Free zones – special economic jurisdictions which promote trade by suspending customs duties – are like Tolstoy’s description of families: while all functional free zones are alike, each dysfunctional free zone is dysfunctional in its own way.
In addition to incentives such as preferable tax, labour, ownership and immigration regulations, compliant businesses choose functional free zones because they provide an efficient and clear service. But for every functional free zone, there is its dysfunctional corollary which is marked by poor regulation, cooperation with domestic authorities and record keeping. These deficiencies appeal to criminals which trade contraband and counterfeit goods, which launder money and evade sanctions, and which evade taxes. As long as governments prioritise revenue generation above addressing criminality, and in the absence of consistent international standards, these challenges are not easily met, and expose the compliant business to regulatory risks and the prospect of losing customers, business and money.
There are hundreds of free zones in the Middle East and Africa. While many are paragons of good governance, various regional factors confound initiatives to improve compliance. Firstly, the ambient risk of corruption and low transparency leave free zones vulnerable to criminal exploitation. Secondly, a chain, so the saying runs, is only as strong as its weakest link; while many registers offer accurate and publicly accessible corporate information, African free zone companies are often owned by entities in the Seychelles or Mauritius, where the beneficial ownership trail goes cold. Lastly, a willingness to make corporate information available falls short where the quality of the data itself is poor. In certain jurisdictions, authorities have cut their losses and are accurately recording (and making available) corporate information after a certain date; the result is that obtaining quality data on older companies is difficult.
A few examples from the region will suffice to illustrate the spectrum of free zone functionality. In Morocco, data on all companies, free zone-registered or otherwise, is listed centrally, and is clear and accessible. In Nigeria, a separate registry for free zone companies provides transparent and clear corporate information for a nominal fee. In Jordan, meanwhile, the six free zones have no publicly accessible register, and commercial law is unclear on how their operations are regulated. Moreover, the responsibility for registering free zone companies lies with the Jordanian Investment Commission, a state body which is mandated to promote investment into the kingdom – a system which is ripe for impartiality.
UAE free zones
My own country of residence, the UAE, is a base for international companies operating in the Middle East and Africa and has a walloping 45 free zones (with six more under construction), which account for one fifth of all companies . Most of the UAE’s free zones are in Dubai, and Jebel Ali accounts for 32% of all foreign direct investment into the UAE . Whatever degree of free zone dysfunctionality there might be, we have it here. But don’t just take my word for it: the UAE’s National Risk Assessment states that 85% of its free zone companies are inherently high risk . Small wonder, given that free zone authorities are constituted by the governments of seven different emirates, with each free zone having its own company formation procedures and compliance requirements. What’s more, there is competition among the free zones, with each one jostling to best serve prospective clients. To counter the dysfunctionality, the UAE has developed the National Risk Register, strengthened its Financial Intelligence Unit, assigned official supervisors for new sectors, and established a Money Laundering Investigations Subcommittee.
What businesses can do
So, while the UAE and other countries in the Middle East and Africa address criminality in their free zones, what steps can businesses take? The answer is to establish a risk-based due diligence programme which is extensive for critical third parties in complex environments, and light-touch in developed markets where the exposure is limited. To manage regulatory risk, due diligence must establish ultimate beneficial ownership, and sanctions and political exposure. Moreover, businesses must promptly and thoroughly investigate their own suspected ethical and legal breaches – and those of their third parties.
Through taking a thoughtful and proportionate approach to third party due diligence, and investigating infractions in a meaningful way, businesses can manage their exposure to any of the hundreds of free zones in the Middle East and Africa, from the functional to the dysfunctional, and everything in between.
Diligencia provides due diligence solutions and corporate intelligence services across the Middle East & Africa. Our legal entity data on organisations, including free zone companies, and individuals across the region is available via our online platform www.ClarifiedBy.com.
Author: Jonathan Siklos, Regional Director
Jonathan leads the growth of Diligencia’s presence in the Gulf region from our Dubai office, building and managing client relationships, and advising organisations on navigating the regional risk and compliance environment. Jonathan has lived in the UAE for over 10 years and joined Diligencia in 2021 from Omni Bridgeway where he was a member of the Case Intelligence Team. Prior to that, Jonathan was head of the Middle East Business Intelligence Practice for Control Risks.