ESMA final report on technical standards under Market Abuse Regulation: the good, the bad and the ugly

On 28 September 2015, the European Securities and Markets Authority (ESMA) published its final report (Final Report) on draft technical standards under the Market Abuse Regulation (MAR). This follows its consultation paper (CP) in July 2014 (which we summarised in our briefing). MAR will generally take effect in the UK on 3 July 2016 and will replace the existing Market Abuse Directive.

There are a number of significant changes introduced by MAR, particularly for buy-side and sell-side firms (and, of course, listed issuers) and this Final Report from ESMA provides some clarification on the real detail that firms will have been waiting on. This briefing summarises some of the key issues. Further, while we consider that there are many European regulatory directives and regulations which the FCA does not believe in, this is certainly not one of them.

Key messages

The (sort of) good…

• Insider lists – ESMA has shortened the list of information that needs to be recorded on the template insider list. Personal or professional email addresses and employment contract dates are no longer required. However, it is still fairly allen compassing requesting, for example, individuals' personal addresses and national identification numbers. Further, the insider list is still required to be in electronic format, updated without delay, when applicable, and kept up to date at all times. Firms will need to build new systems to draw the information together so that it can be inserted into the prescribed template format.
• Suspicious transaction and order reports (STORs) – under MAR, these reports must be submitted "without delay". The CP suggested that this should be within two weeks. The Final Report removes this requirement, stating it was always intended as a guideline only and firms should consider what is appropriate in each case.
• Transactions by persons discharging managerial responsibilities (PDMRs) – while MAR requires that PDMRs notify all relevant transactions undertaken, they will be allowed to submit a single notification which details multiple transactions provided the three-day deadline has been complied with (i.e. a PDMR could notify in respect of multiple transactions made on days one to three inclusive).

The (remains so) bad…

• Market soundings – the obligations in this field remain onerous, in particular the record-keeping obligations, formalised assessment to be conducted prior to a market sounding, and information to be provided to a recipient (with ESMA having removed the possibility for "simplified" standard scripts). Further, the obligation on a disclosing market participant (DMP) to inform recipients of market soundings (MSR) that the information has ceased to be inside information is not necessarily satisfied on the information becoming public, so the DMP will still need to inform the MSR separately. The FCA will be increasingly focused on compliance with such rules. Indeed, they should reduce issues that were at play in recent enforcement activity (such as Greenlight and Hannam ).
• Transactions by PDMRs – the notification to the regulator in respect of every transaction will be publicly disclosed in its entirety (previously, it was envisaged that the notification may be split into sections, with some sections remaining accessible by the regulator only).

And the omissions

• Obligations on MSR – we were expecting ESMA to provide guidelines on the obligations that would be imposed on those receiving market soundings. ESMA has stated that it will consult on these in due course and supplement the draft technical standards accordingly.
• Timings for notifications of PDMR transactions – as noted above, the rules under MAR require PDMRs to notify issuers of transactions within three business days, alongside a requirement for the issuer to notify the regulator within three business days. In practice, this cannot work but this timing issue has not been addressed in the Final Report.

Some of these issues are discussed in more detail below.

Market soundings

The market soundings requirements of MAR have been the most commented on and one of the most controversial of the regulation. As one of the respondents to the CP pointed out, this regime is new at European level with only France currently having a domestic market soundings regime. MAR describes a market sounding in article 11(1) as a "communication of information prior to the announcement of a transaction in order to gauge the level of interest of potential investors in a possible transaction and the conditions relating to it". MAR has a safe harbour from the market abuse regime, providing certain conditions are met, which means that a market sounding will be in the normal course of a person's employment and therefore not constitute the improper disclosure of information.

The Final Report provides some clarification on the scope of the market soundings obligations. First, the Final Report confirms when a DMP is acting on behalf of, or on the account of, a market sounding beneficiary (MSB) (e.g. the issuer). Here, ESMA has noted that this will be where the DMP is acting at the request of the MSB under a general mandate, even where specific instructions or engagement are yet to be formalised. If the DMP questions investors on its own initiative without being mandated by the MSB (for example, to gauge a potential investors' appetite for a corporate transaction), this will not be considered as a market sounding for the purposes of the safe harbour.

Second, ESMA has clarified that market soundings for the purpose of undertaking a block trade where the DMP is acting on behalf of a secondary market offeror will be captured within the safe harbour. However, where discussions are taking place with a view to concluding the block trade – rather than gauging interest – this will not be captured. It would be helpful to have clarification as to the distinction that ESMA is making here. ESMA has also highlighted that market soundings prior to, and in relation to, a private placement are within the scope of MAR provided they fulfil the criteria in article 11(1) set out above.

