Foreign Direct Investment (FDI) is an investment by one party in one country into a business or company in another country to create lasting benefits. Enduring interest distinguishes FDI from foreign portfolio investment, in which investors passively hold foreign securities. Foreign direct investment can be made by earning permanent interest or expanding the business abroad.
In 2018, the UAE ranked first in the Arab world, accounting for 36% of total foreign direct investment flows to Arab countries. However, it ranks second in West Asia, accounting for 35.5% of total FDI and approximately 22% of total annual FDI in the MENA region. Switzerland, the UK, India, the US, France, Austria, Japan, Saudi Arabia, Kuwait, and the Netherlands are some of the major investors in the UAE.
The UAE has no separate legislative system to regulate the country’s operation and control of foreign direct investment (FDI). With the recent passage of the Foreign Investment Law, the UAE is in the process of establishing a foreign direct investment regime. This is complemented and coordinated by strategies implemented within the individual emirates.
Through several measures, the UAE supports greater participation of international investors in the economy. Establishing nearly 40 specially designated free trade zones is vital to encourage foreign direct investment (FDI). These free zones, which can establish different regulatory frameworks within their specific jurisdictions, are attractive to international investors due to their clear business regulations, wholly foreign-owned entities, and guaranteed tax breaks on all corporate taxes. The UAE does not impose any rules to control foreign exchange within or outside the free zone.
Despite various initiatives to attract international investment, the UAE still strictly prohibits foreign investment in primary industries such as defense and oil and gas. In addition, some economic activities remain restricted to UAE nationals and companies fully controlled by UAE nationals. The state is not a signatory to the WTO’s multilateral agreement on government procurement. Therefore, government contracts are allocated to local companies and suppliers where possible. Furthermore, outside the free zones, the UAE must own a majority shareholding in any company incorporated in the UAE to the extent permitted by the recently enacted Foreign Direct Investment Law.
Foreign Direct Investment Law in UAE
The Foreign Direct Investment Law, which came into force on September 23, 2018, allows foreign ownership of majority ownership in UAE companies. According to the Foreign Direct Investment Law, the Foreign Direct Investment Committee (FDI Committee) was established by the Council of Ministers and chaired by the Minister of Economy (Minister). The Foreign Direct Investment Committee has the right to study and make recommendations to the UAE Cabinet on the following issues after consulting with local governments:
Develop a list of economic activities that companies fully controlled by foreign investors can carry out in the UAE (Positive List). In the positive list, the resolution shows 122 economic activities. 100% foreign ownership is permitted for these businesses. Investors can start a business on the positive list in three places. They are as follows:
- Agricultural industry,
- Service industry.
Authorize foreign-invested projects to carry out activities not included in the positive list based on recommendations from relevant licensing government agencies; and
Under the incentives offered for foreign direct investment projects in the UAE.
They developed a list of economic zones (negative list) where foreign direct investment is prohibited. The Ministry of Economy (Ministry) reserves the right to modify the negative list as appropriate. These industries are as follows:
- Petroleum Exploration and Production
- Military (including the production of weapons, explosives, materials, equipment, and military uniforms);
- Banking and financing operations;
- Hajj and Umrah services.
- Various recruitment jobs;
- Water and energy services.
- Fishery services;
Postal, telecommunications, and video services;
FDI projects can take any of the following legal forms:
- Limited liability companies, which include sole proprietorships (one owner).
- Private corporations, including sole proprietorships (one owner).
- Legal Consequences of the New Foreign Direct Investment Law on Enterprises
Considering whether a local company based in the UAE should be converted into an FDI company, consider that any conversion from a limited liability company to an FDI company may open the door for further shareholder negotiations, mainly if the conversion results in a buyout of all Existing Shareholders. Companies should conduct contract audits to examine the impact on key business relationships and any changes in control regulations that may arise in key business contracts as a result of any transfer; consider using a corporate service provider for new investments – learn these Company Services are familiar with the platform and understands its requirements;
Consider using corporate service providers for new investments, bearing in mind that these corporate service providers are familiar with existing systems and understand the need for foreign investors to seek contractual security through side agreements; and
Consider including future provisions in shareholder agreements – we generally like to see provisions requiring domestic shareholders to transfer their shares to foreign shareholders in companies should the law change to allow a foreign shareholder to be the company’s sole owner. In addition, depending on the parties’ negotiating positions, some agreements also include clauses allowing foreign shareholders to return a pro-rata return of any service fees paid to domestic shareholders if the arrangement is dissolved due to legislative changes.
Advantages and disadvantages of the FDI regime
Advantages of the FDI regime
The most obvious benefit of FDI is job creation, one of the main reasons a country (especially a developing country) seeks to attract FDI. FDI stimulates industry and services, creating jobs and reducing unemployment in the country. In addition, more employment increases wages and gives people more purchasing power, which boosts a country’s overall economy.
Human capital growth
Human capital requires the knowledge and skills of the workforce. Therefore, human skills acquired through training and experience can help improve the country’s education and human capital.
Target countries and companies can access the latest financing tools, technologies, and operating practices worldwide. The introduction of newer and improved technologies has led to the dispersion of companies in the local economy, thereby increasing the efficiency and effectiveness of the industry.
Many goods produced by FDI have global markets in addition to domestic consumption. Therefore, establishing 100% export-oriented companies helps FDI investors to increase exports from other countries.
Exchange rate stability
Foreign direct investment flows into a country, translating into a steady stream of foreign exchange flows. This helps the country’s central bank maintain healthy foreign exchange reserves, leading to exchange rate stability.
Increase capital flow
Fund inflows are particularly beneficial to countries with limited internal resources and those with limited access to cash in global capital markets.
Create a competitive market.
By allowing foreign companies to enter local markets, FDI helps create a competitive environment and break up domestic monopolies. A stable competitive environment encourages companies to continuously improve their processes and product offerings, fostering innovation. However, consumers can get a wide range of affordable goods.
Disadvantages of the FDI regime
Hinder domestic investment
Foreign direct investment can sometimes kill domestic investment. Domestic companies in these countries are beginning to lose interest in local products due to foreign direct investment.
Risk of political change
Political dynamics in other countries can frequently change, which can be difficult for investors.
Negative exchange rate
Foreign direct investment can sometimes affect currency exchange rates, favoring one country and benefiting another.
When investors invest in other countries, they may find that these items are more expensive than when they were exported. Often, more money is spent on machinery and intellectual property than on the wages of local workers.
Since FDI can be capital-intensive from an investor’s point of view, it can sometimes be risky or economically unviable.
The ongoing political change could lead to expropriation. In this case, the governments of these countries will have the power to manage the property and assets of investors.
Modern economic colonialism
Many third-world countries, or at least those with a legacy of colonialism, worry that foreign investment will lead to modern economic colonialism that exposes host countries to exploitation by foreign companies.
Multinational corporations are punished for poor working conditions in factories abroad.
The UAE government is working hard to promote economic development and attaches great importance to international investment. This is illustrated by the FDI Law, which is an essential step towards greater diversification across all industries and furthering the UAE’s goal of becoming a world leader in attracting FDI. Encourage companies to prepare for changes by implementing future-proof procedures under the new FDI law.