UAE Proposed Legislative Framework for DLT Foundations: ADGM Financial Freezone

In another example of the United Arab Emirates (UAE) attempting to position itself at the forefront of global regulation of the digital assets sector, the Registration Authority (RA) of Abu Dhabi Global Market (ADGM), a financial freezone located in the UAE, has issued a public consultation paper to propose a new legislative framework for foundations (DLT Foundations) that facilitate distributed ledger technology (DLT) and token issuances.

Background

DLT has progressed rapidly in recent years and the technology is now at the heart of the global digital assets sector.  Decentralisation through a democratic operating model has been a core principle of DLT projects, with the lack of a centralised controlling body providing benefits such as insulation from the vested interests of individuals or groups, a reduced risk of censorship, and more value distribution among stakeholders.  The further evolution of this idea has developed into the concept of a decentralised autonomous organisation (DAO) that operates on smart contracts and allows for the governance of the organisation to be provided through voting rights associated with native tokens issued by the DAO. We have therefore seen many examples of DLT projects that have been developed with a DAO forming a fundamental part of the underlying structure.

Some DLT projects have been developed and operated as unincorporated DAOs while others have elected to use a legal form for their DAO. The establishment of DAOs as unincorporated associations operating on smart contracts is seen as the purest form of a conceptual DAO.  However, such unincorporated arrangements lack legal safeguards to limit personal liability of tokenholders. There are also potential advantages to incorporating a DAO as a legal entity, including the ability to allow the DAO to operate and contract in the real world (for example by holding assets or acting as an issuer of any tokens associated with the DLT project).

To date, there have been limited options for the incorporation of a DAO as a legal entity for the purposes of DLT projects in a manner that provides legal certainty for participants and their investors while also remaining true to the decentralised concept of a DAO.

The RA has an existing regime in the ADGM for the regulation of foundations.  Similar to common law trusts, foundations offer a high level of transparency combined with a robust legal structure but are also legal entities in their own right and do not have any shareholders.  For these reasons, foundations have been the preferred structure for the establishment of DLT projects and/or DAOs in the UAE as they have most closely aligned with the concepts set out above.

However, as the existing ADGM foundation regime was originally developed for charitable and wealth management purposes, it has certain features and requirements that may not be ideally suited for DLT projects and/or DAOs.

The proposed DLT Foundation regime

The proposed regime for DLT Foundations has taken parts of the existing ADGM foundation regime and includes additional provisions that are intended to be fit for purpose for DLT projects that seek to operate with a decentralised governance model while also seeking to promote transparency in the digital assets sector.  Some features of the proposed regime include:

• creating a legal personality for the DLT Foundation;
• low initial capital requirement of USD 25,000;
• expressly allowing for decentralised governance models through tokenholder voting mechanisms;
• ·no prohibition on the provision of financial services provided the DLT Foundation is adequately authorised to do so by the ADGM financial services regulator;
• mandatory accounting and audit requirements;
• transparency through the publication of the DLT Foundation’s charter, audited annual accounts and information on the founders, council members and guardian;
• ·no AML, sanctions, data protection, cybersecurity and marketing requirements in addition to those which already exist in the ADGM; and
• provisions for the insolvency / winding up of the DLT Foundation.

We note that some of the proposals may be seen to undermine the purely decentralised and private nature of DAOs which facilitate DLT projects.  However, we note that at the time at which this article was written, the consultation period for the ADGM’s proposed new DLT Foundation framework had recently closed and it is open to the RA to consider making amendments to the proposed framework prior to its final implementation based on feedback to be obtained from market participants.

Looking forward

We expect that the new DLT Foundation regime will be finalised and brought into effect towards the end of 2023.

In addition, the UAE Emirate of Ras Al Khaimah (a legal jurisdiction separate to the ADGM) recently announced that it intends to implement the world’s first economic freezone solely dedicated to digital and virtual asset companies innovating in new and emerging sectors of the future including metaverse, blockchain, gaming, non-fungible tokens, DAOs, DApps, and other Web3-related businesses.  The regulations for Ras Al Khaimah’s new freezone have not yet been issued, but it is expected to launch in the coming months.

We therefore expect the UAE to develop as an attractive place for the future establishment of DLT projects and DAOs with a number of its jurisdictions offering regulatory regimes intended to be custom made to suit these cutting-edge technologies and use cases.

Should you be interested in exploring the options for establishing a DAO or a DLT project in the UAE, please reach out to our UAE specialists Gregory Man and Jessica White.