial system in the UAE.

The new Law also provides certain legal protections for designated Financial Infrastructure Systems, and allows legal enforceability of netting in designated Financial Infrastructure Systems and preservation of rights in underlying transactions.

Future Role of the Central Bank

The new Law comes at a time when there has been a surge of new Federal legislation in the UAE, including the new Anti Money Laundering Law and the Netting Law. Collectively, all new laws are aimed at strengthening and protecting the UAE’s financial system, its consumers, and regulating carrying out financial activities in the UAE.

The new Law’s inclusion of new provisions related to good governance and consumer protection are aimed at ensuring that UAE government and the Central Bank continue to allow development of the UAE’s financial services industry, aligned with international standards on financial supervision.

 

(Previously published by LexisNexis Middle East)

 
 

This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the developing jurisdiction of the UAE.