The Significance of Identifying and Managing Conflicts of Interest in Regulated Entities

This is Part I of III of an article series on Identifying and Managing Conflicts of Interest in Regulated Entities.

1. Introduction – requirement to avoid conflicts of interest

Regulated entities[1] and in particular their directors, are required to avoid, prevent, mitigate and manage conflicts of interest. The requirement emerges from general and specific legislation. The general law which requires directors of regulated entities to avoid conflicts of interest is the Companies Act.[2] Several specific laws, rules and regulations also require regulated entities (and their directors) to avoid conflicts of interest including but not limited to:

1. the Conduct of Business Rulebook;
2. the Insurance Rules;
3. the Pension Rules (for Service providers, for Personal Retirement Schemes, for Occupational Retirement Schemes, and for Retirement Funds);
4. Standard License Conditions (SLCs) applicable to Investment Services License Holders which qualify as Alternative Investment Fund Managers;
5. SLCs applicable to Alternative Investment Funds (AIFs);
6. SLCs for Malta based Undertakings for Collective Investment in Transferable Securities (UCITS) Collective Investment Schemes (CISs);
7. the Company Service Providers Rulebook (the “CSP Rulebook”); and
8. Trusts and Trustees Act as well as the Code of Conduct for Trustees.

The MFSA’s New Corporate Governance Code (the “Code”) [3] also imposes a requirement on directors of regulated entities to avoid, manage and mitigate conflicts of interests.

2. Rationale behind avoiding and preventing conflicts of interest

Directors are required to act honestly and in good faith in the best interests of the company [4]. Directors of regulated entities are also obliged to act in the best interest of their clients. [5] Conflicts of interest (whether apparent, actual or potential) run counter to the principles of legality, good faith, honesty and integrity and can result in reputational or financial damage to the company, its members and its clients and also to the integrity and stability of Malta’s financial services sector.

3. Forms of conflicts of interest

Different forms of conflicts of interest exist. However, it is possible to categorise conflicts of interest into two distinct groups:

1. situational conflicts of interest; and
2. transactional conflicts of interest.

Situational conflicts of interest arise where the direct or indirect interests of a director conflict or may possibly conflict with the interests of the company or of the company’s clients. A situational conflict of interest can also arise when the direct or indirect interests of the company conflict with the company’s clients.

Transactional conflicts arise when a director is interested, directly or indirectly, in a proposed contract, transaction or arrangement to be entered into by company, or an existing transaction or arrangement that has been entered into by Company.

Conflicts of interest may arise, inter alia, between:

1. the directors and the company;
2. the directors and the company’s clients;
3. the company and its clients;
4. two or more Clients of the Company in the context of the provision of services by the company to those clients.

Part II & III from this series will be released in the coming weeks. 

[1] Regulated entities include credit and financial institutions, insurance entities, insurance intermediaries, investment services entities and collective investment schemes, pensions and retirement funds, company service providers and trusts.

[2] Article 136A(3)(c) of the Companies Act obliges directors ensure that their personal interests do not conflict with the interests of the company. Article 145 of the Companies Act requires directors who are interested (directly or indirectly) in a directly or indirectly, interested in a contract or proposed contract with the company to declare the nature of his interest to the other directors.

[3] The Code does not apply to Listed Entities falling within the scope of the Capital Market Rules, to Authorised Entities which are also Listed Entities falling within the scope of the Capital Markets Rules to Authorised Persons who are natural persons.

[4] Article 136A(1) of the Companies Act. See also Principle 2.1.1.2.8 of the Code.

[5] See for example Chapter 3 of Conduct of Business Rulebook and Principle 1.2.1 of the Code.