20 Aug 2015 NEW DFSA CLIENT CLASSIFICATION RULES
A Regulatory Update: New DFSA client classification rules
The client classification requirements defined by the Dubai Financial Services Authority (the new DFSA client classification rules) were amended on 1 April 2015. The changes are intended to reflect developments and practice in the financial services industry and are contained in Chapter 2 of the DFSA Rulebook’s Conduct of Business Module (the “COB”). This publication summarizes below the principal changes for authorized firms in the UAE’s leading financial free zone, the Dubai International Financial Centre (the “DIFC”).
The objective of the client classification requirements is to ensure that the scope of regulatory protection provided to a person or entity is adequate given their experience, knowledge and resources. The previous client classification rules were introduced in 2007 and required authorized entities to classify a prospective client as a Retail Client, Professional Client or Market Counterparty (as described below) before providing any financial services to that client.
The new client classification rules adopt a more risk-based approach to client classification and provide Authorized Firms (as defined by the DFSA Rulebook) with much greater flexibility (please refer to COB Rule 2.2). To ensure that Authorized Firms provide their clients with the appropriate level of regulatory protection, the new DFSA rules (the “Rules”) take into account:
- the higher degree of knowledge and experience (“expertise”) and resources available to certain institutional and wholesale clients;
- who primarily bears the risk associated with a particular type of a financial service; and
- the type of clients to whom a financial service is usually provided.
Additionally, the Rules provide flexibility for:
- an Authorized Firm (as defined by the DFSA Rulebook) to rely on a client classification made by its head office or a group member, provided risks associated with such reliance are effectively addressed;
- group-based financial services to be provided where risks associated with such services are effectively addressed; and
- look-through arrangements where reliance can be placed on expertise and resources available to a client, such as at its holding company or at controller level.
TYPES OF CLIENTS
There are three types of clients as per the DFSA Rules:
- Retail Clients;
- Professional Clients; and
- Market Counterparties.
A person who cannot be classified as a Professional Client or Market Counterparty in accordance with the DFSA Rules is required to be classified as a Retail Client (as defined in COB Rule 2.3.2.). An Authorized Firm cannot classify a person as a Professional Client or Market Counterparty if:
- the Person does not meet the relevant criteria; or
- being a person who meets the relevant criteria, exercises the right to opt-in as a Retail Client.
If an Authorized Firm (as defined by the DFSA Rulebook) chooses to provide financial services to a person/entity as a Retail Client, it may do so by simply classifying that person as a Retail Client without having to follow any further procedures as required for classifying persons as Professional Clients or Market Counterparties (as detailed below).
Professional Clients can fall into the three following sub-categories:
- “Deemed” Professional Clients: These comprise of essentially institutional and wholesale clients with significant assets, experience and knowledge so that Authorized Firms (as defined by the DFSA Rulebook) can carry on financial services with or for such a client without the need to undertake a detailed assessment of the client’s assets or expertise. The Authorized Firm (as defined by the DFSA Rulebook) must have a reasonable basis for classifying a client within the list of “deemed” Professional Clients (as per COB Rule 2.3.4). The Authorized Firm (as defined by the DFSA Rulebook) should undertake some due diligence to make sure that the person falls within one of the specified categories listed under COB Rule 2.3.4(1). This may include:
- verifying that the Person has the relevant regulated status (e.g. that the person holds a license issued by the DFSA or by a financial services regulator outside the DIFC);
- obtaining copies of the most recent financial statements to establish:
- that the relevant criteria to be a large company are met; or
- that the person meets the criteria to be a trustee of a trust with at least assets of USD 10 million;
- verifying information through publicly available sources, for example, by checking the website of the relevant exchange to ascertain whether an entity is a listed company on an exchange in an International Organization of Securities Commissions (the “IOSCO”) jurisdiction; and
- where necessary, verifying any information directly with the person.
- “Service-based” Professional Clients: Due to their inherent nature, certain financial services activities such as credit provided to a company for business purposes (“commercial credit”), and advisory and arranging activities relating to corporate structuring and financing, are generally provided to persons with sufficient expertise to obtain such services or are of relatively low risk to the client. Therefore, a person to whom such a financial service is provided can be classified as a “service-based” Professional Client (COB Rule 2.3.5); and
- “Assessed“ Professional Clients: These comprise of clients who, based on an assessment of the client’s assets, experience and knowledge would be classified as Professional Clients (please refer to COB Rules 2.3.7 and 2.3.8 for the full list of requirements for “assessed” Professional Clients).
