HK clamps down on market sounding

IFR Asia 1313 - 25 Nov 2023 - 01 Dec 2023
7 min read
Daniel Stanton

Hong Kong’s market regulator has proposed to regulate the way information is shared when arrangers prepare for transactions like block trades and debt offerings.

Banks typically sound investors ahead of the launch of block trades so that they can get a better idea of demand. Investors who agree to be sounded hear about a potential deal from an unnamed company, which requires them to agree not to trade stocks in that sector until after the deal is done.

Now, the Securities and Futures Commission is proposing to introduce guidelines on how market sounding is conducted.

“In the past years, the SFC has observed an increasing number of cases regarding trading activities ahead of placings and block trades, amongst others,” wrote the SFC in a consultation paper on October 11. “These cases appear to indicate that some intermediaries might have taken advantage of or unfairly exploited information received during market soundings to make unjustified profits whilst the same information was not generally available to the rest of the market.”

The SFC said that since there are currently no specific regulations regarding market soundings in Hong Kong it may be difficult for market participants to know how they are supposed to behave. It has proposed guidelines to define market sounding and ensure that market participants do not trade on information derived from it.

“Hong Kong is taking the lead in looking at market-sounding and we welcome that, but some of the guidelines might need to be refined to avoid unnecessary complexity,” said Kher Sheng Lee, co-head of Asia Pacific and deputy global head of government affairs at the Alternative Investment Management Association.

The proposed guidelines, which appear to cover both equities and bonds, define market sounding as “the communication of non-public information, irrespective of whether the information is price-sensitive inside information or not”, to gauge investor interest ahead of a potential transaction.

Bankers and the buyside feel this definition is too broad, as it implies that disclosing anything non-public, however minor, will require investors to be restricted from trading in relevant securities.

“Everything hinges on what non-public information means," said Patrick Pang, head of compliance and tax at the Asia Securities Industry and Financial Markets Association. "The industry bases itself around the concept of material non-public information. Market participants already err on the side of caution when determining what is MNPI and penalties for arriving at the wrong conclusion are significant.”

Pang said Asifma would be seeking clarity on whether the proposed guidelines could apply to jurisdictions outside Hong Kong, namely SFC-licensed people in Hong Kong dealing with overseas investors and/or securities listed outside Hong Kong; SFC-licensed people based outside Hong Kong; and non-SFC-licensed people outside Hong Kong dealing with Hong Kong-based investors and/or Hong Kong-listed securities.

The SFC has also suggested that banks conducting market sounding should follow a standard script to ensure they are compliant with the proposed guidelines.

“Having a rigid, standardised script for wall-crossing might be too restrictive,” said the AIMA's Lee. “The SFC needs to balance that with the practicality of how the market operates. The SFC should aim for guidelines that are both clear and flexible.”

The proposals do not cover pitching speculative trade ideas to clients or marketing public offerings.

Cumbersome and restrictive

However, it seems that the guidelines would cover most bond deals, since only retail bond offerings are technically public. Big issuers with MTN programmes often issue small private placements tailored to specific investor requirements, so each discussion necessitates talking about a potential deal that is not public knowledge. The frequency of these issues would make it extremely cumbersome and restrictive for issuers and potential investors to comply with the proposed guidelines.

One market participant pointed out that some non-public information would have little impact anyway. For instance, if a company with no public securities were to discuss a potential bond deal, investors could not use that information to trade anything. If investors learned of a new issuance from a large SSA issuer that comes to market many times a year, it would be unlikely to move the prices of its billions of dollars of existing debt, he said.

Syndicate bankers make multiple small judgements about what they deem to be non-public information, and fund managers make their own decisions about whether they want to be sounded, so “this is not the kind of thing that is really captured by blunt analysis on the compliance side”, said the market participant.

Sounding techniques vary from firm to firm, with some houses providing minimal details such as the jurisdiction of the issuer, the industry or its market turnover, while others might give more information. After wall-crossing an investor and asking them to sign a non-disclosure agreement, the firms can provide the name of the issuer.

Investors implement their own trading bans on certain securities based on the information they have been given. That means they might want to avoid calls from firms known to give too much information away in market-sounding calls.

One grey area is that investors and analysts may already know a company has a refinancing coming up, or that a lock-up on its shares is about to expire, based on public information. Receiving a call about an unnamed company in the same industry or jurisdiction might give an investor enough extra information to put the pieces together and identify it.

It is also unclear whether the SFC would be able to regulate an issuer that arranged a bond issue directly with an investor, without involving an arranger.

The proposals would require market participants on the buyside and sellside to keep audio, text or video recordings of soundings, as well as details of everyone who was sounded, for seven years. This is stricter than the European Union’s Market Abuse Regulation, for example, which does not require soundings to be made through recorded channels, though written records of face-to-face meetings must be kept, and only asks market participants to maintain records for five years.

Market participants have until December 11 to give their feedback, and the requirements are likely to come into effect in the second half of 2024.

There will be a grace period of six months to implement the new requirements, but the AIMA’s Lee said the industry might need more time to adapt.