23 May 2012

LEGAL FRAMEWORK OF DUBAI MULTI COMMODITIES CENTRE'S TRADEFLOW

Authored by: Jonathan Brown

LEGAL FRAMEWORK OF DUBAI MULTI COMMODITIES CENTRE'S TRADEFLOW

Jonathan Brown dissects and analyses the legal framework of the Dubai Multi Commodities Centre’s Tradeflow, an online trading platform which has facilitated transactions in excess of US$1bn since its introduction in December 2011.

In brief

  • Tradeflow is the DMCC’s online trading platform bringing together all parties involved in inventory based trading and the provision of associated finance.
  • In the event of a party default in an underlying finance agreement, the party accepting a pledge over a Tradeflow warrant should have immediate recourse against the issues of the Tradeflow Warrant.
  • Question marks exist as to the ability of a Tradeflow member to dispose assets under a finance agreement within the Tradeflow system unless an order of the Dubai Court has not been obtained.
  • Potential legal complications could arise in the operation of Tradeflow in connection with the ascertainability of goods where non-DMCC licensed storage facilities are used to deal with capacity as such facilities are not bound by the terms of the Corporate Access Agreement which DMCC requires its members to enter into.

Tradeflow – DMCC’s electronic trading platform
The Dubai Multi Commodities Centre (DMCC) was originally launched in 2002 as an initiative by the Government of Dubai laying the foundation for Dubai as a global commodities trading market. DMCC became a Free Zone Authority in its own rights (DMCCA) in 2006. The DMCCA is headquartered in the Jumeirah Lake Towers (JLT). While JLT comprises the physical extent of the DMCC Free Zone, the DMCCA activities go far wider than this, including sophisticated trading structures for a variety of commodities. DMCC is the only International Commodity Centre in the region.
 
In December 2011 DMCC introduced a specialised electronic trading system called Tradeflow. Tradeflow is an online trade enabling platform which provides a secure and transparent environment within what it describes as a robust legal and Sharia compliant framework, bringing together all parties involved in inventory based trading and associated finance provision. Membership to Tradeflow is available to any trade company worldwide. Tradeflow allows physical inventories that are stored in certified and regulated warehouses and vaults in the UAE, to be converted into negotiable warrants.

This is governed by a regulatory regime administered by DMCC, and this offering has so far facilitated transactions in excess of US$1 billion since its introduction. Warrants can be used by the owners to pledge beneficial ownership to financiers as collateral in return for working capital or to transfer title in actual trades.
 
Legal framework
The legal framework of the Tradeflow system is based on a contract namely the Corporate Access Agreement which is intended to make the service and structure fully enforceable. This document is the contract between the DMCC and the member participants. Its function is to ensure that all members adhere the rules of engagement required to use Tradeflow and that they are aware of the obligations and the responsibilities implicit in membership. Acceptance of the Corporate Access Agreement confirmed by each member by signing what is termed the DMCC Tradeflow Letter of Adherence.
 
Tradeflow Warrants can only be issued and stored within DMCC certified warehouses and by other storage facility operators which are accredited by DMCC. The commodities stored in such facilities are subject to verification by independent inspection service providers who themselves adhere to the Corporate Access Agreement. Thus the system provides uniformity of storage conditions and certainty as to the quantity and quality of the underlying commodities.
 
Prior to the introduction of Tradeflow, the original system by DMCC allowed for paper warehouse warrants to be issued on behalf of commodity owners which where negotiable and facilitated trade finance by pledging the goods to banks, usually as a means of obtaining working capital.

Perhaps the most significant effect of the introduction of Tradeflow Warrants is that a trade finance party who has accepted a pledge of a Tradeflow Warrant under the Tradeflow system should, upon the occurrence of an event of default in the underlying finance agreement, have immediate recourse against the issues of the Tradeflow Warrant. This is done by requesting close out of the outstanding trade, followed by the sale of the Tradeflow Warrant to purchasers within the Tradeflow system. This procedure should allow the inventory to be liquidated in order to recover the outstanding balance due. The close-out procedure is managed and handled by the DMCC on behalf of the finance parties.
 
