Soundings out: Hong Kong's new regime on market soundings

Following significant engagement with the industry, the Securities and Futures Commission (SFC) has finalised Hong Kong's brand new market soundings regime, by publishing its eagerly anticipated Guidelines for Market Soundings (Guidelines) as well as its Consultation Conclusions (Consultation Conclusions). The SFC has also published a set of frequently asked questions (FAQs) to facilitate intermediaries' compliance with the new requirements.

We have been leading the AIMA Working Group in relation to market soundings, and have been heavily involved in the industry engagement with the SFC. Our team is therefore well placed to advise on the impact of the new Guidelines on existing operations and to facilitate the necessary enhancements of intermediaries' systems, policies and procedures. Please reach out to us or your usual HSF contacts for further information.

In this briefing, we summarise the new regime as well the implications for firms.

Timing

The new regime will take effect on 2 May 2025, after a 6-month transitional period.

After the Guidelines come into effect, intermediaries that have not completed the corresponding enhancements to their systems, policies and procedures should put in place interim measures to meet the objectives of the Guidelines.

What should firms do

Intermediaries that are required to comply with the Guidelines should review their systems, policies and procedures, including:

• reviewing their processes for disclosing and/or receiving information during market soundings, including when, from whom, and to whom information is exchanged;
• analysing the categories of information disclosed and/or received during pre-sounding and market soundings, and identifying potential market sounding information disclosed and/or received; and
• ascertaining how their current systems, policies and procedures should be updated or enhanced.

The consultation process

The SFC launched a public consultation with the proposed guidelines for market soundings in October 2023 (see our previous briefing) and received 27 written submissions. Before publishing its consultation conclusions, the SFC held further discussions with various industry stakeholders earlier this year. Although most respondents supported the objectives of the proposed guidelines in principle, the majority of the respondents disagreed with the proposed application of the guidelines to the communication of "non-public information" during market soundings, including trade restrictions. In view of this, and to better reflect the SFC's policy intent, the SFC has refined the Guidelines to apply to "Market Sounding Information" – further detail is set out below.

Scope of the application of the new Guidelines

The application of the Guidelines has been restricted to:

1. the disclosure and receipt of "Market Sounding Information" (MSI), which is:
   1. confidential information;
   2. entrusted to a licensed or registered person by a client, an issuer or an existing shareholder selling or buying in the secondary market (Market Sounding Beneficiary); and
   3. is disclosed or received during a market sounding;
2. in connection with a possible transaction in:
   1. shares that are listed on an exchange; and
   2. any other securities which is likely to materially affect the price of shares that are listed on an exchange.

The SFC will continue its supervision of intermediaries' trading activities and will keep in view the need for the Guidelines to cover more transactions in the future.

The Guidelines also contain the following definitions:

• Market sounding: "[T]he communication of information with potential investors, prior to the announcement (if any) of a transaction, to gauge their interest in a possible transaction and assist in determining the terms and specifications related to it, such as its potential timing, size, pricing, structure and trading method". The SFC has also clarified that market soundings are typically conducted in connection with capital market transactions, such as private placements and "block trades" (see paragraph 1.3 and footnote 2 in the Guidelines).
• Disclosing Person: Licensed or registered person who discloses MSI during the course of a market sounding (paragraph 1.4(b)(i) of the Guidelines).
• Recipient Person: Licensed or registered person who receives MSI during the course of a market sounding (paragraph 1.4(b)(ii) of the Guidelines).
• Market Sounding Intermediary: A Disclosing Person or a Recipient Person (paragraph 1.4 of the Guidelines).

In order to determine whether an intermediary is in possession of MSI, the SFC takes the view that intermediaries should rely on well-established principles around confidentiality and refer to their existing policies and procedures. The SFC gave some examples of MSI (where a duty of confidentiality is established):

• name of the subject security (or specific information that would allow the name of the subject security to be deduced);
• identity of the Market Sounding Beneficiary;
• the Market Sounding Beneficiary's intent to pursue a possible transaction; or
• the terms of or specifications related to the possible transaction such as its potential timing, size, pricing, structure and trading method (see Note 2 of paragraph 1.4. of the Guidelines and FAQ 1).

The SFC confirmed that routine conversations between intermediaries and investors which are not associated with market soundings are not in scope, for example:

• generic discussions about public information, market trends and sentiments, or other anecdotal or unverified information, such as rumours;
• sharing of speculative trade ideas and market sentiments;
• trade ideas put forward by a sell-side broker or reverse enquiries from a buy-side firm or investor without any indication from a Market Sounding Beneficiary to engage potential investors for feedback on a potential transaction, such as acknowledgement, consent, confirmation or mandate from the Market Sounding Beneficiary; and
• communications in relation to an intermediary's efforts in sourcing potential buyers or sellers to match and execute a trade after receiving an actual order instruction placed by a client with an intent for execution (see paragraphs 35 and 41 of the Consultation Conclusions and FAQ 2).

The SFC also indicated that Market Sounding Intermediaries should apply:

• the duty of confidentiality test for market soundings involving transactions in shares that are listed on an exchange; and
• the price sensitivity test for market soundings involving transactions in other securities, such as DCM transactions (paragraph 49 of the Consultation Conclusions).

