Recognizing new realities in decentralization, the regulations aim to provide market players with governance flexibility within distributed ledger technology foundations.

By Stuart Davis, Brian Meenagh, Andrew Moyle, and Ksenia Koroleva

On October 2, 2023, the Board of Directors of Abu Dhabi Global Market (ADGM), a financial free zone in the United Arab Emirates (UAE), enacted the Distributed Ledger Technology Foundations Regulations 2023 (Regulations). The Regulations were published on November 1, 2023.

Latham & Watkins has advised ADGM in drafting the Regulations. The Regulations were developed following extensive benchmarking across a number of peer jurisdictions and incorporate stakeholder feedback from ADGM’s April 2023 consultation paper. The adoption of the Regulations is part of the strategy to promote ADGM as a global center for digital assets.

The Regulations recognize the suitability of common law foundation structures for projects related to digital assets, and aim to allow maximum flexibility for the sector with respect to governance.

What are DLT Foundations?

While ADGM had an existing regime for common law foundations prior to the Regulations (under the Foundation Regulations 2017), that regime was primarily intended and used for asset management projects.

The Regulations lay down key rules regarding a new type of foundation, based on distributed ledger technology (DLT). DLT foundations are defined in Section 3 as foundations established for the use, deployment, development, facilitation, or support of DLT or the issuance of tokens (as defined below).

Under Section 7, DLT foundations have legal personality and thus have their own assets distinct from those of their founders or beneficiaries (each, as defined below) and, accordingly, can sue and be sued.

Do the FSRA rules still apply?

The Regulations are not intended to replace or disapply the regime imposed with respect to digital assets by the ADGM’s Financial Services Regulatory Authority (FSRA).

For example, the Regulations:

  • refer to terms defined by the FSRA (such as tokens); and
  • state in Section 4 that founders must ensure that FSRA permissions are obtained if required, but that the DLT foundation itself is not allowed to conduct any activities for which the permissions are required.

How are DLT foundations to be governed?

DLT foundations:

  • pursuant to Sections 11, 24, and 29, must have:
    • founders (persons establishing DLT foundations, who may, until they resign or step down, participate in managing certain activities of DLT foundations); and
    • a DLT foundation council (with a minimum of two councillors managing DLT foundations on a day-to-day basis)
  • may, but do not need to, have other governing bodies, including:
    • beneficiaries, i.e., persons with rights to the assets of DLT foundations (regulated by Section 39); and
    • tokenholders, i.e., persons holding rights to tokens issued by DLT foundations (regulated by Section 40).

Are beneficiaries, tokenholders, and beneficial owners the same?

Tokenholders may or may not be beneficiaries; for example, tokenholders may not have rights to the assets of DLT foundations (and thus not be beneficiaries) but have governance rights with respect to project management.

The Regulations are accompanied by amendments to the Beneficial Ownership and Control Regulations 2023, which define persons who may be treated as beneficial owners of the DLT foundation. This concept is different from the concept of beneficiaries and means persons “controlling” the DLT foundation. This concept is important for compliance purposes because beneficial owners may be liable for the DLT foundation’s violations in certain cases (as described below).

How Is DLT governance to be documented?

The Regulations require each DLT foundation to have a charter, which, pursuant to Section 24, must include key provisions regarding DLT governance, including:

  • governance and the governing bodies of the DLT foundation, rules on their appointment, and rules on removal and quorum for decision-making;
  • rules for token issuance, including types and purposes of tokens and rights attached thereto; and
  • provisions relating to the DLT foundation’s assets, white papers, and DLT frameworks, including frequency of audits and security audits.

If the DLT foundation issues tokens, its charter must regulate the rights and categories of relevant tokenholders, including whether the tokens are voting or non-voting and the scope of matters decided upon by the voting (delegated matters).

Delegated matters reserved for tokenholders must be distinguished from reserved matters falling within the competence of the DLT foundation council. As part of the reserved matters, Section 27 requires the councillors to make sure that the DLT foundation complies with applicable laws. In particular, councillors must exercise their veto rights on decisions of tokenholders which:

  • violate applicable laws, public order, morality, or the charter;
  • contradict the principles in the white paper; or
  • could lead to a detrimental result caused by an attack on the DLT framework.

In certain circumstances set forth by the Regulations, councillors and other persons exercising control over DLT foundations, including beneficial owners (Relevant Persons) may be:

  • held accountable for breaches by DLT foundations; and
  • liable for any loss in value of the DLT foundation assets resulting from the breach.

How can a DLT foundation be registered?

Section 4 requires founders to submit a number of documents to the ADGM Registration Authority (Registrar), including:

  • the charter;
  • a declaration of compliance with laws;
  • a statement of initial beneficial ownership; and
  • if developed, a hyperlink to the white paper setting forth details of the project and DLT framework outlining details of the DLT used.

The Registrar may, pursuant to Section 7, also require founders to submit legal opinions and security audit reports with respect to the DLT charter, white paper, and DLT framework.

Under Section 19, DLT foundations must have minimum assets of US$50,000 payable in fiat currency.

An already established foundation can become a DLT foundation under the Regulations (including Sections 107-111).

What are the ongoing obligations of DLT foundations?

DLT foundations are required to:

  • disclose certain information, including names of founders and councillors;
  • keep adequate and fair accounting records;
  • appoint auditors to review annual accounts; and
  • conduct periodic security audits on data protection and security systems.

Councillors may be liable for breach of these requirements. The amount of fines depends on the type of breach and is set forth in different sections of the Regulations.

Section 120 also allows striking off DLT foundations for default.

Next steps

The Regulations mark a significant step in promoting ADGM as a global center for digital assets and provide a new option for corporate structures of digital assets projects.

They also present the world’s first purpose-built legislative framework for establishing and operating DLT foundations.

Latham & Watkins will continue to monitor developments on virtual assets in the Middle East, including the forthcoming additional rules and regulations.