What Are Market Soundings Under the Market Abuse Regulation?

The EU’s Market Abuse Regulation (MAR) came into effect in July 2016, with the European Securities and Markets Authority (ESMA) defining the rules for issuing and receiving market soundings. 

The market sounding definition and requirements have led to some concern and uncertainty from issuers, who protested that they might accidentally misunderstand the rules and find themselves in contravention of MAR. This is why it is important to look closely at the details. Keep reading to find out what a market sounding is, why you would issue one, what you need to know about the market sounding process, and how soundings relate to inside information. 

1. What is a market sounding according to Article 11 of the Market Abuse Regulation?

Article 11.1 of MAR refers to market soundings in this manner: 

“A market sounding comprises the communication of information, prior to the announcement of a transaction, in order to gauge the interest of potential investors in a possible transaction and the conditions relating to it such as its potential size or pricing, to one or more potential investors by:

a) an issuer;

b) a secondary offeror of a financial instrument, in such quantity or value that the transaction is distinct from ordinary trading and involves a selling method based on the prior assessment of potential interest from potential investors;

c) an emission allowance market participant; or

d) a third party acting on behalf or on the account of a person referred to in point (a), (b) or (c).”

Both the issuer of the market sounding, known as the disclosing market participants (DMP) and the recipient, called the market sounding recipient (MSR), need to adhere to the regulation’s requirements to ensure compliance. 

2. Why conduct a market sounding?

Market soundings can be useful for both initial public offers (IPOs) and secondary offers on securities. They help the issuer judge what the market will pay for the financial instrument they want to offer so they can set their price accordingly. 

• For IPOs, the issuer has no guide for their offer price until they sound out the market. Once they understand the demand for the securities, they can set the price accordingly.
• For secondary offerings, the issuer can gauge the reaction to the offer’s conditions. 

Another reason to conduct a market sounding would be in the case of a potential merger or acquisition (M&A). The bidding company would have to engage the shareholders of the target business in order to find out if they would be willing to sell before they make a move. If a company talks to its own shareholders about a possible M&A transaction, it would not count as market sounding, unless the company intended to undertake fundraising to finance the operation.

In all of these circumstances, you would have to complete the steps required by the market soundings regime as set out by ESMA. 

3. What you need to know about the market sounding process

3.1 Who can make a market sounding?

Article 11 of MAR defines the entities that might make a market sounding. This can be a listed company that wants to gauge the market ahead of a debt issuance or additional equity offering, for example. On this occasion, a sell-side firm could approach potential investors with the details in order to attract interest or financial commitments. Another example is a listed company trying to assess interest from investors about a potential transaction so that it can determine the terms of the deal. Finally, a market sounding might be conducted by a sell-side business looking for potential investors to buy a large number of securities from another investor.  

Essentially, it is usually an issuer, an organisation looking to make a secondary offer, a participant in the emission allowance market or a third party acting on behalf of any of these bodies.

3.2 When should you conduct the market sounding?

You should conduct a market sounding ahead of a potential transaction in order to gauge reaction, determine the terms of the transaction, seek commitments or assess the willingness of holders of securities to sell in the case of an M&A transaction. 

If you conduct a market sounding too early, before you have a clear idea of what you have to offer, you might not gain accurate market insights. You need to have a concrete suggestion in order to find the answers you need.

3.3 What to consider when determining whether or not the market sounding regime applies?

The scope of the Market Abuse Regulation is detailed in Article 2, which helps you to understand the types of financial instruments covered by the regulation and, therefore, subject to the market sounding regime. These include: 

a) 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;

b) 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;

c) financial instruments traded on an OTF;

d) 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.

The market sounding requirements apply when you, as an issuer, secondary offeror or a third party, such as an advisor or investment bank, acting on behalf of one of these entities, whether through a formal agreement or not, provide information to one or more investors ahead of a transaction relating to one of the financial instruments above to gauge interest in it.

3.4 How can you make a market sounding? 

There are a number of ways to make a market sounding. Regardless of the form of communication you use, you must record the market sounding in accordance with the guidelines laid down in the Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS). 

The minutes or notes from unrecorded meetings or telephone calls or meetings should include: 

• the date and time of the meeting or call
• the identity of the participants
• details of all the information regarding the market sounding discussed between the DMP and the MSR
• Materials or documents relating to the market sounding supplied by the discloser during the meeting

You should keep these records for five years in a format that is easily accessible and readable. 

4. Market soundings and prohibition against disclosure of inside information

Article 10 of MAR deals with the unlawful disclosure of inside information. This is likely to be a concern for anyone making a market sounding, as there is the potential for sharing ‘information of a precise nature’ that would, if made public, have such a significant effect on the price of a financial instrument that it could be used by a reasonable investor as the basis on which to make their investment decisions. 

In usual circumstances, a market sounding would contravene the regulations on disclosing inside information, but there is some leeway when it comes to market soundings. Article 11.4 states that “disclosure of inside information made in the course of a market sounding shall be deemed to be made in the normal exercise of a person’s employment, profession or duties.” This is providing that the DMP has considered whether the information is inside information and documented their decision making and the reasons behind it, as well as performing some tasks before they disclose the inside information to the MSR.

These tasks are as follows: 

• Obtain the consent of the MSR to receive inside information.
• Inform the MSR that they should not use the information to decide on buying or selling any financial instrument to which it relates, nor should they instruct any third party to do similar.
• Inform the MSR that they should not amend or cancel any orders already placed after receiving the information.
• Ensure the MSR knows that they are obliged to keep the information confidential by agreeing to receive it. 

5. Procedures when Article 11 is not applied

If you feel that Article 11 does not apply to your communication with investors, you should make sure that you document the considerations that informed that decision. If regulators question the decision to not follow the market soundings regime, you should be able to produce evidence of the reasoning for bypassing it. 

In addition, it is good practice to still perform a level of record-keeping throughout your communications with investors. This should include notes of conversations, documents shared, presentations given and other interactions. 

6. FAQs

6.1 What is a pre-sounding?

A pre-sounding is another term for a market sounding, meaning the communication you have with an investor to gauge interest in a transaction before it occurs. 

6.2 Who can benefit from the market sounding safe harbour?

The market sounding safe harbour is the detail that declares the disclosure of inside information is “made in the normal exercise of a person’s employment, profession or duties”. This means that, as long as the DMP performs the tasks required of them and the MSR adheres to the obligations on the possession of insider knowledge, both should remain compliant even when there is a disclosure of inside information.

7. Conclusion

Market soundings are an essential tool for businesses when seeking out investor interest, considering a pricing strategy, reviewing transaction terms and more, but there are a number of steps to take to comply with the Market Abuse Regulation when you make a sounding. Working out whether the information you want to disclose classes as inside information is an important part of complying with the regulation. 

If you are looking for an online tool to save you time and regulatory headaches when it comes to MAR compliance, we invite you to try  InsiderLog, our insider list management software. 

8. References and further reading

• What is insider dealing under MAR
• InsiderLog – insider list automation
• ESMA guidelines for receiving market soundings
• ESMA report on market soundings
• Harvard Law School on MAR