Private Equity (Fund Formation)

The establishment of and offer of units in private equity funds in Saudi Arabia is regulated by the Saudi Arabian Capital Market Authority (CMA) through the Investment Fund Regulations (IFRs).

Although the IFRs recognise funds as having a separate legal personality (with the ability to buy and sell assets), funds are not incorporated legal entities and do not have a commercial registration certificate. Rather, funds are established as a contractual arrangement entered into between a fund manager who is an authorised person licensed by the CMA to conduct managing activities (the fund manager) and the holders of the units in the fund (the unitholders). These terms and conditions set out the rights and obligations of the fund manager and unitholders.

Given that funds are not separate legal entities, all actions of the fund must be carried out by a fund manager and all assets must be held a separate entity, usually a custodian or a special purpose vehicle established by a custodian.

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In Saudi Arabia private equity funds are established by way of private placement process under the supervision of the CMA and in accordance with the requirements of the IFRs.

Prior to approaching the CMA, the fund manager must appoint an independent custodian to hold the fund’s assets and an independent auditor.

The fund manager must then submit the following documents as part of the private placement offer:

• a declaration by the fund manager that the information contained in the notification to the CMA and the offering documents are clear, fair and not misleading (the form of which is specified in the IFRs);
• the fund’s terms and conditions and any other offering documents;
• the fund manager’s organisational structure;
• the fund’s compliance monitoring programme; and
• a summary of the key terms of the terms and conditions.

The IFRs stipulate that the CMA has 15 business days to review the fund’s application and offering documents. Should the CMA have no comments on the application or the offering documents, the fund manager may proceed with the offer to investors. However, in the event the CMA has comments, the 15 business-day review period will reset from the date the fund manager resubmits the application.

Private equity funds are not subject to any minimum capital requirement; however, each investor must subscribe for at least 1 million Saudi riyals for the offering to qualify as a private placement unless the investor is considered to be a ‘sophisticated investor’.

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Private equity funds must at all times maintain a local custodian licensed by the CMA, although there is no requirement to appoint an administrator. However, any third-party administrator appointed by a fund must be licensed by the CMA to conduct custody activities.

The fund manager is required to host the registered office of the fund and carry out secretarial functions (ie, establish and maintain a register of unitholders). The fund manager must retain all books and records for a period of 10 years (or longer in the event of any ongoing or pending litigation, claim or investigations).

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The CMA’s website contains a register of all public and private funds, which can be accessed at https://cma.org.sa/en/Market/imf/Pages/Private_Investment_Funds.aspx.

This register includes the following information:

• the fund’s name;
• the date which the fund manager notified the CMA of its intention to establish the fund;
• the offer period dates; and
• the fund term.

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Pursuant to article 77 of the IFRs, the unitholder’s liability is limited to the amount of its investment in the fund and it will not be liable for the debts and obligations of the fund, although we are not aware of the extent to which this has been tested in Saudi courts.

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Under the IFRs a fund manager is subject to a general duty to act in good faith for the benefit of the unitholders and to exercise reasonable care and skill in the discharge of its duties.

The Authorised Persons Regulations (APRs) separately provide that all authorised persons are subject to a number of prescribed fiduciary duties. Given that each fund manager is also an authorised person, fund managers are also subject to these duties, which are as follows:

• loyalty: a fund manager must act in all cases in good faith and in the interests of the unitholders;
• conflict of interest: a fund manager must ensure that no conflict of interest between its interests and the interests of the unitholders will affect the services the fund manager is providing;
• no secret profits: a fund manager must not use the unitholder’s property, information or opportunities for its own or anyone else’s benefit unless the fund manager makes full disclosure of such usage to the unitholder and obtains its consent; and
• care, skill and diligence: a fund manager owes the unitholders a duty to exercise the care, skill and diligence which would be exercised in the same circumstance by a person having both the know­ledge and experience that may reasonably be expected of a person in the same position as the fund manager and the actual knowledge and experience that the fund manager has.

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The definition of gross negligence is usually specified in the terms and conditions as the relevant CMA regulations to not provide a definition of gross negligence.

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There is no guidance in the IFRs with regards to the redomiciliation of funds from foreign jurisdictions and no concept of converting any different form of vehicle to a fund in Saudi Arabia.

