Hong Kong SFC proposes new guidelines for market soundings

Hong Kong’s Securities and Futures Commission (SFC) has issued a consultation paper proposing draft new guidelines on market soundings. The new guidelines are aimed at clarifying regulatory expectations during market soundings and deterring substandard conduct which could impact the integrity of the market. They set out core principles on market integrity, governance, policies and procedures, information barrier controls, review and monitoring controls and authorised communication channels to be followed in conducting market soundings. The proposed guidelines set out specific requirements for both persons who disclose information (which extends beyond price-sensitive information to apply to non-public information) during a market sounding and those who receive it and so it is relevant to both buy-side and sell-side firms. In this bulletin we set out the key elements of the proposed guidelines.

The SFC had noted an increase in cases where there had been trading activities ahead of placings and block trades, indicating potential exploitation of information received during market soundings. This led to a thematic review of the market sounding practices of intermediaries in Hong Kong and the governance, supervision and controls adopted. This review revealed a divergence of practices across the industry suggesting the need for further regulatory guidance. The SFC notes that the proposed guidelines reflect existing practices adopted by most firms in respect of inside information shared during market soundings. However, it is extending the regulatory expectations to the communication of non-public information, which may not currently be treated in the same way under firms’ compliance policies across the industry.

In formulating the guidelines, the SFC has also looked to international comparisons from other major international financial centres which are considered in the consultation paper.

Scope and application of proposed guidelines

The proposed guidelines apply to market soundings, being the communication by a licensed or registered person of non-public information (irrespective of whether it is price-sensitive inside information) with potential investors prior to a securities transaction being announced either to gauge interest in the transaction or to assist in determining a potential transaction’s specifications such as its size or price.

In proposing that the guidelines should apply to all non-public information (and not be limited to only price sensitive inside information), the SFC notes in the consultation paper the difficulty in determining what constitutes inside information. The consultation paper refers to the 2022 decision of the Securities and Futures Appeal Tribunal (SFAT) relating to disciplinary action taken against a hedge fund manager following administrative proceedings against him in South Korea for dealing based on information obtained during a market sounding call. The SFAT determination focused on the substandard conduct of the regulated person which was found to have amounted to a breach of the Code of Conduct, and noted that, for this purpose, it was not necessary to establish that an offence had been committed under the Securities and Futures Ordinance. In light of this, the SFC is proposing that the guidelines apply to the broader non-public information.

The guidelines apply both to the person disclosing the information (generally a sell-side broker) (Disclosing Person) and to the person receiving the information (generally a buy-side firm being sounded out in relation to a possible securities transaction) (Recipient Person).

The draft guidelines make it clear that they will apply to a Disclosing Person where it carries out market soundings on behalf of a Market Sounding Beneficiary (being either an issuer or an existing shareholder selling in the secondary market) irrespective of whether the appointment has been formalised. Whether the Disclosing Person is acting on behalf of a Market Sounding Beneficiary will be determined on a case-by-case basis, depending on the level of certainty of the potential transaction materialising. This will be assessed by reference to various factors such as the extent to which the Market Sounding Beneficiary has expressed an interest with the Disclosing Person in proceeding with the transaction. Specifically, the guidelines do not apply to communications regarding speculative transactions or trade ideas which are put forward without consulting the Market Sounding Beneficiary or without any level of certainty that the transaction will materialise. Similarly, the guidelines will not apply to communications regarding day-to-day trade executions or public offerings.

Core principles

The proposed guidelines set out core principles that must be complied with in conducting market soundings. These cover:

• Market integrity – requiring confidentiality to be observed and restricting trading on the non-public information or otherwise using it until the information ceases to be non-public.
• Governance – requiring robust governance and oversight arrangements to be in place to ensure market soundings are subject to effective management supervision.
• Policies and procedures – requiring written (and periodically reviewed and updated) policies and procedures to be in place governing the conduct of market soundings.
• Information barrier controls – requiring both physical and electronic information barriers to be in place to avoid disclosure or misuse of any non-public information during market soundings.
• Review and monitoring controls – requiring implementation of effective procedures and controls to monitor and detect suspicious behaviours, misconduct, misuse of information or breach of internal guidelines.
• Authorised communication channels – requiring the sole use of recorded communication channels authorised by senior management or independent functions (such as legal and compliance) to conduct market soundings.

Requirements for Disclosing Persons

The guidelines also set out specific requirements for Disclosing Persons for each disclosure of non-public information during market soundings. These include:

• Pre-sounding procedures – requiring an assessment of the information to be disclosed to identify any that is non-public, obtaining the consent of the Market Sounding Beneficiary to the market sounding and advance determination of various aspects such as the standard set of information to be shared, the timing for market soundings and the suitable number of investors to be contacted.
• Standardised script – requiring a pre-approved standardised script to be used that is regularly reviewed by senior management or independent functions (such as legal and compliance). The proposed guidelines set out the minimum expected content for the script and the sequence of the information flow.
• Cleansing – requiring best endeavours assessments to be made to determine whether information has ceased to be non-public (eg following the transaction being announced or called off) and informing the recipient in writing of this.
• Record keeping – requiring records in relation to market soundings covering various specified compliance requirements to be kept for not less than seven years.

Requirements for Recipient Persons

The guidelines also prescribe specific requirements for Recipient Persons in respect of each receipt of non-public information during market soundings. These include:

• Handling of market sounding requests – requiring a Recipient Person to designate a properly trained, specified person to receive market soundings and to inform the Disclosing Person as to whether it wishes to receive market soundings (either generally or for particular transaction types).
• Record keeping – requiring record keeping, again for seven years, of specified compliance requirements relating to the market soundings.

Consultation timetable

The consultation is open for comment until 11 December 2023.