On 31 October 2023, the Financial Conduct Authority (FCA) issued Market Watch 75, in which it raised concerns over possible abuses of the market sounding process. 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 in brief
A market sounding is the communication of information, prior to the announcement of a transaction, in order for issuers to gauge the interest of potential investors in a possible transaction and the conditions relating to it such as its potential size or pricing. By their nature, market soundings can involve the communication of inside information (though this is not always the case, as explained in the Practical Law feature article “Market soundings: to MAR or not to MAR” (February 2023), co-authored by Doug Smith of Freshfields, which looks at how market participants have approached market soundings where no inside information is disclosed).
The UK Market Abuse Regulation (UK MAR) provides a safe harbour for the disclosure of inside information in the context of market soundings as long as robust procedures are followed by DMPs to prevent MSRs from inappropriately using that information. Before contacting an MSR, DMPs must assess and document whether the information to be disclosed contains inside information. If inside information will be disclosed, DMPs are required to follow standardised procedures and scripts for communications with MSRs during market soundings. MSRs are also required to independently assess whether they receive inside information from the market sounding, including when combined with any other information that they hold.
The FCA’s observations
The FCA says it has observed cases where MSRs have traded in relevant financial instruments (i.e. financial instruments within the scope of UK MAR) after the initial communication from a DMP requesting the MSR’s consent to receive a market sounding but before the DMP has disclosed any further information. Although DMPs may not have specifically disclosed the details of the financial instruments when initially requesting the MSR’s consent to receive the sounding, MSRs might have other information available to them that allows them to identify, with reasonable confidence, the financial instruments referred to by the DMPs. Frequently, this has occurred where there has been a delay between DMPs requesting the MSR’s consent and the MSRs giving it. In such cases, the MSRs could have an unfair advantage similar to the position they will be in after the consent process.
According to the FCA, the rationale provided by the MSR to explain the trading in these cases was not easily reconcilable with the circumstances of the trading. For 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 (likely at a discount), would not be easily reconcilable with rebalancing a portfolio, nor would this rationale reconcile easily with instructions to trade being phrased with urgency.
FCA guidance to market participants
The FCA reminds MSRs of their obligation under UK MAR to assess whether they possess inside information before trading. This includes situations where the MSR has not yet received inside information from a DMP but has other information that enables them to determine the identity of a financial instrument that is the subject of a market sounding. As the FCA points out, the market sounding regime only provides protections against the unlawful disclosure of inside information by the DMP and does not provide protections against MSRs trading on any inside information from market soundings: MSRs who have identified a security before agreeing to receive inside information should assess whether they possess inside information before trading.
In order to reduce the risk of insider dealing, the FCA recommends that DMPs and MSRs minimise time intervals between the DMP’s initial communications and requests for consent, and the MSRs consenting to such requests.
The FCA also offers the following specific guidance to DMPs and MSRs, respectively:
- 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 should tailor the information they plan to give, depending on the nature of the transaction, so that they do not inadvertently disclose inside information.
- DMPs should consider following specific arrangements and scripts where the MSR is a private individual who may be less aware of possible breaches than 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 put in place “gatekeeper” arrangements such as appointing specific teams or staff in Compliance as the first point of contact for potential market soundings.
- MSRs should 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.
In light of the FCA’s warning, market participants should carry out a comprehensive evaluation of their market sounding procedures, not least because of the serious consequences for firms and individuals that do not get it right. 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.