Clifford Chance

The Securities and Futures Commission ("SFC") gazetted the Guidelines for Market Soundings ("Guidelines") on 1 November 2024, with them set to come into effect six months later on 2 May 2025. Intermediaries should have completed the requisite enhancements to their systems, policies, and procedures, or to have implemented interim measures, to meet the objectives of the Guidelines upon their commencement.

On 11 October 2023, having observed an increasing number of cases regarding trading activities ahead of placings and block trades (amongst others) taking advantage of or unfairly exploiting information received during market soundings^[1], the SFC issued a Consultation Paper on the Proposed Guidelines for Market Soundings ("Consultation").

"Market sounding", as defined in the Guidelines, refers to the 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. In practical terms, this typically involves the circumstances of a sell-side broker, acting as an intermediary for its (potential) clients, reaching out to buy-side firms to gauge their interest in a possible private placement or block trade.

The SFC's policy intent of the Guidelines is to deter substandard conduct by providing clarity on regulatory expectations, ensure a level playing field for the industry and assist intermediaries in upholding market integrity in compliance with the Code of Conduct for Persons Licensed by or Registered with the SFC during market soundings.

A total of 27 respondents, including Clifford Chance, submitted their views to the SFC regarding the Consultation.

The SFC published the conclusions of the Consultation on 31 October 2024 along with FAQs for Market Soundings to provide practice guidance and examples. The Guidelines were gazetted on 1 November 2024.

SCOPE OF APPLICATION OF THE GUIDELINES

The SFC clarifies that the Guidelines align with the SFC's existing regulatory requirements associated with functional barriers and protection of confidential information. The Guidelines apply to confidential information that is entrusted to a licensed or registered person (a disclosing intermediary, referred to as "Disclosing Person" in the Guidelines) by a client, an issuer or an existing shareholder selling or buying in the secondary market (a market-sounding beneficiary) during the course of a market sounding. Such confidential information is defined as Market Sounding Information ("MSI") in the Guidelines.

• Scope of MSI. The scope of such MSI is broad and general, encompassing notably the following aspects: 
  
  * Meaning of "entrusted". This would depend on whether the disclosing intermediary has a "duty of confidentiality" to the market-sounding beneficiary. The disclosing intermediary should also refer to its existing policies and procedures and well-established principles around confidentiality to determine if it is in possession of MSI.
  
  * Examples of MSI (non-exhaustive). This includes the name of the subject security (or specific information that would allow the name of the subject security to be deduced), the market-sounding beneficiary's identity, its intent to pursue a possible transaction, and the terms of or specifications related to the possible transaction such as its potential timing, size, pricing, structure and trading method.
  
  Any preliminary information provided by a disclosing intermediary prior to the receipt of consent to receive MSI during the course of a market sounding should be (i) on a "no-name" basis so as not to reveal the name of the subject security; and (ii) sufficiently broad, limited, vague and anonymised to ensure that a reasonable recipient would not be able to deduce the name of the subject security (see Note 2 of paragraph 3.3(b) of the Guidelines).

• Scope of securities. Considering the distinctive characteristics of debt capital market and private equity transactions, the Guidelines apply exclusively to a possible transaction in (i) shares that are listed on an exchange (irrespective of the listing venue of the securities in question); and (ii) any other securities which is likely to materially affect the price of shares that are listed on an exchange (in other words, a price-sensitivity test is included for securities other than shares). Moreover, the SFC has removed the carve-outs regarding the three types of exempted transactions initially contemplated in the draft Guidelines during the Consultation.

• Relationship with insider trading regime. We consider in our written submissions that the ambit of "non-public information" in market soundings, as envisaged in the initial draft Guidelines proposed during the Consultation, may effectively expand the scope of the existing laws and regulations that apply to insider dealing and disclosure of inside information. In this regard, the SFC clarifies that the Guidelines are aimed at addressing regulatory issues that are unrelated to the insider dealing laws under the Securities and Futures Ordinance (Cap. 571) ("SFO"). Notably, the SFC also clarifies that the SFAT Determination was not one of the main drivers behind the Guidelines as some respondents presumed. The compliance with the Guidelines is no substitution or defence to one's obligation to comply with the relevant laws and regulations concerning insider dealing (see Paragraph 1.9 of the Guidelines).

• Cross-border aspects of the Guidelines. Regarding the matters of regulatory arbitrage and potential confusion when Hong Kong intermediaries are dealing with overseas counterparts that may adopt a different approach to market soundings, the SFC takes the view that the Guidelines align with the general regulatory principles adopted by other major jurisdictions around protection of confidential information. Intermediaries licensed by the SFC are held to a higher standard of conduct compared to unlicensed persons. The SFC believes that the regulatory principles articulated in the Guidelines are well-established. It is expected that most intermediaries already have existing policies and procedures in place around subject matters such as prevention of misuse or leakage of confidential information, staff personal dealing policies, proprietary trading rules, and prevention of front-running, etc.
  

KEY REQUIREMENTS OF THE GUIDELINES

Both disclosing intermediaries and recipient intermediaries

• Handling of information. The SFC has removed the trading restrictions regarding the non-public information that is passed or received during market soundings. Instead, the Guidelines have been refined to require an intermediary to (i) protect MSI and safeguard its confidentiality; and (ii) ensure that there is an effective system of functional barriers to prevent inappropriate disclosure, misuse and leakage of MSI.
  
