Market soundings are a useful tool for determining interest in potential upcoming primary transactions, aiding price discovery without sensitive information being shared. Crucially they also give investors, such as asset managers, a chance to influence the structure and price of the offering. As such they play an important role in the smooth functioning of a part of the financial markets.

In Market Watch 75 the UK FCA has neatly summarized the requirements for issuers acting as Disclosing Market Participants (DMPs) under the UK MAR market soundings regime. These include:

• assessing and recording whether a market sounding will involve disclosing inside information;
• producing standardized procedures and scripts for communications with Market Sounding Recipients (MSRs) during market soundings;
• getting MSRs’ consent to receive a market sounding and inside information;
• informing MSRs that they are prohibited from using the information to trade or attempt to trade relevant instruments;
• making and maintaining a record of all the communications with, and all the information given to, MSRs.

It is also drawing attention to the obligations of the MSRs who receive market soundings as set out in ESMA Market Sounding Guidelines. These include:

• independently assessing whether they possess inside information, taking into account both the DMP’s assessment and other information available to the MSR;
• recording the market soundings they receive and their inside information assessments;
• arrangements to receive, manage and control the internal flow of inside information on a ‘need to know’ basis.

The FCA is specifically concerned about trading by MSRs occurring after initial contact between them and DMPs in the context of a market sounding.

While no inside information is usually shared at this stage, the FCA believes that some MSRs are able to identify the financial instruments in question on the basis of other information that was available to them, and potentially trade to their advantage on this basis. 

According to the FCA’s observations this scenario arises most frequently in instances where there is a delay in an MSR consenting to the receipt of inside information from the DMP and that “[i]n these instances, the MSRs have provided rationales that are not easily reconcilable with the circumstances of the trading”.

The FCA emphasizes that the market soundings regime will not protect those who trade on any inside information derived from market soundings. And here the reference to the ESMA guidelines is crucial because of the requirement for MSRs to consider “other information” that is available to them in assessing whether they possess inside information. The FCA recommends that MSRs consider putting in place gatekeeper arrangements, including preferably designating compliance staff as a first point of contact for DMPs. Adequate training concentrating on the market abuse rules should also be offered to all staff who receive and process market soundings.

The FCA also suggests that DMPs should adopt the following market sounding practices:

• Pay particular care when few actors are involved.
• Consider potential external information held by MSRs that would help identify the financial instrument.
• Assess scripts being used at all stages of the sounding.
• In initial communications with MSRs;
  • assess the risk of disclosing inside information;
  • consider carefully the information being provided;
  • tailor the information being provided;
  • apply an extra level of care to situations in which an MSR is a private individual;
  • make clear at the start that the communication is a market sounding.

Both DMPs and MSRs are urged to minimise the time between initial contact and consent to a request for market sounding because this will help “minimise the risk of insider dealing”.

Finally the FCA is reminding firms of their recordkeeping obligations in connection with market soundings. As indicated in Market Watch 58 “[g]ood record-keeping is key to gaining protection under the market soundings regime.” Comprehensive recordkeeping of both documents, trades and communications is essential for all firms engaging in market sounding, particularly given the potential elevated threat of regulatory intervention.

GRIP comment

This is a warning shot by the regulator aimed at firms engaged in market soundings. It identifies a specific scenario in which the FCA believes insider trading may be happening – namely the time between initial contact between the parties and the market sounding itself being agreed on – and makes very clear what the obligations and best practices are in order to avoid falling foul of the rules. For those who wish to minimize the risk of a potential regulatory action against them, ensuring adequate recordkeeping is an essential part of this belt-and-braces approach.