Navigating Conflicts of Interest: DFSA and FSRA Requirements for Authorised Firms
The effective management of conflicts of interest is a fundamental part of an authorised firm’s compliance framework and allows for the safeguarding of client interests, enhances market integrity, and fosters a fair and transparent environment.
Introduction
Under the respective regulatory regimes, the DFSA and FSRA’s framework for managing conflicts of interest is outlined in Principle 7 of the General Rulebooks. The regulatory bodies place a strong emphasis on transparency, independence, and effective management strategies to mitigate risks arising from conflicts. Specifically stating that Firms “must take all reasonable steps to ensure that conflicts of interest between itself and its customers, between its Employees and customers and between one customer and another are identified and then prevented or managed, or disclosed, in such a way that the interests of a customer are not adversely affected”.
Firms must consider both actual and potential conflicts, ensuring these are firstly identified and then either prevented or appropriately managed or disclosed to their customers. Regulators in the financial free zones expect Firm’s to manage conflict fairly, both between itself and its clients and between one client and another. Firms must therefore, implement arrangements at both a corporate and a personal level.
Conflicts of Interest explained
What is a Conflict of Interest?
A conflict of interest occurs when a Firm or any individual who acts for it, or any of its associates has competing interests, such as personal or financial interests, that could impair their ability to act in the best interest of their clients or to make impartial decisions. Conflicts of interest may arise in various scenarios, such as:
- A Firm providing advice that could lead to financial benefits for its own interests
- Employees or stakeholders benefiting personally from decisions made in their professional capacity
- Competing interests between clients that a Firm cannot resolve fairly.
Corporate conflicts
Corporate level conflicts can undermine the integrity of business decisions, jeopardise stakeholder trust, and violate regulatory standards if not properly managed. Below are some examples:
- Self-dealing by executives or directors: When executives or board members engage in transactions where they personally benefit at the expense of the Firm or shareholders
- Related party transactions: When a Firm enters into contracts or deals with businesses owned or controlled by executives or their family members, potentially at non-market terms
- Influence of major shareholders: When large shareholders use their voting power to influence company decisions in a way that benefits their interests, not necessarily the broader shareholder base
- Corporate loans to executives: When the Firm provides preferential loans or financial benefits to executives or employees, leading to potential conflicts of interest
- Incentives tied to short-term performance: Executives making decisions that favor short-term gains (e.g., cutting costs) for personal bonuses, which may harm the company’s long-term viability
- Misuse of confidential information (insider trading): When executives or employees use non-public, material information for personal gain, such as insider trading based on upcoming mergers or acquisitions
- Kickbacks or bribery: When an employee or executive accepts financial rewards from a business partner or service provider in exchange for securing a contract, potentially leading to suboptimal business decisions.
Personal conflicts
Similarly, personal level conflicts can undermine professionalism, trust, and ethical standards if not properly managed or disclosed. Below are some examples:
- Accepting gifts or bribes (inducements): An employee accepting gifts, travel, or other benefits from clients, vendors, or business partners that may influence their professional decisions
- Investing in competitors (personal account dealing): An employee working for a company while also investing in or holding shares in a competing business
- Outside business interests: An employee running a side business that competes with or creates a conflict with their primary employer’s interests
- Using confidential information for personal gain: An employee using proprietary or non-public information for personal financial advantage, such as insider trading or personal investment opportunities
- Conflicts from dual roles: Holding multiple positions that might create a conflict, like being employed by one company and simultaneously serving as an advisor to a competitor
- Referring clients for personal commissions: An employee referring clients to a third-party business for a personal commission or referral fee, even if it’s not in the client’s best interest
- Misuse of company resources: Using company time, funds, or resources to benefit personal projects or side businesses, such as working on personal business ventures during a Firm’s operating hours.
Firms must consider and assess both actual and potential conflicts, the latter refers to situations or circumstances that could reasonably be expected to lead to an actual conflict of interest in the future, regardless of whether an actual conflict has yet arisen.
