On 31 October 2023, the FCA published its Market Watch newsletter no. 75 ("MW75"), expressing concern about instances of possible market abuse it has come across when routinely reviewing trading, and communications and documentation that have been shared in connection with market soundings under MAR (i.e., the UK Market Abuse Regulation). Recipients of market soundings ("MSRs" - market sounding recipients) as well as those who instigate market soundings and communicate with MSRs ("DMPs" - disclosing market participants), are warned about the need to have in place necessary systems and processes to avoid any insider dealing or other market abuse in connection with market soundings.
UK MAR continues EU MAR's regime for providing a safe harbour for the disclosure of inside information made in the course of communications by an issuer or (say) a bank or broker acting on its behalf “prior to the announcement of a transaction, in order to gauge the interest of potential investors in a possible transaction and the conditions relating to it such as its potential size or pricing, to one or more potential investors”. Strict conditions attach to the way in which such communications may be conducted in order to benefit from the safe harbour, including standardised procedures and scripts for communications, the consent of MSRs to receiving any inside information, prohibitions on trading by the MSRs on the basis of what is communicated and records of all communications.
ESMA, somewhat controversially, took the view in its final September 2020 MAR Review Report that market sounding requirements are mandatory and not merely optional for those wishing to avail themselves of the safe harbour. The proposed EU Listing Act takes the contrary view and will clarify EU MAR to make it clear that the market sounding requirements are only mandatory if reliance is to be placed on the soundings safe harbour with respect to the disclosure of inside information.
In MW75 the FCA doesn't take a position on the mandatory or optional nature of the market sounding regime under UK MAR (and there are no current specific proposals in the UK to revise UK MAR in line the changes to be made to EU MAR). Instead it is more focused on steps that both DMPs and MSRs should take to avoid inadvertent disclosure of inside information and facilitation of potential insider trading, even before a full market sounding exercise gets underway and the safe harbour might be available to the DMP (but not, of course, to a MSR engaging in any insider trading after receiving information from the DMP).
What the FCA has seen happening and why it is concerned
The FCA has noticed from its review of post-market soundings tradings reviews that sometimes a MSR has traded in a security after it first received an approach from a DMP without the DMP having disclosed the identity of the security the subject of the intended market sounding. The rationales provided the MSR to the FCA for the trading “are not easily reconcilable with the circumstances of the trading”. As the FCA drily notes: “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.”
The concern is that despite not being provided with details of a particular security in the first contact by the DMP, the MSR was able to correctly identify the relevant security and then trade in it. Often this would happen when there was a delay between the DMP requesting the MSR's consent to receive the market sounding information and the MSR giving that consent.
This indicates to the FCA that the MSR may have other information available to it which enables it to identify the security. This position could be exacerbated where the security concerned is held by a small number of investors.
Trading in the security in these circumstances could breach MAR's prohibition on insider trading and the offence of insider dealing (for individuals) under Part V of the Criminal Justice Act 1993. The FCA points out that the safe harbour under the market sounding regime is only available to DMPs (with respect to disclosure of inside information) and not MSRs (including, of course, with respect to any insider trading). It also gives MSRs an unfair advantage in having the sort of information which, after they have consented to receiving the market sounding, they would be expressly precluded from trading with.
What the FCA wants to see happening in the future with market soundings
MW75 sets out a number of steps and precautions that the FCA says both DMPs and MSRs should consider taking to minimise the risks of unlawful activity being facilitated by these early market soundings communications. These include the following.
MSRs who have guessed which security the DMP is calling about must assess whether they hold any other information that, when connected to knowledge of the security, could constitute inside information. They should also consider having in place “gatekeeper” arrangements (see Market Watch 51 and 58) with identified staff in their compliance departments who will take the first call from the DMP.
DMPs may need to take greater care with the content of the scripts they use to initiate (and subsequently in) their market soundings. They need to be alert to the risk of inadvertent disclosure of inside information before the required consents to receiving have been given. They also need to recognise that their market sounding arrangements may need to be modified when speaking to private individuals who may have less awareness of possible breaches of the market abuse rules than corporate investors.
They should also consider whether all the information they are ready to share is really necessary to enable the MSR to decide whether to receive the market sounding and they should make it clear at the start of the call that it is about a possible market sounding, thereby allowing the MSR to decline to continue with the discussion.
Finally, both DMPs and MSRs are encouraged to minimise the time interval between the DMP's initial approach and the time by which the MSR must consent (or not) to receiving the market sounding and possible inside information.
MW75 repeats a number of observations previously made by the FCA in its Market Watch newsletters 51 and 58 linked to above and so is, in some sense, a deliberate reminder by the FCA of the seriousness with which it treats (and monitors) pre-deal discussions with investors. Issuers, their advisers and banks, etc., and investors need to take notice of this and, as necessary, review their existing market sounding procedures to ensure that they meet the standards and have the integrity that the FCA expects.
Market Watch 51 and 58
To conclude, as a reminder of what the FCA has previously said about market soundings and wall-crossings: Market Watch 51 discussed the advantages of adopting a “gatekeeper” approach with regards wall-crossings and stressed the need for firms to consider the “need to know principle” when determining which individuals need to be wall-crossed on a transaction.
Market Watch 58 - which is still provides valuable FCA guidance to MSRs (and DMPs) as to how they should handle receiving market soundings - went into more detail about this gatekeeper approach. While saying investors should retain flexibility over the type of internal organisation (gatekeeper function in compliance or otherwise) that best suits their business model, it nevertheless clearly recognised the benefits of the gatekeeper approach. As with MW75, it warned DMPs to take care only to disclose information necessary to establish whether the sounding approach will be accepted and, as noted above, said that “firms should take particular care when discussing markets that have few actors and where information could reasonably be used to identify the security in question.” It also highlighted how a declined wall-crossing could still convey inside information, particularly where “the sell-side making contact only initiates soundings for a small number of securities”. And finally, that record-keeping - especially of declined wall-crossings - could be improved, including with respect to the explanation given for declining a market sounding.