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Abu Dhabi, UAETuesday 20 November 2018

Quick take: Abraaj put it in the mainstream but what is commingling of funds?

Abraaj Group, once the Middle East’s biggest buyout firm with almost $14bn of assets under management, has been slammed for mixing sources of money before it unravelled this year

The Gate in DIFC. Only one Abraaj unit is registered there. Sarah Dea / The National
The Gate in DIFC. Only one Abraaj unit is registered there. Sarah Dea / The National

“Commingling”, an investment term, entered mainstream media during the coverage of private equity firm Abraaj Group’s downfall this year. The company, which was founded in 2002 by Arif Naqvi with offices in Asia, Latin America, the United States and Europe, was accused by investors including the Bill and Melinda Gates Foundation and IFC of mismanaging their funds in a $1 billion (Dh3.67bn) healthcare vehicle, raising questions of corporate governance.

What exactly is commingling of funds and why has Abraaj been criticised for it?

What is commingling?

The term describes when a fund manager or other fiduciary mixes investor funds with other pots of money. If the funds were entrusted to the manager for a particular purpose and, once commingled, are used for something else, then the manager could be in breach of fiduciary duty or their legal mandate to steward the funds in the sole interest of the investor.

How did Abraaj commingle funds?

Abraaj, which is in provisional liquidation following allegations of mismanagement of funds, was reliant on short-term borrowing, sources revealed in recent months. After facing cash shortages, the company commingled around $95 million, including money from the healthcare fund, to pay management fees and other expenses, according to a report in June by Deloitte, one of the liquidators.

Abraaj has denied any wrongdoing.

Is it illegal?

It depends on the jurisdiction but not usually, as commingling of funds in some industries is standard practice. Banking is the most obvious example. Deposits are combined with other funds and appear on a balance sheet as assets to be used by the bank in various ways to achieve its objectives and service customers. Commingling is an integral part of the business model.

Then why is it frowned upon?

In other sectors, such as private equity, commingling is regarded as a violation of fund manager duties and prohibited by financial services regulators. While not a criminal offence, the penalties can include hefty fines and suspension of business, not to mention reputational damage arising from poor financial management and lack of transparency.

In addition, a court of law may treat commingling as breach of contract and penalise the manager. Investors and managers enter into a contractual agreement stipulating how, when and where the money is spent. It is “highly unlikely” such contracts would not be drawn up, said Imad Ghandour, managing director of private equity firm CedarBridge Partners in Dubai. “Every time [a manager] receives monies to invest, there are restrictions on what he can and can’t do with them.”

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Read more:

Deloitte releases review of Abraaj $1bn fund

Explainer: What now for Abraaj Group?

Greater controls may be silver lining in Abraaj collapse

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Are there other risks?

Commingling can pose serious risks to investors. If funds are mixed and the manager goes bust, the money can become part of the pot distributed to creditors during insolvency proceedings. As unsecured creditors, investors are often the last to be paid and could lose out. “[Fund managers] are obliged to create ‘bankruptcy remoteness’ for their clients, which is why commingling is prohibited in many jurisdictions,” said a lawyer who asked not to be named.

What action can be taken against Abraaj for commingling funds?

Abraaj is known as a Middle East company but only one of its units is registered here – the Dubai International Financial Centre-incorporated Abraaj Capital Limited, whose activities have already been scaled back by the DIFC regulator. All other units, including the parent company and funds management business, are incorporated in the Cayman Islands and subject to the rules of that jurisdiction. The scale of commingling Abraaj undertook is expected to emerge during provisional liquidation proceedings, but it is not clear how, or if, the money will be recovered.