The SFC also clarified that the Guidelines are aimed at addressing regulatory issues that are unrelated to the insider dealing laws under the SFO.

Overseas market sounding activities

The Guidelines apply to licensed or registered persons who conduct market sounding activities in Hong Kong. The FAQs reminds intermediaries that an SFC licence permits holders to carry on business in regulated activities or perform regulated function in relation to regulated activities carried on as a business, in Hong Kong, and the SFO does not confer upon licensed or registered corporations or individuals the ability to carry on a business in regulated activities outside Hong Kong after being licensed.

The SFC expects the intermediary to be responsible for compliance with the Guidelines where the market sounding activity is conducted by an overseas affiliate or group company for or on behalf of or as delegated by an intermediary (FAQ 5).

Core principles

The Guidelines include four Core Principles:

1. CP1: Handling of information

• In order to protect MSI and safeguard its confidentiality, Market Sounding Intermediaries should ensure there is an effective system of functional barriers to prevent inappropriate disclosure, misuse and leakage of MSI.

2. CP2: Governance

• Market Sounding Intermediaries should have robust governance and oversight arrangements in place to ensure effective management supervision over its market sounding activities.

3. CP3: Policies and procedures

• Market Sounding Intermediaries should establish and maintain effective written policies and procedures specifying the manner and expectations in which its market soundings should be conducted.

4. CP4: Review and monitoring controls

• Market Sounding Intermediaries should establish effective procedures and controls to monitor and detect suspicious behaviours, suspected misconduct, inappropriate or unauthorised disclosure, misuse or leakage of MSI, and non-compliance with internal guidelines related to market soundings.

The Guidelines should be read in conjunction with, among other provisions:

• Code of Conduct for Persons Licensed by or Registered with the SFC
  • General Principle 1 (Honesty and fairness)
  • General Principle 2 (Diligence)
  • General Principle 6 (Conflict of interest)
  • Paragraph 9.3 (Front-running)
• Fund Manager Code of Conduct
  • Paragraph 1.3 (Functional barriers)

Requirements on Disclosing Persons

Disclosing Persons will be required to:

• adopt specific procedures before conducting market soundings, including determining a standard set of MSI to be disclosed in advance;
• use authorised communication channels, such as a recorded line, to conduct market sounding conversations;
• use a pre-approved standardised script which contains, at a minimum, certain information, such as the fact that the communication is for the purpose of a market sounding, to confirm that the individual receiving the information is authorised to receive market soundings, and a request for consent from the Recipient Person to receive the MSI, safeguard its confidentiality and prevent inappropriate disclosure, misuse or leakage of such information;
• retain market sounding records for a period of not less than 2 years (reduced from the proposed 7 years).

A Disclosing Person should not proceed with the market sounding if relevant consent is not obtained.

A Disclosing Person should ensure that any preliminary information provided prior to receiving consent from the Recipient Person (eg, preliminary information to allow them to assess and determine if they wish to provide such consent) is:

• on a "no-name" basis so as not to reveal the name of the subject security; and
• sufficiently broad, limited, vague and anonymised to ensure that a reasonable Recipient Person would not be able to deduce the name of the subject security.

Care should be taken in determining the amount of information to be provided where the subject security may be identified even with the provision of only limited information (eg, for narrow industry sectors).

In general, a Disclosing Person should only provide specific MSI regarding the subject security (eg, market capitalisation, market volumes, market prices) after receiving the said consent from the Recipient Person.

Requirements on Recipient Persons

Recipient Persons are required to authorise a person who has adequate knowledge of its internal policies on the receipt and handling of market soundings.

Recipient Persons should inform the Disclosing Persons about:

• the individual who is authorised to receive MSI upon being contacted by Disclosing Persons for the purpose of market soundings; and
• whether it wishes to, or not to, receive market soundings in relation to either all possible transactions or particular types of possible transactions from the Disclosing Persons.

In circumstances where a Disclosing Person does not specify whether the communication is a market sounding, the Recipient Person should use its reasonable effort to verify whether it is in possession of MSI, including making further enquiries with the Disclosing Person to confirm:

• whether they are conducting a market sounding; and
• whether the information to be shared involves MSI (see FAQ 11).

Cleansing

The SFC has also removed the proposed requirement for cleansing in the Guidelines. In determining whether a Market Sounding Intermediary is still subject to the requirement to protect MSI, the SFC takes the view that it should consider, on a case-by-case basis, whether it continues to have a duty of confidentiality, trust or care towards the handling of the information.

The SFC referred to some current best practices to determine when MSI ceases to be confidential:

1. Disclosing Persons notifying Recipient Persons when there is a change of status of the proposed transaction (eg, where the transaction has been completed, suspended, postponed or cancelled);
2. Disclosing Persons give advance notice that Recipient Persons could consider MSI as "stale" if they do not receive any status update from them within a set period of time; and
3. Disclosing Persons and Recipient Persons agree upfront among themselves on when the duty of confidentiality will end (see paragraph 113 of the Consultation Conclusions and FAQ 8).