The key changes from the existing assessment regime are:
- the current net asset threshold of five hundred thousand dollars (USD 500,000) will be increased to one million dollars (USD 1,000,000) with effect from 1 April 2016;
- the Professional Client status of one person (the “Primary Account Holder”) can be attributed to another person (the “Joint Account Holder”) in the following circumstances:
- the Joint Account Holder is a family member of the Primary Account Holder;
- the account is used for the purposes of managing investments for the Primary Account Holder and the Joint Account Holder;
- the Joint Account Holder has confirmed in writing that investment decisions relating to the joint account are generally made for, or on behalf of, him by the Primary Account Holder.
It should be noted that individuals can only be classified as “assessed” Professional Clients as only companies can be “deemed” and “service-based” Professional Clients.
Additionally, all Professional Clients can opt-in to be treated as a Retail Client. Although originally the DFSA had proposed that only “service-based” and “assessed” Professional Clients would have a right to opt-in to being treated as a Retail Client, this proposal was amended following public comments. Thus, all three types of Professional Clients are allowed to opt to be treated as Retail Clients.
The previous Rules in relation to Market Counterparties have been amended to clarify the notification and consent process. A person and/or an entity may be classified as a Market Counterparty if the person/entity is a “deemed” Professional Client or an “assessed” Professional Client and the Authorized Firm has complied with the notification and consent procedures set out in COB Rule 2.3.9(2). According to this Rule, an Authorized Firm must, before classifying a person/entity as a Market Counterparty, ensure that:
- the person/entity has been given a prior written notification of the classification as a Market Counterparty; and
- that person/entity has not requested to be classified otherwise within the period specified in the notice.
If the person/entity does not object within the specified period, the Authorized Firm can classify that person/entity as a Market Counterparty.
Reliance on Client Classification Made Elsewhere
Under the new client classification regime, an Authorized Firm (as defined by the DFSA Rulebook) which is a branch or a member of a group can rely on the client classification undertaken by its head office or any other branch of the same legal entity, or by a member of its group where:
- the Authorized Firm (as defined by the DFSA Rulebook) has reasonable grounds to believe that the client classification is substantially similar to the client classification rules prescribed by the DFSA;
- if any gaps are identified between the requirements applicable to the Authorized Firm (as defined by the DFSA Rulebook) prescribed by the DFSA and the requirements under which the client classification is undertaken by another entity as mentioned under (i), the Authorized Firm (as defined by the DFSA Rulebook) may rely only on such a client classification if it has effectively addressed the identified gaps.
The Authorized Firm (as defined by the DFSA Rulebook) should be able to demonstrate to the DFSA the due diligence process undertaken by the Authorized Firm in relation to the above.
If an Authorized Firm (as defined by the DFSA Rulebook) is a member of a group, and provides a client with one or more financial services in conjunction with a bundle of financial services provided by the Authorized Firm (as defined by the DFSA Rulebook) itself and its group members, then the Authorized Firm (as defined by the DFSA Rulebook) must ensure that:
- the client classification adopted for any financial services provided to the client is appropriate for the overall bundle of financial services provided to that client;
- the nature of the arrangement must be clear to the Client (e. who provides which service);
- any risks arising from the arrangement must be identified and effectively addressed; and
- proper records must be kept.
Authorized Firms (as defined by the DFSA Rulebook) will need to comply with the new client classification regime from 1 April 2015, with the exception of the increase of assets test for “assessed” Professional Clients from five hundred thousand dollars (USD 500,000) to one million dollars (USD 1,000,000), as mentioned previously.
Client classifications made under the old regime will remain in force and the new regime does not trigger the need to reclassify existing clients.
If an existing client wishes to obtain a new financial service after the new regime has come into force, an Authorized Firm (as defined by the DFSA Rulebook) will not be able to rely on the existing client classification relating to that client in respect of the new financial service. For any new clients beyond 1 April 2015, the new client classification requirements will apply.
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