The Securities and Futures Commission (SFC) has proposed requirements for market sounding that will affect both buy side and sell side market participants. The SFC consultation is available here. The deadline to submit responses to the consultation is 11 December 2023.
This article outlines the proposed requirements for buy side participants.
Overview of proposals
Market sounding refers to discussions with potential investors to gauge interest in a potential securities transaction and/or the terms of a potential securities transaction, such as its potential size, pricing, structure and selling method.
The SFC notes it has seen an increasing number of cases regarding trading activities ahead of placings and block trades that appear to the SFC to indicate some intermediaries may have taken advantage or unfairly exploited information received during market soundings to make unjustified profits. As a result of these cases, in 2022 the SFC conducted a thematic review of market sounding practices and controls adopted by intermediaries. The SFC now proposes to issue Guidelines for Market Soundings (Draft Guidelines) to provide clarity on its regulatory expectations.
Key feature – application to non-public information
The key feature of the proposals is that they apply to provision or receipt of non-public information, whether or not such information is price-sensitive inside information.
What is market sounding for regulatory purposes?
The Draft Guidelines define market sounding as:“the communication of non-public information, irrespective of whether this is price-sensitive inside information or not, with potential investors prior to the announcement of a securities transaction, to gauge their interest in a potential transaction or assist in determining the specifications related to a potential transaction, such as its potential size, pricing, structure and selling method […], by a licensed or registered person acting in the following capacity:(a) as a person disclosing information during the course of a market sounding (Disclosing Person) (eg, this is generally a sell-side broker acting on behalf of a client, an issuer or an existing shareholder selling in the secondary market (Market Sounding Beneficiary) in a possible securities transaction); or(b) as a person receiving information during the course of a market sounding (Recipient Person) (eg, this is generally a buy-side firm that is sounded out by a Disclosing Person as a potential investor in a possible securities transaction)
(collectively referred to as a “Market Sounding Intermediary”).”
There are carve-outs for certain types of communication. The following communications are not “market sounding” for the purposes of the Draft Guidelines:
(a) speculative transactions or trade ideas put forward by a Disclosing Person without consulting with the potential Market Sounding Beneficiary or without any level of certainty of such transactions materialising;
(b) transactions, in such size (e.g., in relation to average trading volume or market capitalisation), value, structure, or selling method, that are commensurate with ordinary day-to-day trade execution (e.g., a broker sourcing potential buyers or sellers to execute a trade after receiving an actual order instruction placed by a client with a genuine intent for execution); and
(c) public offerings of securities.
Obligations of all market participants
Under the Draft Guidelines, all market participants are required to:
(a) maintain confidentiality and not trade on or use any non-public information passed or received during market soundings for their own or others’ benefit or financial advantage until the information ceases to be non-public;
(b) implement robust governance and oversight arrangements in place to ensure effective management supervision over their market sounding activities;
(c) establish and maintain effective policies and procedures specifying the manner and expectations in which their market soundings should be conducted;
(d) implement adequate and effective physical and electronic information barrier controls to prevent the inappropriate disclosure, misuse and leakage of non-public information during the course of market soundings; and
(e) establish effective procedures and controls to monitor and detect suspicious behaviours, suspected misconduct, inappropriate or unauthorised disclosure or misuse of information and non-compliance with internal guidelines related to market soundings.
Additional obligations for buy side participants
Under the Draft Guidelines, a buy side participant will also be required to:
(a) designate a specified person(s) who is properly trained for that purpose to receive market soundings, and inform Disclosing Persons of such arrangement upon being contacted by Disclosing Persons for the purpose of market soundings;
(b) inform Disclosing Persons whether it wishes to, or not to, receive market soundings in relation to either all potential transactions or particular types of potential transactions from the Disclosing Persons;
(c) keep records of:(i) any notifications given to Disclosing Persons of its wish to or not to receive market soundings;(ii) audio, video or text recordings of market soundings received; and(iii) a list of all internal and external person(s) (including legal and natural persons) who possess non-public information as a result of the market sounding, including details on the date and time of sounding, name and contact details of persons sounded, and information and materials received.
When will the requirements come into effect?
The requirements are likely to come into effect in the 2nd half of 2024.
The consultation period ends on 11 December 2023. The SFC will then consider the consultation responses and issue the final form of the guidelines. The guidelines will be published in the Gazette and will become effective on such publication.
The SFC has proposed a six month transition period for market participants to revise their policies and procedures to comply with the guidelines.
What should buy side participants do now?
Buy side participants should:
1. Review the SFC consultation paper (available here);
2. Ensure key staff, such as relevant responsible officers and managers in charge, portfolio managers and compliance, are aware of the consultation and the proposed requirements;
3. Consider whether to make a submission on the Draft Guidelines to the SFC, either directly or through an industry body, on or before 11 December 2023;
4. Review their existing policies and procedures for market soundings against the Draft Guidelines to identify potential areas for enhancement; and
5. Develop a plan to implement necessary enhancements.