Complete Guide To The Market Sounding Process

In September 2020, the European Securities and Markets Authority (ESMA) issued its clarifications over implementing the EU’s Market Abuse Regulation (MAR). The MAR Review Report was the culmination of a consultation held about the application of the 2016 regulation and concluded that it had worked well in practice. However, many stakeholders still wanted more detail on some of the aspects, including the market sounding process. 

The report confirmed that all disclosing market participants (DMP) must abide by the MAR guidelines and that this would, in turn, protect them from compliance issues over disclosing inside information. 

So, what are the correct market sounding procedures when gauging interest in a potential transaction?

Keep reading for details on what you need to do to comply with MAR in these circumstances.

1. What is a market sounding?

According to MAR, a market sounding is the process of an issuer, secondary offeror of a financial instrument or a third party, such as an advisor, acting on their behalf communicating with investors and sharing information about a possible transaction and its conditions. The goal of a market sounding is to gauge interest in the transaction and to help determine the size and price of the instrument.

It could be for an initial public offering (IPO), a secondary offering or ahead of a merger and acquisition (M&A) transaction. Particularly in the case of the latter, there is often the need to disclose inside information during a market sounding, which is accounted for in MAR. 

In every market sounding, there is a disclosing market participant (DMP) and a person receiving the market sounding (MSR):

2. Procedures related to market soundings 

2.1 Steps DMPs should take before conducting a market sounding

There are a number of compliance obligations DMPs should take before they conduct a market sounding:

• Check that the intended MSR is not on a list of investors who have opted out of receiving market soundings.
• Find out if there is a designated person or contact point at the MSR to receive market soundings.
• Prepare the exact information that will be disclosed. 

Determine whether this information or any part of it consists of inside information. You should keep a written record of the decision making process whether or not you deem it to be inside information. A financial regulator may ask to see this in the future.

Devise a method of obtaining consent from the MSR to receive inside information without disclosing information that could, alone or in combination with other information, amount to inside information when delivered to the MSR.

Whenever possible, determine a date when the information will no longer be inside information, inform the MSR of any factors that might delay this process and let them know how you will communicate that with them if it should happen.

2.2 Procedures concerning persons receiving market soundings (MSRs)

An MSR should carry out the following procedures before and upon receiving market soundings: 

• Implement reporting lines for information it receives through its internal contact point. 
• Ensure that staff are trained and understand how to share information only on a ‘need-to-know’ basis. 
• Appoint an internal body of trained staff to decide whether the information it receives in market soundings is inside information or not. It should also independently decide when it stops being inside information, rather than relying on the definition from the DMP. 
• Create a recipient list to document the personal details of all of the employees who have accessed the information within the market sounding.
• Train staff to handle inside information if it is received and how to create an insider list. By the way, cloud-based platforms such as InsiderLog automate this process to make compliance with MAR easy. 
• Inform the DMP when the MSR wants to decline the marketing sounding and clarify whether they want to permanently decline future market soundings about a particular transaction, a type of transactions or all transactions in total.
• Establish policies in place for when an entity receives a market sounding unintentionally. This could be during a conversation, for example, where a representative of the firm receives the sounding even though the firm would decline the request. If the disclosure includes inside information, the MSR must fulfil its obligations relating to this, even if it formally declined the market sounding. 

3. How to determine whether the market sounding regime applies

You should consult MAR to decide whether the market sounding regime applies. The regulation lists four main criteria for making that decision. A market sounding is: 

• communication of information to a potential investor or investors
• made by the issuer, secondary offeror or a third party such as an investment bank or advisor
• made prior to the announcement of a transaction
• intended to gauge the interest of potential investors in the financial instrument and its conditions

However, a market sounding also needs to be in-scope for MAR, which is dictated in Article 2. It is stated that the regulation, and, therefore, the market sounding regime, applies to: 

• financial instruments admitted to trading on a regulated market or for which a request for admission to trading on a regulated market has been made;
• financial instruments traded on an MTF, admitted to trading on an MTF or for which a request for admission to trading on an MTF has been made;

• financial instruments traded on an OTF;

• financial instruments not covered by point (a), (b) or (c), the price or value of which depends on or has an effect on the price or value of a financial instrument referred to in those points, including, but not limited to, credit default swaps and contracts for difference.

If the action you are taking relates to one of the in-scope financial instruments and fits the definition of a market sounding, you must undertake the obligations of the regime. 

Communications made after the announcement of the transaction are not counted as market soundings. However, MAR does not define what form the announcement should take, so it is up to the DMP to determine whether the announcement it makes about the transaction is substantive enough to mean that further communications no longer count as market soundings. 

4. Disclosing market participant process 

Once the DMP has considered whether the information it will disclose counts as inside information, it must proceed in one of two ways. 

4.1 If it DOES contain inside information

For cases where an issuer or advisor will disclose inside information during a market sounding, they must: 

• make a statement to the effect that the disclosure will be for the purposes of a market sounding
  
• confirm that the person they are talking to is the internal contact point for market soundings on behalf of the MSR
  
• make clear that the following disclosure, if they choose to receive it, will contain inside information and that they should also make an independent judgement on its status 
  
• provide an estimate on when it is likely to cease being inside information, factors that could affect that timeline and how they will communicate any delays 
  
• inform the MSR that they should not use the information to inform a transaction by themselves or a third party or to inform an amendment or a cancellation of a transaction they have previously ordered
  
• obtain the MSR’s consent to receive inside information
  

4.2 If it DOES NOT contain inside information

Even when a DMP determines that a market sounding does not contain inside information, there is still a set procedure to go through. They must: 

5. Record-keeping requirements for the DMP

There are also a number of record-keeping requirements for DMPs. They must note:

• the names of those who received the sounding, the date and time it took place and details of any follow-up 
• the details of the communication, including documents sent to the MSR in the course of the market sounding
• any recordings of in-person or telephone conversations, or detailed written minutes for unrecorded meetings, as well as copies of written communications between the DMP and the MSR
• the details of those who declined the sounding and the undertaking not to contact them
• the DMP’s policies on market soundings.

The DMP should keep these records for five years in a durable medium that can be easily read. 

In addition, the DMP must keep an insider list of those individuals in possession of inside information, as is required by MAR. 

6. Record-keeping requirements for the MSR

The market sounding recipient should keep the following records: 

• record of a disclosure to a DMP that it wished to decline market soundings
• an assessment of whether the disclosure featured inside information and whether it continues to be inside information
• details of a disagreement with the DMP over the status of the information
• internal procedures on market soundings
• assessment of the issuer and financial instruments affected by the inside information
• an insider list of everyone with knowledge of the inside information.
• details of everyone employed or acting on their behalf who has access to the information, whether it is inside information or not.

The MSR should keep these records for at least five years.

7. FAQs

7.1 What happens if a transaction does not proceed?

Generally, the DMP doesn’t inform the MSR if the deal does not proceed. When the transaction does not go ahead, informing the MSR that it won’t proceed and giving them a reason can sometimes accidentally lead to further disclosure of inside information. 

8. Conclusion

The market sounding process is complex due to the legislation and paperwork that it involves, but it is important to understand for compliance. Doing things the correct way means that a DMP is covered in terms of the disclosure of inside information. Without that, they can find themselves being hit with substantial penalties. 

One of the key requirements of MAR is to keep an insider list when documenting and disclosing inside information, whether that is during a market sounding or for another reason. You can make this time-consuming task easier and ensure you stay compliant with InsiderLog. Request a free demo to learn more.

9. References and Further Reading

• Insider list FAQs
• What is insider dealing under MAR?
• Guidelines for MSRs
• How to use InsiderLog
• ESMA