The Final Report also gives confirmation on the procedural aspects that must be followed before, during, and after conducting market soundings. There are specific requirements set out in MAR about the process a DMP must undertake, some even before they decide to conduct a market sounding. Some of the key actions that must be taken include:

• an assessment prior to conducting a market sounding – recorded in writing – to determine whether the market sounding will involve inside information and what information will need to be disclosed to potential investors (it is worth noting that there is an obligation on DMPs to avoid disclosing unnecessary information);
• the MSR's consent must be obtained before the market sounding. Importantly, this requires that the DMP must keep a list of those investors who have said they do not want to be sounded (either generally or in relation to particular types of transactions); and
• a standard set of information (set out in the draft technical standards in the Final Report) which needs to be provided to MSRs by DMPs conducting market soundings (and which will depend whether the market sounding will involve inside information or not).

All of these actions are subject to strict record-keeping requirements. If the market sounding can be done over a recorded line, it should. Otherwise written minutes (based on templates set out in the technical standards) of market soundings are required which should be agreed and signed by both parties (with ESMA setting out extensive requirements on what a DMP must do if the MSR refuses to sign a copy of the minutes).

Importantly, the market sounding requirements apply to market soundings irrespective of whether inside information will be transmitted, much to the dismay of the industry. This means that the record-keeping requirements on who has been sounded out, who has declined to be sounded out, when and, if sounded, what information was passed will not correspond with insider lists as the market sounding requirements are wider. "Sounding lists" will now become common terminology along with "insider lists".

If inside information was passed during the market sounding, the DMP should inform the MSR as soon as possible when that information has ceased to be inside. The onus is on the DMP to assess when information is no longer inside information: this is straightforward where there is a public announcement but less so when a potential transaction is aborted.

Some provisions on market soundings have been deleted in the Final Report. There had been a discussion about providing simplified scripts for market soundings, which has been dropped in favour of consistency of the same process for all. The Final Report also notes that the provision relating to a single point of contact with potential investors for market soundings is no longer a requirement. Finally, ESMA expects to publish further guidance on some of the market sounding issues which it feels it is not empowered to deal with through the technical standards, including obligations on the buy-side firms and their internal procedures.

STOR reports

ESMA is required to produce technical standards relating to procedures and notification templates for STORs, which aim to help the prevention and detection of market abuse.

It is clear that STORs relate to suspicious orders regardless of whether they have been executed. ESMA reiterates what it said in the CP last year that the obligation to submit STORs extends to OTC derivatives trading where the underlying instrument is traded on a RM, a MTF or an OTF, and it applies irrespective of the trading capacity in which the order is entered or the transaction executed.

A key change in the Final Report relates to the timing of submission of STORs. MAR states that reports should be made "without delay" which ESMA previously suggested should mean within two weeks of the suspected breach. ESMA is amending its position and removing this language to avoid any confusion over a formal time-frame within which reports must be submitted. ESMA confirms that a report should be submitted without delay once a reasonable suspicion has formed in relation to a trading behaviour. Delays will need to be justified.

ESMA reiterates its view that firms will need automated surveillance systems, subject to effectiveness and appropriateness tests for firms and always with an element of human analysis. ESMA seems to have provided smaller firms with more leeway in the monitoring system they use to detect market abuse. While the CP suggested proportionality,it was still onerous in its requirements for both automated and human surveillance systems. The Final Report cements the idea that the system used, whatever this is, must be effective, and an automated system may not be necessary in all instances (but a human one is).

The Final Report also expressly mentions that training in the detection of market abusive behaviour should be provided to all relevant staff. Such training should be comprehensive, robust and tailored so that the relevant staff is confident of its ability to detect suspicious behaviours. Vanilla and high-level type sessions will not be viewed as appropriate. A template STOR is provided by ESMA in the technical standards.

Technical means for public disclosure of inside information

Issuers are under an obligation under MAR (article 17) to publicly disclose inside information as soon as possible. This is a well-established requirement, certainly for UK issuers and not new under MAR. There are, however, certain circumstances when such disclosure can be delayed although such a delay will, going forward, require that a notification is made to the regulator.

The Final Report sets out the technical means for, and for delaying, public disclosure. ESMA has clarified that it expects compatible standards to those set out in the Transparency Directive (which deals with disclosure of inside information for regulated markets (RM)) to apply to all markets within scope of MAR, i.e. RMs, organised trading facilities (OTFs) and multilateral trading facilities (MTFs). Publication on an issuer's website will not satisfy the MAR requirements. ESMA is clear that there will not be a lighter regime for issuers of financial instruments traded only on MTFs or OTFs. However, ESMA is not proposing to apply the full Transparency Directive regime to financial instruments on MTFs and OTFs. In this way, and to avoid confusion, the technical standards no longer reference the Transparency Directive.

In relation to delayed disclosure, which is notified to the relevant authority, ESMA has specified what information should be presented by the issuers but not the template which should be used.

ESMA does not, as requested by some respondents to the CP, provide more details on rumours and when a rumour should be considered "sufficiently accurate". Guidelines are also still awaited from ESMA to establish a non-exhaustive indicative list of the legitimate interests of issuers referred to in article 17(4)(a).

