Abu Dhabi’s capital markets tap distributed ledger technology

Abu Dhabi’s international financial centre and free zone, the Abu Dhabi Global Market (ADGM), has sought to establish itself as a global pioneer in the development of distributed ledger technology (DLT). In June 2018 the emirate issued a comprehensive regulatory framework for virtual asset activities in ADGM, and followed it up with further detailed guidance on the regulation of stable coins and digital securities in May and September 2019, respectively. Under its regulatory framework, crypto-asset businesses such as exchanges, brokers and custodians of cryptocurrencies can operate in ADGM. Previously, cryptocurrency exchanges have preferred to serve the Middle East from jurisdictions outside the region, such as the British Virgin Islands. ADGM’s rapidly evolving virtual asset framework, however, has altered this dynamic and prompted a surge of interest in the free zone as a cryptocurrency exchange centre. In mid-2019 a number of such exchanges were reportedly in the process of transferring their operations to ADGM, including Gemini, MidChains, Binance and the largest cryptocurrency exchange in the region, BitOasis.

Potential Outcomes

The UAE Blockchain Strategy 2021 calls for 50% of government transactions to be carried out using blockchain technology by 2021. How ADGM’s strategy to provide an inclusive and regulated market for DLT-based transactions to take place will align with the UAE’s broader digital roadmap remains to be seen. According to the Securities and Commodities Authority (SCA), the new regulations will “encompass all aspects of the virtual assets industry in the UAE, ranging from token issuance requirements to trading and safekeeping practices”. Their finalisation will provide greater guidance to domestic DLT players. The creation of a fiat-backed dirham coin would also help to propel the UAE further into the DLT era. Regulations could also allow for the establishment of cryptocurrency exchanges outside of free zones. Such a development would see the Central Bank of the UAE play a more prominent role – which would be welcomed by many; the International Securities Services Association said that until central banks issue central bank digital currencies or support synchronised settlement in their real-time gross settlement systems, virtual assets are likely to entail some credit risk on the cash payment side.

Looking Ahead

Future development is contingent on the resolution of a number of challenges. The risk of loss of assets or entitlements in virtual asset investing is relatively high, and it remains to be seen how regulators will mitigate such threats. Independent, private key custodial services are a possible solution to this problem, but they too will require comprehensive regulation. The internationalisation of cryptocurrency regulations is complex, given that the laws governing core areas such as issuance, trading, settlement and custody vary between jurisdictions.

In 2018 ADGM successfully piloted an electronic know-your-customer project with a consortium of UAE financial institutions to lower costs and processing time, and published specific guidance relating to the offer and trading of digital securities. As regulations develop, cryptocurrencies are becoming seen as a useful portfolio diversification tool. Other obvious gains lie in the realm of equity and fixed-income security issuances, where DLT applications and virtual assets can streamline the tasks and information exchanges required to originate, syndicate and close a new issue. DLT networks also have the potential to open up alternative asset classes that currently are considered illiquid and require a high level of specialist intermediation to trade. These include fine art, rare coins, real estate and collectibles such as classic motor cars. “It is likely that tokenisation and DLT applications will be as revolutionary as the internet for finance,” Khalid Howladar, senior managing director at RJ Fleming, told OBG. “This presents a rare chance for new jurisdictions to take the lead from incumbent financial centres during this paradigm shift.” As capital markets continue to develop and innovate, DLT will surely play an increasingly influential role.