Practical considerations
The contribution of Tradeflow to the establishment of DMCC as a regional, if not a world, player in the commodities markets is recognized by all. However, as with any innovational on this scale, some questions arise in relation to the ability of existing legal frameworks to satisfy the practical and commercial intentions of its creators. Tradeflow itself is an electronic representation of a type of commodity trading that is existed for many decades, if not centuries. It is long been common practice for warehouse keepers to issue warrants to owners of goods stored in their facilities and for these warrants to be pledged or traded as the equivalent of the underlying goods themselves. This process is recognized and permitted under the Commercial Transactional Law (Law no. 18 of 1993 articles 178 to195, part 4 “Deposit in Public Warehouses” (CTL)).
 
In this context, two specific problems arise. The first relates to the close-out and liquidation provisions in the Tradeflow systems which are intended to allow a finance party immediate recourse by close out and the sale of the warrants.
 
Outside the Tradeflow system, the pledgee of a warehouse warrant (i.e. a finance party) would be obliged to apply to the Court under article 172 of the CTL in the event of default under the finance agreement where the finance party wishes to liquidate the underlying security represented by the warrants and secured by a pledge.
 
Nothing in the enabling legislation which created DMCC (Dubai Laws no. 1 and 4 of 2001 as amended by Dubai Decree No. 4 of 2002 and No. 2 of 2006) displaces the federal law requirements of the CTL. However, it is not recognized or anticipated by the Corporate Access Agreement that a finance party must apply to the Court and obtain its permission before disposing of a Tradeflow Warrant under the Tradeflow system or that another Tradeflow member could obtain title by such a transfer unsanctioned by the Court. A significant question mark must, therefore, exist as to the ability of a Tradeflow member in default under a finance agreement to challenge disposal of a Tradeflow Warrant within the Tradeflow system where an order of the Dubai Court has not been obtained.
 
The second area in which potential legal complications could arise in the operation of Tradeflow lies in connection with the ascertainability of goods. Under circumstances, where DMCC has approved and rated a storage facility for commodities in bulk, it is sometimes the case that larger storage facilities are also made available to the third party commodity owners outside the Tradeflow system.
 
The custodianship arrangements which govern the obligations of the warehouse keeper and commodity inspector within the aegis of the Corporate Access Agreement can extend only to part of the storage space available. A particular instance of this, as a reason in respect of a Floating Production Storage and Offloading (“FPSO”) facility which was a rated warehouse entered with Tradeflow for the storage of petroleum product. However, the Tradeflow custodian arrangement conferred a right to store goods within various compartments up to a maximum volume. The balance of the space in each compartment could be occupied by same product but belonging to a third party, not necessarily within the Tradeflow system. In the particular case of the FPSO, the fact that it is a vessel for the purposes of the UAE Maritime Code (Law No. 26 of 1981) (“Maritime Code”) means that any claim against the vessel in relation to this storage of the balance of the product could be secured by way of an arrest under the article on 115 of the Maritime Code. Furthermore, any claim by the third party finance provider in respect of any default in the finance provisions over the balance could itself be secured an attachment under article 252 of the UAE Law on Civil Procedure (Law No. 11 of 1992). Either step would affectively a immobilise that product which was subject to the Tradeflow Warrant.
 
A further associated problem arises in relation to the contractual status of a Tradeflow Warrant in relation to a commodity consignment admixed with property of a third party. Article 199 of the UAE Civil Code (Law No. 2 of 1987) (“Civil Code”) requires that every contract must have a subject matter. Article 203 of the Civil Code further requires that where a contract involves property, the subject matter must itself be specified and identifiable. Failing this, a contract risks being held void. Thus, that is a question mark over the status of the Tradeflow Warrant which is referable only to property defined as a quantity within a greater whole.
 
Conclusion
Tradeflow is in its early stage of operation and, by all accounts, has proved a commercial success today. Nonetheless, over the course of the coming months and years, we anticipate that the legal questions described above will necessarily need to be resolved before Tradeflow’s full market potential can be achieved. The success of Tradeflow depends on effective security enforcement in a seamless way yet the federal laws require judicial process to realise assets and the philosophies do not yet match.