  We note that the term "misuse" in the Guidelines appears similar to the wording in sections 270(1)(c) and 291(3) of the SFO (i.e. "make use of the information"), referring to the liability of a "tippee" in insider dealing. In this regard, Question 7 of the FAQs clarifies that the Guidelines are not intended to restrict an intermediary's legitimate trading activities. By restricting MSI only to authorised personnel on a "need-to-know" basis, other personnel of the firm (e.g., other staff from trading and investment management functions) may continue to trade on the subject security so long as they are not in possession of the MSI.

• Governance. Intermediaries should have robust governance and oversight arrangements in place to ensure effective management supervision over its market sounding activities.
  
  The SFC clarifies that the committee or person(s) designated to monitor market soundings by an intermediary should have adequate knowledge of its internal policies and procedures governing market soundings. Such committee or person(s) are not required to be sufficiently independent from the "front office", as the SFC recognises that there might be instances where front-office personnel are best placed to monitor market soundings.

• Policies and procedures. Intermediaries should establish and maintain effective policies and procedures specifying the manner and expectations in which its market soundings should be conducted, including the identification and handling of MSI. These should be documented in writing, reviewed periodically and updated.
  
  Notably, intermediaries should establish and maintain firm and staff personal dealing policies and restrictions to prevent the firm and its staff from inappropriate disclosure, misuses and leakage of MSI for their own or other's benefit or financial advantage (see paragraph (c) of Core Principle 3 (Policies and procedures)).

• Review and monitoring controls. 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 relevant internal guidelines.

Disclosing intermediaries

• Procedures before conducting market soundings, standardised script and authorised channels. The Guidelines also set out specific requirements for disclosing intermediaries when conducting market sounding activities. These include: (a) obtaining advanced agreement or consent from the corresponding market-sounding beneficiary to engage in market soundings regarding the possible transaction, and determining in advance the standard set of information to be disclosed, a suitable number of potential recipients to contact and appropriate timing to conduct market soundings; and (b) using only communication channels authorised by and a standardised script pre-approved and regularly reviewed by senior management or independent functions, such as Legal and Compliance, to conduct market soundings. There is no express requirement for the scripts used to be consistent across a syndicate for a transaction.
  
  The requirement to only use authorised communication channels in market soundings does not apply to recipient intermediaries (which are receiving MSI).

• Record keeping. The record-keeping requirement has been significantly streamlined as compared to the initial draft Guidelines proposed during the Consultation. Recipient intermediaries are not required to keep records pertaining to market soundings, as the requirement will rest with disclosing intermediaries. The retention period for records has been reduced to two years. However, the scope of the records to be retained is extensive, encompassing essentially all communications between the relevant parties during the conduct of market soundings.

Recipient intermediaries

• Handling of market sounding request. A recipient intermediary should authorise a person who has adequate knowledge of its internal policies on the receipt and handling of market soundings and inform disclosing intermediaries of such arrangement upon being contacts for marketing soundings, and whether or not it wishes to receive market soundings. In circumstances where a disclosing intermediary does not specify whether the communication is a market sounding, the recipient intermediary should use its reasonable effort to verify whether it is in possession of MSI (see paragraph 4.1(c) of the Guidelines). It appears that such requirement only covers the situations where the disclosing intermediary is a licensed or registered person by the SFC (based on the literal definition of "Disclosing Persons" in the Guidelines).
  
  Such reasonable efforts to verify include further enquiries with the disclosing intermediaries to confirm whether they are conducting a market sounding and whether the information to be shared by them involves MSI (see Question 11 of the FAQs).

WHEN WILL MSI CEASE TO BE CONFIDENTIAL

A "cleansing" requirement was initially included in the draft Guidelines during the Consultation but has been removed in the final version. The term "cleansing" is commonly understood by market participants to be associated with inside information, which is cleansed when it no longer constitutes inside information (for instance, through public announcement or disclosure, or when it is no longer materially price-sensitive). In our written submissions, we highlighted the practical difficulties of applying the Guidelines to scenarios involving potential transactions that did not materialise, where the non-public information might never be disclosed publicly.

The SFC does not consider it necessary to prescribe the requirements for determining when MSI ceases to be confidential in the Guidelines, in order to provide flexibility. The SFC recognises that the current best practices include (i) disclosing intermediaries notifying the recipient intermediaries when there is a change of status of the proposed transaction; (ii) disclosing intermediaries giving advance notice that recipient intermediaries could consider the MSI as "stale" if they do not receive any status update from them within a period of time; and (iii) disclosing intermediaries and recipient intermediaries agreeing upfront among themselves on when the duty of confidentiality will end. Practical guidance on this matter can be found in Question 8 of the FAQs.

CONCLUSIONS

MSI, as widely defined in the Guidelines, encompasses essentially any confidential information entrusted to a sell-side broker during the course of market soundings. With the implementation of these Guidelines, it is imperative that sell-side brokers and buy-side firms ensure adherence by establishing appropriate policies, procedures and practices, by adapting the existing norms regarding inside information or otherwise, in order to protect the confidentiality of MSI and prevent any inappropriate disclosure, misuse and leakage of such information. 

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¹The SFC referred in its Consultation Paper on the Proposed Guidelines for Market Soundings to a determination by the Securities and Futures Appeals Tribunal regarding the substandard conduct of a hedge fund manager during a market sounding ("SFAT Determination"), the relevant SFC announcement can be found here.