Who is affected?
When does insider information arise?
When is an insider list required?
When is disclosure required?
Selective disclosure and market soundings
The EU Market Abuse Regulation(1) came into force on July 3 2016. Although the regulation has not radically overhauled the EU Market Abuse Directive(2) regime that it replaced, many of the procedural requirements under the directive have now been clarified or supplemented in, or by further guidance under, the regulation. Even where the changes are minimal, the regulation serves as a reminder to securities issuers and other market participants of some practical questions. These include the following:
- When do the various obligations and restrictions associated with inside information arise?
- Who is responsible for complying with them?
- When can inside information be selectively shared?
This update is not a comprehensive review of the regulation; rather, it discusses some of these practical questions as they may affect issuers in securitisation and other structured finance transactions, which are typically special purpose company (SPC) issuers.
At its core, the Market Abuse Regulation reiterates well-established prohibitions on insider dealing and market manipulation and the requirement for issuers to publish inside information and maintain insider lists. A key difference from the Market Abuse Directive is that the regulation applies directly – that is, EU member states need not bring in legislation to implement the new regime, thus making it more harmonised across the European Union.
More transactions will be caught under the regulation than under the directive because the regulation covers not just any instrument for which trading on a regulated market has been obtained or applied for (and its derivatives), but also any instrument for which trading on multilateral trading facility (MTF) or organised trading facility (OTF) platforms has been obtained or applied for (and its derivatives). To some extent, even this change is not as significant as might appear at first sight, since the rules of many of the major European MTFs already largely reflected the directive. Notably, the regulation applies regardless of whether the conduct or action takes place on a trading venue; however, it does not apply to private transactions with no public admission to trading.
Although the general prohibitions and obligations imposed under the new regime have not substantially changed compared to the requirements of the directive, several key changes were made to the scope and application of safe harbours and the management of internal policies. There is also new guidance from the European Securities and Markets Authority and technical standards regulations which clarify and expand issuers' obligations.
The prohibitions on insider dealing, market abuse and selective disclosure apply to everybody, but two key continuing obligations in the regulation fall only on the issuers of affected securities, including SPC issuers – in particular, the duty to disclose inside information and maintain insider lists. All issuers should now have introduced (or at least considered introducing) new, or revisiting existing, internal policies, procedures and training for the control of inside information and the reporting of transactions by persons discharging managerial responsibilities (PDMRs).
The regulation allows issuers to delegate maintenance of insider lists, but not the duty of disclosure.
When does insider information arise?
'Inside information' is broadly defined. In relation to bonds and equities, four elements are involved – the information must be:
- precise ("information of a precise nature");
- non-public ("which has not been made public");
- relevant ("relating, directly or indirectly, to one or more issuers or to one or more financial instruments"); and
- price sensitive ("which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments").
'Precision' is further defined as follows:
"[I]nformation shall be deemed to be of a precise nature if it indicates a set of circumstances which exists or which may reasonably be expected to come into existence, or an event which has occurred or which may reasonably be expected to occur, where it is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of the [bonds and related derivatives]. In this respect in the case of a protracted process that is intended to bring about, or that results in, particular circumstances or a particular event, those future circumstances or that future event, and also the intermediate steps of that process which are connected with bringing about or resulting in those future circumstances or that future event, may be deemed to be precise information." (Emphasis added.)
From this definition, it is clear that identifying an exact moment when inside information arises can be difficult. It involves not only a deep understanding of what might affect prices, but also a degree of foresight. Since important obligations arise as soon as insider information exists, a cautious approach to the question of when insider information arises is advised.
When is an insider list required?
Insider lists were required under the directive, but the new regime has introduced further guidance on the format and content of insider lists through a new template list.(3) An insider list must include all persons who have access to inside information and who are working for the issuer (or any person acting on their behalf or on their account) under a contract of employment. It also must include any persons performing tasks through which they have access to inside information (eg, advisers, accountants and credit rating agencies).
The requirement arises only if there is in fact inside information. For information that is immediately disclosed to the market (whether following the obligation to disclose in the regulation or otherwise), no insider list is required.
However, as mentioned above, issuers in general – and SPC issuers in particular – will not always find it easy to identify whether, and when exactly, insider information has arisen. SPC issuers are particularly poorly placed to monitor inside information, not being operating companies with day-to-day managers and a functioning executive board. Instead, they are run by corporate services providers; they may or may not have one or more individuals acting as non-full-time directors and all functions are outsourced to agents.
Given the difficulty for SPC issuers in knowing at any time whether insider information exists, the cautious approach suggests that corporate services providers should consider drawing up permanent insider lists of persons who may have access to inside information for each SPC that they manage which issues securities caught by the regulation. Such lists could comprise, for example, all individuals who are directors of the issuer and key operational personnel within in the corporate services provider for the SPC.
The technical standards regulations(4) for insider lists under the regulation recognise a distinction between event-driven insider lists and permanent insider lists. From time to time, events may arise that suggest that the issuer should establish an event-driven list. Again, the cautious approach should be adopted. The broad definition of 'inside information' suggests that such information may often arise early on in the contemplation of a given development affecting the issuer, its assets or the securities.