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There is no clear guidance as to the consequences or legal issues in the case of a fund manager’s bankruptcy, insolvency, change of control or restructuring. However, article 20 of the IFRs invests the CMA with the authority to remove a fund manager in the event that such fund manager has materially failed to comply with the CMA’s laws and regulations (including the minimum capital requirements set out in the APRs), the death, incapacity or resignation of a portfolio manager appointed to manage assets of the fund or any other grounds the CMA considers reasonable.

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The CMA is the regulatory authority that oversees the financial services and asset management industry in Saudi Arabia. In addition to conducting regular audits on fund managers, the CMA has the right to inspect the books and records of a fund at any time upon request.

The fund manager must provide unitholders with annual reports (including audited financial statements) and short-form annual reports upon request and without charge.

The fund manager must also annual reports available no later than 70 calendar days from the end of the year and provide a copy of the report to the CMA within five days after delivering it to unitholders.

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A fund manager must be licensed by the CMA, as must the custodian and any third-party advisers appointed to by the fund (eg, administrator). However, if the fund is investing outside of Saudi Arabia the fund may appoint custodians or advisers licensed in the appropriate jurisdictions.

Prior to establishing the fund, the fund manager must submit the terms and conditions and any other offering documents for the CMA’s approval. The IFRs stipulate that the CMA has 15 business days to review the fund’s application and offering documents. Should the CMA have no comments on the application or the offering documents, the fund manager may proceed with the offer to investors. However, in the event the CMA has comments, the 15 business-day review period will reset from the date the fund manager resubmits the application.

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There is no requirement for a fund manager or any of its officers, directors or control persons to register as an investment adviser in Saudi Arabia.

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The fund manager must be licensed by the CMA as an authorised person to engage in management activities. Authorised persons are governed by the APRs. Pursuant to the recently amended APRs, the minimum capital of a fund manager conducting management activities is 20 million Saudi riyals.

The following employees of a fund manager must be registered with the CMA:

• chief executive officer or managing director;
• finance manager;
• directors or partners;
• senior officers or managers;
• compliance officer;
• money laundering reporting officer;
• client functions, including sales representatives, investment advisers; and
• portfolio managers and corporate finance professionals.

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All contributions in Saudi Arabia are subject to the Saudi Anti-Bribery Law. That being said, there are no specific disclosure requirements or restrictions regarding political contributions.

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There are no specific disclosure requirements or restrictions in Saudi Arabia in relation to placement agents, lobbyists or other intermediaries in the marketing of the fund to public pension plans and other governmental entities. The fund manager and its employees are not required to register as lobbyists to market to public pension plans and other governmental entities.

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The Saudi Arabian Monetary Agency (SAMA) is the authority governing and regulating investments by banks in Saudi Arabia. SAMA requires banks to maintain specific liquidity ratios but does not restrict banks from investing or sponsoring private equity funds.

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Tax in Saudi Arabia is regulated by the General Authority for Zakat and Tax (GAZT). Pursuant to Saudi Arabia’s tax regulations, private equity funds are deemed as ‘capital companies’, which contemplates that they are subject to the following:

• 2.5 per cent zakat (tax on wealth) in the case that the fund is owned by Saudi Arabian nationals or Gulf Cooperation Council (GCC) nationals (ie, Bahrain, United Arab Emirates, Kuwait, Oman and Qatar);
• 20 per cent tax on profits in the case that the fund is owned by non-GCC unitholders; and
• 5 per cent withholding tax on payments of all dividends and capital gains to unitholders.

However, since 2006, the GAZT has not assessed any taxes on private equity funds in Saudi Arabia or its unitholders. This is not deemed a formal exemption and GAZT reserves the right to begin taxing funds at any point in the future (including on a retroactive basis).

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Non-resident unitholders in Saudi Arabian funds are not obliged to file tax returns or pay tax to the GAZT with respect to any units held in any private fund.

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There is no requirement to obtain tax rulings from the GAZT or any other local tax authority for the purpose of establishing a private equity fund.

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No organisational taxes are required to be paid with respect to private equity funds.

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A Saudi fund manager or entity receiving such payments is be required to report the management fees in its tax or zakat returns and pay income tax or zakat due from such returns.

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Saudi Arabia has double tax treaties with several countries including Austria, Bangladesh, Belarus, China, the Czech Republic, France, Greece, Hungary, India, Italy, Japan, Korea, Luxembourg, Malaysia, Malta, the Netherlands, Pakistan, Poland, Romania, Russia, Singapore, South Africa, Spain, Syria, Tunisia, Turkey, Ukraine, the United Kingdom, Uzbekistan and Vietnam.