Regulatory approach to conflicts of interest
Identification and Management
Firms are required to have appropriate systems and controls in place and adopt clear conflict management policies to identify actual or potential conflicts of interest that may arise in the course of their business operations. This includes:
- Assessing whether the Firm’s business and its operating model exposes the Firm to conflicts of interest risks
- Assessing the nature and scope of potential conflicts in various business activities (e.g., advisory, investment, or custodial services) and client relationships
- Recognising situations where the Firm’s or an individual who acts for it, interests could conflict with clients’ interests
- Implementing control mechanisms to manage conflicts effectively, such as adopting Chinese walls, segregating duties and functions when necessary
- Implementing policies which clearly outline procedures for identifying, reporting and managing conflicts of interest.
Independence
Firms and individuals who act for them, must ensure that any conflicts do not impair their ability to act independently and in the best interests of clients, thereby maintaining independence in decision making. This can be achieved by:
- Ensuring an independent function is responsible for reviewing and assessing disclosed or identified conflicts of interests
- Maintaining clear lines of responsibility and decision-making authority that ensures segregation of duties
- Ensuring any individuals with conflicting interests are not in positions to influence or affect decisions inappropriately.
Disclosure requirements
In situations where conflicts cannot be avoided, Firms and individuals acting for them, must disclose conflicts internally and where required externally to their clients in a clear, concise, and timely manner. This disclosure should include:
- The nature of the conflict and any actions taken to address it
- Full transparency regarding how the conflict could impact client outcomes.
Record keeping and Reporting
Firms must maintain comprehensive records of potential or actual conflicts of interest, both at a corporate and personal level, which must also detail actions taken to manage them such conflicts. These records should include:
- Register of identified conflicts and any mitigation strategies applied
- Documentation of procedures followed to ensure oversight, ongoing compliance and monitoring, particularly conflicts which remain open or active
- Any communications with clients regarding conflicts
- Situations where the Firm has declined to act if the firm was not able to prevent or manage an actual or potential conflict of interest.
Best Practices for Managing Conflicts of Interest
Beyond regulatory compliance, Firms should consider adopting best practices to foster a culture of integrity and transparency:
- Regular Training: Ensuring that employees are trained to recognise and manage conflicts of interest effectively
- Independent Oversight: Appointing compliance officers or audit committees to regularly review conflict management practices
- Whistleblower Mechanisms: Establishing mechanisms for employees to report conflicts without fear of retribution
- Proactive Conflict Mitigation: Taking steps to eliminate or mitigate conflicts at the earliest stages of decision-making, rather than addressing them after the fact.
Conclusion
By implementing effective conflict management systems, Firms can not only comply with the applicable regulation and legislation but also strengthen their reputation and business practices in an increasingly competitive marketplace.
While both regulatory authorities operate in separate jurisdictions (DFSA in DIFC and FSRA in ADGM), they share key principles in their approach to Firm’s managing conflicts of interest:
- Clear Policies and Procedures: Both DFSA and FSRA require Firms to implement robust internal policies to detect, manage, and resolve conflicts of interest
- Disclosure to Clients: Transparency is a cornerstone of both authorities’ conflict management frameworks, with an emphasis on providing clients with clear and comprehensible information about potential conflicts
- Independence: Both regulatory bodies stress the importance of maintaining independence in decision-making processes, ensuring that client interests come first
- Record-Keeping and Audit: Both DFSA and FSRA have strict documentation requirements, ensuring that Firms keep detailed records of identified conflicts and the measures taken to address them. These records should be made available for inspection by regulators.
Whilst the regulatory bodies share the same key principles as described above, it is important to apply the rules and regulations specific to your jurisdiction, where certain differences, particularly in relation to the financial service offered, may apply.
What can Waystone do to help?
Identify Conflicts of Interest
- Help identify conflict of interests in your business and advise senior management on how to manage such conflicts.
Policies and Procedures
- Implement effective policies and procedures to identify, manage and report conflicts of interest.
Governance Structure
- Develop effective governance structures, appropriate reporting lines, clear job descriptions, and terms of reference to ensure independence in the management of conflicts of interest.
Effectiveness Reviews
- Review existing policies and procedures and make recommendations for improvement and help implement changes.
Training and Awareness
- Provide training to governing body and all employees on how to navigate conflicts of interest.