The Financial Conduct Authority (FCA) published 'Market Watch 75' on 31 October 2023, in which the FCA shared its observations about market soundings since the publication of Market Watch 51 and Market Watch 58. The FCA’s concerns relate to cases of trading by Market Sounding Recipients ("MSRs") during the period after Disclosing Market Participants ("DMPs") initially seek consent of the MSRs to receive the sounding, but before the DMPs disclose the inside information.
Market soundings are interactions between issuing companies and investors to help gauge the interest of potential investors in a transaction to help set their price, size and structure. By their nature, market soundings can involve the communication of inside information.
The UK Market Abuse Regulation ("UK MAR") provides formalised arrangements for issuing companies and their advisers acting as DMPs, to legitimately disclose inside information where the disclosure is made in the normal exercise of a person's employment, profession or duties (the so-called 'safe harbour), including standardised arrangement and information requirements to ensure that no potentially sensitive information is unnecessarily disclosed. The FCA has set out the requirements that DMPs must follow for inside information to be deemed to be 'legitimately disclosed' under the market sounding regime, which include:-
- DMPs should assess and document whether the information to be disclosed contains inside information;
- DMPs should produce and adhere to standardised procedures and scripts for communications with MSRs during market soundings;
- DMPs should get MSRs' consent to receive a market sounding and inside information;
- MSRs should be informed that they are prohibited from using the information to trade or attempt to trade relevant instruments
- DMPs should make and document all communications with, and all information given to, MSRs.
Under UK MAR, MSRs must also independently assess if they possess inside information from the market sounding which would prohibit them from trading – and such assessment should include any other information the MSR has. This might include the MSR being able to identify the issuing company if it e.g. holds a very small number of investments in its portfolio.
FCA's recent observations
The FCA says that it has observed cases where MSRs have traded in relevant financial instruments during the period after the initial communication from a DMP or the DMP has sought the MSR's consent to receive the market sounding and inside information, but before the DMP has disclosed the inside information. The DMPs may not, during the initial communication, have disclosed the identities of the financial instruments or the nature of the proposed transaction and the likelihood of it taking place However, MSRs were still able to identify those details using other information available to them. In such circumstances, the MSRs could have an unfair advantage that is similar to that after the consent process. Frequently, this has occurred where there has been a delay between DMPs requesting the MSR's consent and the MSRs giving it.
The FCA go on to state that the rationale provided by the MSRs to explain the trading in these instances was not easily reconcilable with the circumstances of the trading. As an example, an MSR selling a financial instrument immediately after a DMP had 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.
Minimising risks of insider dealing and unlawful disclosure
The FCA has provided some safeguards that DMPs and MSRs may want to implement to mitigate these risks of insider dealing and unlawful disclosure:-
- DMPs should be particularly careful when making soundings on financial instruments that have a few actors and where potential external information held by the MSRs could reasonably be used to identify the relevant financial instrument - and this might include assessing the scripts that the DMPs use at all stages of the sounding.
- DMPs should consider whether the information provided to MSRs when seeking their consent to receiving a market sounding is essential for MSRs to decide if they wish to receive the information.
- DMPs 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 make clear at the start of any market sounding that the communication is a market sounding so as to give the MSR the opportunity to decline.
- MSRs should consider putting in place 'gatekeeper' arrangements including the appointment of specific teams or staff in Compliance as the nominated first point of contact for DMPs.
- MSRs should ensure that staff who receive market soundings are properly trained in relevant internal procedures and UK MAR prohibitions on unlawful use of inside information.
- DMPs and MSRs should keep the period between the DMP's initial communications and requests for consent, and the MSRs consent to such requests to a minimum.
In light of the serious consequences of falling foul of the procedures market participants should take the opportunity to fully evaluate their market sounding procedures. DMPs should take particular care in respect of financial instruments that are thinly traded and where potential external information held by MSRs could reasonably be used to identify the relevant financial instrument.