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Hong Kong authorities are cracking down on how banks discuss block trades with hedge funds, after a criminal case against Segantii Capital Management and its founder Simon Sadler threw a spotlight on the practice.
The Securities and Futures Commission, the territory’s financial watchdog, announced new guidelines on Thursday that cover so-called “market sounding”, a grey area in which banks discuss upcoming or potential block trades with hedge funds in order to gauge their interest in buying the stock.
Block trades are privately negotiated sales of a large chunk of a company’s shares, which can depress the price. If hedge funds or other investors bet against a company in the belief that a block trade is likely to happen, they stand to make money if the transaction materialises and pushes down the shares.
“The guidelines aim to address market integrity issues related to the abuse of confidential information entrusted by a client in the course of market sounding, resulting in an unfair playing field,” said Julia Leung, chief executive of the SFC. They are due to take effect next year.
The SFC’s move comes after it announced in May a criminal insider trading case against hedge fund Segantii, Sadler and former trader Daniel La Rocca. Segantii, once one of the dominant players in block trading in Asia, has said it plans to defend itself “vigorously”.
Block trades can be a lucrative corner of the market for banks and hedge funds, but have attracted the attention of regulators, including in the US and UK.
The SFC’s guidance says that when a bank is sounding out a hedge fund about its interest in buying shares in a possible block trade, it can only give details that are so “broad, limited, vague and anonymised” that the fund cannot guess the identity of the issuer — unless the fund has agreed to treat it as confidential.
It says if a bank or hedge fund abuses so-called “market sounding information” it could be in breach of the regulator’s guidelines, even if what is discussed is not deemed to be price sensitive or to constitute inside information. Banks should record market sounding conversations and use authorised communication channels, it says.
Hedge funds will be required to make a “reasonable effort” to find out whether information from a bank counts as a market sounding if the bank does not specify it, the guidance adds.
The SFC’s guidelines do not have the force of law, but the watchdog said that failure to comply could lead them to consider whether a person should remain licensed or not.
Segantii is in the process of closing operations and handing back investors’ cash in the wake of the court case. The case relates to trades in retailer Esprit that took place in 2017.
Separately, in January Morgan Stanley agreed to pay $249mn to settle federal investigations into misconduct on block trades. The Securities and Exchange Commission found that Pawan Passi, the former head of the bank’s US equity syndicate, had shared non-public information about impending block trades with investors.
The SEC handed Passi a $250,000 civil penalty and barred him from working in the industry. He admitted to misconduct and agreed a deferred prosecution agreement.
