On 31 October 2023, the Financial Conduct Authority (FCA) published Market Watch No. 75, sharing some observations about the market soundings procedure under the UK Market Abuse Regulation (UK MAR), and a reminder to market sounding recipients (MSRs) to independently assess whether they have inside information, even if the disclosing market participant (DMP) has not disclosed any inside information.
The market soundings regime is a well-established procedure, allowing issuers to disclose inside information to selected investors to determine interest in a transaction before it is announced. The regime acts as safe harbour to the offence of unlawful disclosure of inside information under UK MAR, provided standardised arrangements and information requirements are followed.
For the DMP, these include assessing and recording whether the market sounding will disclose inside information, producing standardised scripts for communications with MSRs, getting MSRs’ consent to receive a market sounding, informing MSRs that they are prohibited from using the information to trade, and making a record of all communications with MSRs.
Importantly, the FCA reminds MSRs that they must independently determine whether they possess inside information from the market sounding that would prohibit them from trading, as there may be information which the MSR possesses which causes it to have inside information about the issuer. This is particularly the case during the period between when the DMP initially seeks the consent of the MSR to receive the sounding but before the DMP has disclosed the inside information (Initial Sounding Period).
The FCA highlights that there is a risk of MSRs being able to identify the issuer during the Initial Sounding Period, even though the DMP did not disclose their identity. For example, this could occur where (i) the issuer has previously held regular and similarly-sized funding rounds executed by the same advisory firms; or (ii) the MSR holds a limited number of investments in its portfolio.
The FCA has observed recent cases where MSRs have traded during the Initial Sounding Period and the rationales provided 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.
In these circumstances, MSRs could have an unfair advantage that is similar to receiving inside information after the consent process. Therefore, if MSRs can identify the issuer during the Initial Sounding Period, they should assess whether they possess inside information before trading. Otherwise, MSRs risk committing insider dealing under both UK MAR and Part V of the Criminal Justice Act 1993.
The FCA has provided the following recommendations for DMPs and MSRs to reduce the risk of insider dealing and unlawful disclosure:
- Particular care should be taken when making market soundings to MSRs where the issuer has few investors and where potential external information the MSRs hold could reasonably be used to identify the issuer (i.e., by tailoring the script and reviewing it at all stages of the market sounding).
- DMPs should carefully assess the information they share with MSRs, and both DMPs and MSRs should consider minimising the time interval between the DMP’s initial communication and request for consent and the MSRs consenting to the request.
- DMPs should also consider whether MSRs are corporate clients or private individuals, the latter may not have an awareness of the potential breaches and may need additional arrangements and commentary with their scripts.
- MSRs should consider appointing a “gatekeeper” as the first point of contact with DMPs (i.e., a compliance team) as highlighted in Market Watch 51 and 58. Staff members receiving this information should be properly trained in relevant internal procedures and aware of UK MAR prohibitions on the use of inside information.
In a final warning shot, the FCA reminds firms and employees of the breadth of information the FCA can request when reviewing trades, communications and documentation relating to market soundings, and its ability to intervene when it suspects behaviour detrimental to the UK markets.
Although the FCA did not cover this in its latest Market Watch, if a DMP declines a market sounding, then we would expect the MSR to still have to independently assess whether it has inside information, for the same reasons above.
This latest Market Watch is a reminder for market participants, both DMPs and MSRs, to review their market sounding procedures to ensure they are robust and appropriate safeguards are in place.