Special Report: The independence of the Dubai Financial Services Authority is part of attraction for companies relocating to DIFC.
Dubai's financial watchdog set to gear up
For Paul Koster, the Dutch-born chief executive of the Dubai Financial Services Authority (DFSA), investigating wrongdoing and setting the rules for companies in a market is not enough any more.
He wants his team to figure out the risks before problems arise.
"The regulatory environment is still in the transition phase after the crisis," he said. "It has revealed to us the weaknesses and we are all working to improve what we do, but the key lesson is that we need to understand the risks before they can cause a crisis."
The ability of regulators to do this, he said, was intertwined with their ability to keep up with the fast-pace of the financial system.
"Innovation is crucial to finance, but it has gone too far," he said. "This is where the regulators need to step in. We are looking at all new products with a keen eye."
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The past two years have been tough on Dubai's business reputation, but the Dubai International Financial Centre has proved a bright spot. There were 792 companies registered in the centre at the end of last year after 113 new companies joined during the year. Occupancy of the main buildings within the DIFC was at 95 per cent.
The DFSA has been one of the main pillars of the centre that has drawn in companies, said Atif Yusuf, the Middle East director of financial services at Deloitte.
"We have been seeing increased scrutiny of regulators across the region, but the DFSA has been taking the lead," he said.
Stronger regulators improve confidence from outside companies and investors interested in doing business with companies under supervision, Mr Yusuf said.
But the challenge is to take a greater role in preventing financial crises, while allowing companies to go about their everyday business.
"I would say there is also a tendency at the moment, with all the political discussion, that we may end up doing a bit too much regulatory reform, which may not be entirely necessary," Mr Yusuf said. "It's important to balance it out."
Mr Koster, a former commissioner of the Netherlands Authority for the Financial Markets, leads one of the smaller regulators in the region. Firms licensed by the DFSA total just 317.
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But being small gives the DFSA the ability to react quickly. The authority is also taking part in the global discussions about regulation after the crisis, including the Basel III framework being hashed out in Switzerland, he said.
The DFSA's size also means it is easier for it to identify where the next problems could crop up. Last year it conducted thematic reviews with 40 firms exploring client assets and fraud, corporate governance, anti-money laundering, combating the financing of terrorism, and auditing.
Future areas of interest include valuations, outsourcing and the behavioural side of finance - how traders and businessmen operate.
Bryan Stirewalt, the managing director of supervision at the DFSA, said the priority when monitoring companies was "anticipation".
His department is made up of four teams that monitor companies based on their business models: commercial banking and insurance; investment banking and brokerage; private banking and funds; and a catch-all group including auditors, representative offices and anti-money laundering protocols.
"We've found that it almost always comes down to the management team of the firm," he said. "A good management team anticipates risk."
Supervision is risk-based, meaning the DFSA analyses which companies in the DIFC present the greatest threat to the centre if they break the rules or take risks that lead them to fail. The highest-risk companies, those that take customer deposits, are reviewed every quarter. Medium-risk companies are examined every year and low-risk companies are checked out every three years.
The way banks do business itself is of concern, especially supervision of traders.
Mr Koster pointed to the Societe Generale trader Jerome Kerviel, who caused the French bank to lose €4.9 billion (Dh24.38bn) through his bad trades. Despite safeguards at the bank, Mr Kerviel was found to have been able to exceed trade limits and conceal his actions from co-workers.
"As a trader dealing with big customers day in and day out, there is an element of trust that is developed," Mr Koster said. "That can lead to excessive positions."
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Peter Casey, the director of policy and the head of Islamic finance at the DFSA, said there were likely to be "clever minds in the banking sector that are already thinking about ways around Basel III capital requirements".
"Something is going to emerge that we haven't thought about yet."
The challenge over the past few years was transforming the DFSA from a division of the DIFC into an independent regulator, with its own budget, back-office operations, and authority.
Jan Bladen, the authority's chief operating officer, said the DFSA had achieved that and was now increasingly focusing on the job of regulating.
"From a reputational standpoint, the independence of the DFSA has been one of the two or three pillars that has made the DIFC a success," he said.
"I really believe Dubai has come to recognise the true value of an independent regulator."
Mr Bladen said the DFSA operated like a "Swiss clock" and had the most comprehensive governance system in the DIFC. The authority has been audited 28 times in the past six years and recently underwent a new type of audit about authorisation, supervision and process conducted by Sir Callum McCarthy, the former chairman of the UK's Financial Services Authority, and Tony Travers of the London School of Economics.