Newsletter on market conduct and transaction reporting issues
Trading during the market soundings procedure
Market soundings are interactions between issuers and investors which help determine interest in a transaction before its announcement. These soundings support the proper functioning of financial markets, and price discovery, by allowing issuers to gauge investors’ opinions on possible transactions to help set their price, size and structure. Robust market soundings procedures are important for protecting market integrity because they manage the risks of investors inappropriately using inside information from these soundings.
The UK MAR market soundings regime provides formalised arrangements for issuers, and their advisors acting as Disclosing Market Participants (DMPs), to legitimately disclose inside information where the disclosure is made in the normal exercise of a person’s employment, profession or duties. It includes standardised arrangements and information requirements to ensure that no potentially sensitive information is unnecessarily disclosed. The requirements DMPs must follow for inside information to be deemed to be legitimately disclosed under the market soundings regime include:
- assessing and recording whether a market sounding will involve disclosing inside information
- producing standardised procedures and scripts for communications with Market Sounding Recipients (MSRs) during market soundings
- getting MSRs’ consent to receive a market sounding and inside information
- informing MSRs that they are prohibited from using the information to trade or attempt to trade relevant instruments
- making and maintaining a record of all the communications with, and all the information given to, MSRs
Under UK MAR, MSRs must independently assess for themselves if they possess inside information from the market sounding which would prohibit them from trading. As well as the information which the DMP discloses at any stage, this assessment should include any other information the MSR has. For example, when an issuer has previously held regular and similarly-sized funding rounds executed by the same advisory firms, or where an MSR holds a very small number of investments in its portfolio, the MSR might be able to identify the issuer.
ESMA Market Sounding Guidelines set out the arrangements by which MSRs receive, protect and handle inside information from market soundings. These include:
- independently assessing whether they possess inside information, taking into account both the DMP’s assessment and other information available to the MSR
- recording the market soundings they receive and their inside information assessments
- arrangements to receive, manage and control the internal flow of inside information on a ‘need to know’ basis
Recently, we have observed cases where MSRs have traded the relevant financial instruments during the time period after a DMP has initially communicated with them or sought their consent to receive the sounding and inside information, but before the DMP has disclosed the inside information. The DMPs did not, during the initial communication, disclose the identities of the financial instruments or the nature of the proposed transaction and the likelihood of its taking place. However, the MSRs were still able to identify those details using other information available to them. Frequently, this has occurred where there has been a delay between DMPs requesting the MSR’s consent and the MSR giving it.
In these instances, the MSRs have provided rationales that are not easily reconcilable with the circumstances of the trading. For example, an MSR selling a financial instrument immediately after a DMP has sought its consent to receive inside information, then buying the same quantity of the financial instrument back in the subsequent placing does not reconcile with ‘Rebalancing a portfolio’. Nor does this rationale reconcile easily with instructions to trade being phrased with urgency.
Why this is important
Given our observations, it is possible that MSRs might have other information available to them that allows them to identify, with reasonable confidence, the financial instruments referred to before they consent to receiving and protecting the inside information in the market soundings. In such circumstances, MSRs could have an unfair advantage that is similar to that after the consent process. Therefore, MSRs who have determined the identity of the security in a market sounding before agreeing to receive the inside information should assess whether they possess inside information before trading.
In these circumstances, MSRs remain subject to the prohibitions on using that information in both UK MAR and Part V of the Criminal Justice Act 1993. The market sounding regime only provides protections against the unlawful disclosure of inside information by the DMP and not to insider dealing by the MSR. The regime does not provide protections against MSRs trading on any inside information from market soundings.
What firms can do to minimise the risks of insider dealing and unlawful disclosure
DMPs should take particular care when making soundings on financial instruments that have few actors and where potential external information the MSRs hold could reasonably be used to identify the relevant financial instrument. This might include assessing the scripts they use at all stages of the sounding. When initially communicating with MSRs, and seeking their consent to receive the market sounding and inside information, DMPs should also be alert to the risk of unlawfully disclosing inside information. They should consider whether the information provided at this stage is essential for MSRs to decide if they wish to receive the information. They may want to tailor the information they plan to give, depending on the nature of the transaction, so that they do not inadvertently disclose inside information. DMPs may also want to consider specific arrangements and scripts where the MSR is a private individual whose awareness of possible breaches may be less than those of corporate clients.
DMPs should carefully consider and assess the standardised information which they intend to provide to MSRs in their initial communications and requests for consent. DMPs should make clear at the start of any market sounding that the communication is a market sounding. This gives the MSR the opportunity to decline, and reduces the risk of disclosing any inside information arising from the market sounding.
MSRs should consider putting in place the ‘Gatekeeper’ arrangements highlighted in Market Watch 51 and 58. These include appointing specific teams or staff in Compliance as the first point of contact for DMPs. MSRs should also ensure that staff who receive and process market soundings are properly trained in relevant internal procedures and UK MAR prohibitions on unlawful use of inside information.
DMPs and MSRs should consider minimising time intervals between the DMP’s initial communications and requests for consent, and the MSRs consenting to such requests. Reducing this time period will help minimise the risks of insider dealing where there are delays to MSRs responding to DMPs’ requests for consent.
Firms and their employees should be aware of the breadth of information that the FCA can request and which is available to us when reviewing trades, communications and documentation relating to soundings. We will intervene when we have reason to suspect behaviour detrimental to confidence in, and the fairness of, UK markets.