Asian capital markets bankers have welcomed Hong Kong's new guidelines for market sounding after they were simplified from originally far-reaching proposals over the course of a year of discussions and market feedback.
The city's Securities and Futures Commission launched a consultation paper on market sounding, or the sharing of information between the sellside and buyside when arrangers prepare transactions, in October 2023 and announced the final guidelines on October 31.
The SFC was concerned that some intermediaries might have taken advantage of private information received during market soundings to make profits from information that was not generally available to the rest of the market. For instance, investors could sell a stock short if they knew a block trade was coming at a discount to the current market price.
Both the buyside and equity and debt capital markets bankers blasted last year's draft guidelines as too broad, opaque and complex. For instance, the proposed rules covered all communication of non-public information, regardless of whether it was price-sensitive inside information or not.
The final guidelines, set to be implemented next May, clarify that regulatory obligations only apply to certain types of transactions and information. This includes a potential transaction in listed shares or any other securities which could materially impact the price of listed shares, but only regarding "confidential information" entrusted to the banks or arrangers by a client. The guidelines say that the disclosing and receiving persons must safeguard that information’s confidentiality and make sure they have effective systems in place to prevent inappropriate disclosure, misuse or leakage.
The switch to "confidential information" was lauded by market participants, as it offers more clarity and puts fewer restrictions on them than the original wording.
“We're much more comfortable with it. It's much more appropriate,” said a DCM banker at an international bank. “They’ve taken on board the feedback they’ve gotten from the market.”
During the consultation period, the SFC examined 27 written submissions from the industry and held additional discussions with stakeholders.
“Big picture, overall, I think the revisions are fair and reflect a balanced and thoughtful approach, and took on broad feedback from the industry, including AIMA,” said Kher Sheng Lee, co-head of Asia Pacific and deputy global head of government affairs at the Alternative Investment Management Association.
“They had to thread the needle, not wanting to unduly burden the industry while also putting guidelines in place,” Lee said. “They have narrowed the scope and that is a big relief to the market.”
The unveiling of the final guidelines comes after the regulator in May started criminal proceedings against hedge fund Segantii Capital Management, its chief investment officer Simon Sadler, and former trader Daniel La Rocca for alleged insider trading.
"We have observed an increasing number of cases regarding trading activities ahead of placings and block trades, which appear to indicate abuse of confidential information entrusted by clients during market soundings, and a divergence in market sounding practices adopted by intermediaries," said an SFC spokesperson, commenting on the final guidelines.
But the spokesperson said that the guidelines do not represent a sea change. "From our discussions with various industry stakeholders, including bankers, most market sounding intermediaries have already adopted similar policies and procedures on protection of confidential information during market soundings," he said.
Block trades and private placements are the main focus of the final guidelines. When an investor agrees to be sounded about a potential transaction, they cannot to trade stocks in that sector until after the deal is done.
Equity capital market bankers said they were happy with the revisions to the guidelines, calling them "fair".
“The regulator’s decision to not adopt the non-public information clause is helpful as it is almost impossible to run a deal under that clause since it’s hard to define what is non-public information,” an ECM banker said. “Under the revised guidelines, we just need to ensure we follow an internal procedure to keep the confidentiality of transactions."
Bond market relief
The clearer focus on ECM transactions addresses one of the main concerns that were raised by the original draft.
“SFC clearly listened to the bond market and took note of the different dynamics of DCM,” said Mushtaq Kapasi, chief representative for Asia-Pacific at the International Capital Market Association. “Ultimately, they refined the guidelines to minimise disruption to investors and issuers. At the same time, we're happy to see the SFC emphasise the basic principles of honesty and fair dealing which help to preserve integrity in the market.”
The draft rules on the disclosure of non-public information would have meant in effect that most bond deals were covered, since only retail bond offerings are considered public. Now, the guidelines will apply if market soundings are conducted in connection with a possible DCM transaction which is likely to materially affect the price of exchange-listed shares.
"Initially, the guidelines targeted both debt and equity transactions but have been honed to primarily cover equity transactions," said Kishore Bhindi, financial regulation partner at Linklaters in Hong Kong. "Under the new rules, mainstream DCM transactions will likely be out of scope. The rules will be more relevant to DCM transactions which are directly linked to equity, such as transactions in convertible bonds."
Still, even though the regulations appear less restrictive than feared for DCM deals, some ambiguity remains.
“Some DCM deals might be impacted, especially where confidential information is exchanged,” AIMA's Lee said. “Since DCM is not explicitly excluded, intermediaries will still have to do the work upfront to clarify internally if this falls under the parameters of one of these transactions."
The DCM banker said the "dialled down" guidelines will still need to be examined by banks' compliance teams, but “it doesn’t really feel like it's going to impact us much”. Formal market sounding is fairly rare in DCM, the banker said, as most investors do not want to be wall-crossed and then have their trading hampered. The wall-crossing happens for more difficult deals, like high-yield trades, and when investors require more time for internal approvals.
Chinese banks looking to buy international bonds often face a long wait to obtain internal approvals, said another DCM banker at a Chinese firm. Lately, more of these banks are participating in offshore deals, which could mean more DCM offerings are subject to the new market sounding guidelines.
“Chinese banks cannot move as fast as fund managers," she said.
The buyside also welcomed the lighter record-keeping procedures. The draft proposals required participants on the buyside and the sellside to keep records of soundings for seven years, but that has now been simplified by putting the burden solely on the sellside and reducing the retention period to two years.
Some bankers and experts said there is still room for interpretation, and intermediaries should use the next six months to prepare.
"Firms will need to enhance their internal control procedures for conducting market soundings and handling market sounding information – the impact will depend on what they currently have in place, and what the 'gap' is," Linklaters' Bhindi said. "Invariably though we anticipate an uptick in records and record keeping more generally. Bankers will need to ensure that they check all these boxes when they conduct market soundings."
(Additional reporting by Fiona Lau)