Given that Saudi Arabian funds are currently not assessed for taxes by the GAZT, the treaties have a limited impact. However, the treaties with some countries reduce payments of dividends and capital gains to zero per cent and therefore may be useful if the tax treatment of funds is altered in the future.

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Unitholders and fund managers in Saudi Arabia must be aware that while funds are currently tax-free, the GAZT reserves the right to begin taxing funds at any point in the future (including on a retroactive basis).

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An offer of units in a private fund is a private placement where the offerees are ‘sophisticated investors’ or the minimum amount payable per offeree is not less than 1 million Saudi riyals. All funds must be registered with the CMA and there are no exemptions to such registration.

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Private equity funds may be offered to ‘sophisticated investors’ or investors who subscribe for a minimum of 1 million Saudi riyals.

Sophisticated investors means any of the following:

• authorised persons acting for their own account;
• clients of a person authorised by the CMA to conduct managing activities provided that:
• the offer is made through authorised person and all relevant communications are made through the authorised person; and
• the authorised person has been appointed as an investment manager on terms that enable it to make decisions concerning the acceptance of the private offers of securities on the client’s behalf without reference to the client;
• the government of Saudi Arabia, any supranational authority recognised by the CMA, the Saudi stock exchange and any other stock exchange recognised by the CMA or the Depositary Centre;
• institutions acting on their own account;
• professional investors (a definition of which is set out in the CMA’s Glossary of Defined Terms); or
• registered persons with an authorised person if the offer is made through the respective authorised person itself.

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The fund manager must establish and maintain a register of unitholders that includes each unitholder’s name, ID, nationality, date of registration in the fund register, details of transactions conducted by such unitholder, the running balance of the number of units and any restrictions or rights attached to such units.

The fund manager must make the register of unitholders available to the CMA for inspection upon request.

Changes in ownership of the fund manager must be approved by the CMA and 30 days’ advance notice must be given prior to any proposed change of control of the fund manager.

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Private equity funds in Saudi Arabia may only be established, and units of such funds may only be offered by a fund manager (licensed by the CMA to conduct management activities), following the expiry of the 15 business-day non-objection period, following which the fund is registered with the CMA.

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A fund manager must comply with all obligations under the CMA’s Anti-Money Laundering Law and Counter Terrorism Financing Rules.

A fund manager must appoint a senior employee as a money laundering reporting officer. The money laundering reporting officer is responsible for ensuring compliance with the requirements of the Anti-Money Laundering Law and its implementing regulations and reporting to the governing body on matters relating to money laundering and terrorism financing.

Furthermore, all unitholders must complete know-your-customer forms (acceptable to the CMA) and provide supporting documentation, and the fund manager must disclose to the CMA a list of all investors who subscribe to units in the fund.

Finally, the fund manager must take a risk-based approach to conduct due diligence on investors; however, lower due diligence requirements are set (ie, beneficial shareholding confirmation is not required) if the investor is:

• regulated and licensed by a government authority;
• based in a jurisdiction that complies with the Financial Action Task Force recommendations; and
• applies anti-money laundering and counter-terrorism requirements that are consistent with Saudi Arabia’s regulations and the Financial Action Task Force recommendations.

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Private equity funds are not permitted to list on the Saudi stock exchange. Only exchange-traded funds and real estate investment-traded funds are permitted to be listed.

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Private equity funds are not permitted to list on the Saudi stock exchange. Only exchange-traded funds and real estate investment-traded funds are permitted to be listed.

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Although the IFRs refer to funds as having some of the attributes of a legal entity, such as buying and selling assets, it should be noted that funds are not incorporated entities and do not have a commercial registration certificate, but are a form of a contractual arrangement that does not make a fund a juristic person and therefore may not participate directly in private equity transactions. Pursuant to the APRs, the assets of a fund must be held by a custodian.

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Only a person authorised by the CMA (licensed to conduct management activities) may be paid management fees. If the fund has multiple sponsors, all fees must be paid to the CMA-regulated sponsor by the fund, who can then pay these fees on to the other sponsors. There are no such restrictions on carried interest or other profit-sharing, which can be paid directly to non-regulated entities.

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