Dubai has been an attractive business location for expatriates since 1894, when new rules provided tax exemptions for foreigners. Today, non-locals make up almost 90% of the city’s demographics.
A myriad of superlatives apply to the region: the Burj Khalifa is the highest skyscraper in the world, the UAE has some of the lowest corporation tax incentives, its yearly temperatures are steadily increasing…
And Dubai is home to the world's biggest private equity insolvency, according to The Wall Street Journal.
Since then, the city has been trying to rebuild its reputation, and operational due diligence has been a key factor in this mission.
Abraaj Group was once upon a time the largest MENA buyout fund. It collapsed in 2018 after its LPs (including the Gates Foundation) began to question the use of investor funds.
Its founder and former CEO Arif Naqvi is still awaiting trial in the US to investigate allegations of fraud and racketeering.
Five years on and after a whopping $315m fine issued by the Dubai Financial Services Authority to two Abraaj companies, the sheer scale of the alleged fraud has left muddy marks on the region.
The reality is such a scandal could have happened anywhere in the world. But it didn’t.
Unfortunately, one firm’s bad reputation can taint another’s, especially if you are operating in an emerging market like the Middle East.
The ancient Greek poet Hesiod said it well: “Bad reputation is grievous to bear and hard to get rid of.”
The show must go on
However, the VC industry is booming in the UAE, with various incentives and a commitment to promote business growth through innovation testing licences, 100% foreign ownership, professional investor fund status and other schemes.
COP28 is also due to be held in Dubai, although not without controversy.
Against this complex landscape, the case for good corporate governance is stronger than ever. No longer just a tickbox exercise, LPs have ramped up their scrutiny of GPs – EMPEA’s 2019 Global LP Survey found that 44% of respondents had upped their operational due diligence game in the last two years.
The aftermath was also experienced in the US, when in 2019 the Institutional Limited Partners Association released updated principles requiring more GP transparency and governance.
Diamond in the rough?
Increasingly stricter regulatory scrutiny has not deterred investors from eyeing up the MENA region. Rather, as time has catalysed the growth of the UAE’s two international finance centres, DIFC and ADGM, the healthy competition has only helped to drive market growth.
Stewart Adams, regional managing director for Middle East and Africa at TMF Group, recognises the level of scrutiny around the application process, and ongoing support has increased during recent years. However, he adds: “This has not reduced the number of applications and funds being established. Many funds are being established, stating that the strict regulatory environment is exactly what they and their investors want as it provides a high level of asset safety.”
The enhanced regulatory environment has brought with it challenges and opportunities for service providers, where they assist with the application process and ongoing mandatory support solutions that can be outsourced, like compliance/MLRO and finance officer. Due to the levels of ODD required from investors, the regulators have imposed a cap on consultants of only five active GPs. While this has made the service more costly, it has created a more rigid financial crime analysis, which can only be a benefit for the GP and LP alike.
Similarly, at Synergy Consulting, an advisory firm that extends its ODD services into the Middle East, senior leaders have noticed a shift in operational due diligence in that it is necessary to dig a lot deeper to get desired answers. Partner at Synergy Chetan Kapoor summarises: “Relationships with sanctioned entities or connections with geopolitically unstable regions can be incredibly damaging in this climate.”
Leaders also notice that investors, lenders and financial institutions are conducting better governance, although there is a heightened concern around acquisitions as stakeholders comply with increasingly more important international regulation to avoid litigations and claims.
Ankit Maheshwari, associate director at Synergy, adds: “Market perception and placement have meant that it is more important to smooth out any red flags.”
For GPs, a key part of conducting corporate governance best practices is the ability to manage expectations of investors and portfolio companies, especially if they are coming from different geographical regions with inconsistent regulatory expectations.
At TVM Capital Healthcare, an emerging markets-focused growth asset manager investing in the Middle East and Southeast Asia, its investors are from various international jurisdictions, including Europe. This means the firm is required to comply with European regulations such as SFDR.
CEO Dr Helmut Schuehsler has believed since the firm’s inception in the potential for the Middle East as an attractive place to focus on healthcare investments, to complement the existing infrastructure of local healthcare systems.
However, there is always a possibility for cultural ESG clashes as metrics or data points required by European firms might not usually be calculated in emerging market portfolios. Monika Schlesinger, head of ESG at the firm, explains that usually any sticky business is avoided by getting the agreement of the company management team to provide that information prior to investment, together with an overall commitment to the TVM Capital Healthcare ESG Framework.
She adds: “We have an ESG due diligence standard, which collects around 36 data points. From there, we determine the status of the ESG system in an investee company. And if you look at companies in Thailand, Vietnam, Malaysia or Saudi Arabia, you usually find fragments of an ESG system but it's not really formalised. These fragments usually help the occupational and healthcare industry, but they probably do not have a corporate governance code, or other key elements of an ESG framework.”
Schlesinger explains that the lack of a streamlined ESG standards approach in an investee company does not bother the firm because it relies upon its own ESG framework, developed along international standards such as EU regulation, which it can roll out in the company as part of its value creation approach.
In TVM’s case, a primary investor in one of its Middle East-focused vintage funds happened to be the International Finance Corporation and it was very clear from the outset on its specific expectations at that time around E&S and reporting requirements.
According to Schlesinger: “When we entered into that partnership, we were still defining our compliance and governance procedures for that fund, for example with regards to corporate culture – in countries where they were not used to an eye-level conversation between senior management and employees. The performance standards of the IFC helped us tremendously to develop our governance as well as environmental and social management systems at the time.”
In sum, the MENA region is continuing to attract investor attention. One GP’s downfall, however significant, should not deter others from seizing opportunities. But service providers and managers operating in the region do not downplay the significance of reputation and the increasing requirement to conform to international standards.