Format of insider lists

There is some (tenuously) good news in the Final Report on the content of insider lists: a couple of the previously suggested fields to be included in insider lists have been dropped, such as personal email addresses and employment history dates. Nevertheless, the list remains substantial with some key provisions relating to national identification numbers (although there remains uncertainty where a member state, like the UK, does not use national identification numbers), and personal home and mobile telephone numbers still included. ESMA's final report sets out the format that insider lists must take, and clarifies how insider lists should be split for deal specific/ event-based sections and permanent insider sections.

There is no flexibility in the format that is expected by ESMA and national regulators for insider lists, and this may mean a substantial change to internal processes.

Notification of managers' transactions

MAR includes a notification and public disclosure requirement for PDMRs within an issuer, as well as for closely associated persons in relation to transactions on their own account. MAR extends the scope of the financial instruments to which this obligation applies so that it now includes instruments traded on OTFs and MTFs, as well as RMs which covers shares or debt instruments, or derivatives or other financial instruments linked to the shares or debt instruments of the issuer.

ESMA has substantially changed its approach following feedback received on the issue of how this information should be disclosed to the relevant authority and the issuer. There is now a single template, the entirety of which will be publicly disclosed. Previously, it was proposed that each transaction would be listed and this section would not be publicly disclosed, but there would also be an aggregated section which would be publicly disclosed. This distinction has been deleted. The information detailed on a transaction-bytransaction basis will be disclosed. Information can be provided in an aggregated form, but not only in this form.

ESMA had also previously consulted on the content of the information to be disclosed, which went beyond that required in MAR. On this point, ESMA has amended its position and will only require the data set out in the regulation (which remains substantial).

Investment recommendations

It would be wrong to say that we were leaving the best until last, but investment recommendations may be the most controversial of the MAR requirements. Investment recommendations caught by the MAR provisions must comply with certain disclosure requirements. These include the date and time when the recommendation was completed and first disseminated, as well as disclosure on conflicts and personal holdings.

MAR requires persons who produce or disseminate investment recommendations or other information recommending or suggesting investment strategies to take reasonable care to ensure objective presentation and to disclose their interests or indicate conflicts of interest. This has been a key and hotly debated proposal in the regulation. ESMA has used the final report to clarify what is meant under MAR. Unhelpfully, ESMA does not clarify whether sales teams will be caught but they have given some useful examples setting out the distinction between those persons expressly captured in MAR referred to as "qualified persons" and experts:

• qualified persons are independent analysts, investment firms, credit institutions, and any other person whose main business is to produce investment recommendations or persons who propose a particular investment strategy;
• "experts" are persons who repeatedly propose particular investment decisions and present themselves as having financial expertise or experience, and put forward his/her recommendation in such a way that other persons would reasonably believe he/she has financial expertise or experience.

The examples of experts that ESMA gives include someone who has been producing investment recommendations in the past; who has a relevant number of followers in relation to his/her recommendations; and whose proposals of investment decisions could be relayed by third parties, such as the media.

Investment recommendations must be intended for distribution channels, such as RIS, news agencies or the firm's website, or for the public. A distribution channel is deemed to be a channel through which information is, or is likely to, become publicly available and which relates to information that a "large number of persons have access" to. ESMA has declined to set a threshold on what constitutes a "large number of persons". However, ESMA considers that this test will be satisfied where the investment recommendation is intended or expected to be distributed to clients or to a segment of the firm's clients.

Qualified persons and experts should maintain a list of investment recommendations produced on any issuer or financial instrument and disseminated in the last 12 months, and the list should include basic information about the recommendation.

One significant confirmation in the Final Report is that threshold for disclosure of personal holdings is reduced to 0.5 per cent and that the methodology in the Short Selling Regulation should be used for the purposes of calculating personal holdings of net long or short positions. ESMA acknowledges the increase in administrative burden that this threshold will entail but suggests that the previously discussed five per cent was insufficient to truly capture conflicts.

There is some discussion in the ESMA final report on how these provisions apply to non-written recommendations but ESMA considers generally that there should be consistency between written and nonwritten to ensure that the rules cannot be circumvented through providing recommendations over the phone.

The Final Report introduces a new article to the technical standards on investment recommendations that will apply to persons who disseminate a summary or an extract of a recommendation produced by a third party. Such summary or extract must be clear and not misleading, identified as a summary or extract and reference the source. This follows the separate requirements for investment recommendations that are produced by a third party and disseminated by another, which remain subject to the requirements to include information on objectivity and conflicts.

Firms will need to examine their businesses carefully to ensure that the investment recommendation requirements are fully considered and any changes to procedures made, if relevant.

Next steps

The draft technical standards will now be submitted to the European Commission for it to decide whether to endorse them. We expect further publications from the FCA to discuss what changes need to be made to determine how MAR, which has direct effect, will affect the regulator's rules and procedures. However, implementation can certainly begin…