Event-driven inside information is a difficult area for SPCs and in many cases the SPC simply will not know when such information arises. As the market comes to absorb the impact of the regulation, it remains to be seen whether provisions will begin to be built into transactions to protect SPC issuers in this regard. Key participants in the transaction who are more likely to become aware of inside information arising (eg, asset servicers) may be required to notify the SPC if events have occurred that give rise to the requirement for an event-driven insider list. Similarly, the market may develop a practice in relation to agents and other service providers who may receive inside information during the life of the transaction. Such agents and service providers may be asked to draw up their own permanent and occasionally event-driven insider lists of individuals with access to information that is or may be inside information.
Notably, the obligation under the regulation to draw up insider lists rests only on issuers, not on their agents or service providers themselves, so that if the agent is not actively required by the relevant issuer to draw up a list, it does not need to do so. Once the list is drawn up, it can be kept with the agent, although it must be available to the issuer on request. This means that, in the ordinary course, the information on the list (which must now include certain personal information, such as national identification numbers and home addresses) can be kept with the agent or service provider, which is likely to be helpful for compliance with local data protection and similar laws.
The regulation requires issuers to disclose inside information as soon as possible. This creates a problem for SPCs similar to the problem of whether and when to draw up an insider list, but this time there is no practical solution equivalent to the permanent list.
There is also no obvious cautious protocol that issuers can adopt (eg, "announce everything that is known as soon as it is known"). The broad definition of 'inside information' may suggest such an approach; but not only is this impractical – it would in fact not ensure compliance. The regulation specifies that the inside information must be made public in a manner that enables not only "fast access [to the information]", but also a "complete, correct and timely assessment of the information" by the market. This is obvious; announcements of developments too early which create an incomplete or misleading picture in the market are contrary to the whole intent of the regulation. An issuer can and should take time to verify whether any given development or potential development does indeed involve inside information, and to ensure the correctness and completeness of any disclosure before making any announcement. The cautious approach would suggest that during this period of assessment, an event-driven insider list is appropriate even if the development turns out to involve no inside information. Also during this assessment period, any person aware of the development should consider himself or herself bound by the prohibition on dealing (again, even if the development turns out never to have involved inside information).
In addition to the assessment period suggested above, an issuer may also decide to delay disclosure to the market for a period, even when it is in a position to make such disclosure in a complete and correct manner. It can delay disclosure if immediate disclosure is likely to prejudice the legitimate interests of the issuer and the delay is not likely to mislead the market. The regulation has clarified that delaying disclosure may be an option where there is a protracted process that occurs in stages, which will help issuers to avoid untimely disclosure. There are further procedural requirements associated with a delay period designed to ensure that confidentiality is maintained and that the delay can be explained and justified to the competent authority.
It remains to be seen whether the regulation leads the market to consider putting in place contractual protections to ensure that those involved in the transaction who are closer to developments that may give rise to inside information are made responsible for notifying the SPC of such developments and for assisting the SPC in complying with the announcement obligations under the regulation.
Selective disclosure and market soundings
The regulation prohibits the unlawful disclosure of inside information other than in the normal exercise of an employment, a profession or duties. The cautious approach suggests that issuers and others should operate on the basis that developments or proposals that cannot yet be announced because they are still being assessed for possible insider information should be treated as insider information as soon as they arise and until the inside information is announced or ceases to exist.
It has long been the case that this prohibition (or its equivalent under the directive) is not breached when insiders disclose information to each other – the point being that all insiders are prohibited from trading so that the integrity of the market at large is not jeopardised by the disclosure. Hence, the practice has arisen of wall-crossing investors or potential investors or other counterparties before discussing a potential trade or other development; such investors or counterparties are thus locked out of trading unless and until the insider information either ceases to be such or is announced to the market.
The regulation has introduced a new formal safe harbour from the disclosure prohibition for market soundings. 'Market soundings' include the communication of information to one or more investors, before announcing a transaction, in order to gauge interest in a possible transaction and its conditions (eg, size or pricing). To fall within the market soundings safe harbour, the disclosing market participant for the transaction must comply with the requirements set out in the regulation. The 'disclosing market participant' may be the issuer, but can also be a secondary offeror of a financial instrument or a third party acting on behalf of or on account of the issuer or the secondary offeror (ie, an arranging bank). The disclosing market participant must have a written record of when it reaches the conclusion that the market sounding will involve the disclosure of inside information (and the reasons for that conclusion), and must update this record for each individual disclosure throughout the course of the market sounding.
Before disclosing any information, the disclosing market participant must:
- obtain the consent of the person receiving the market sounding;
- inform that person that he or she is prohibited from using the information in any manner prohibited by the regulation; and
- inform that person that he or she must keep the information confidential.
The disclosing market participant must maintain a written record of the information disclosed and the identity of the investors. The written record must also include the identities of the legal and natural persons acting on behalf of the investors who have received the information. Finally, when the information ceases to be inside information, the disclosing market participant must inform the recipient of the market sounding.
The delegated regulation in relation to market sounding(5) provides guidance on how the content of information communicated in the course of market soundings should be recorded. It also sets out the standard set of information that should be given by the disclosing market participant to persons receiving the market sounding and the information that should be given when information ceases to be inside information. Market sounding operations involving the issuer will either take place in an assessment period or a delay period for the purposes of the requirement for an insider list will apply, as discussed above.
For further information on this topic please contact Andrew Carey at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email ([email protected]). The Hogan Lovells International website can be accessed at www.hoganlovells.com.