Material Non-Public Information and IFIs
Laurence Glynn (Associate Director, Policy & Ethics, Office of the Chief Compliance Officer, EBRD) ([email protected]) and Craig Spruce (Senior Counsel, Office of the General Counsel, EBRD) ([email protected])
Introduction
The instruments used by international financial institutions (“IFIs”) to finance projects are continually evolving. In the last few years at the European Bank for Reconstruction and Development (“EBRD”), the number of projects financed with instruments that trade in the capital markets has steadily increased, including investments in listed debt and equity. In addition, a number of EBRD investee companies that were originally not listed have successfully conducted initial public offerings on stock exchanges both within and outside EBRD’s operating region.
This growing portfolio of listed investments prompted EBRD to revisit its existing controls and procedures. In particular, attention focussed on how EBRD handled inside information, a.k.a. “material non-public information” or “MNPI”. This article explains the background and highlights some of the challenges faced on the way to producing a revised Bank-wide procedure on MNPI management.
As an IFI, taking a responsible approach to handling MNPI is as much about promoting good practice, as it is compliance with regulatory standards and expectations. Indeed, we see this as part of EBRD’s commitment to promoting high ethical standards, integrity and good business practices, both in relation to its own conduct and as a key transition component in its operations (as set out in the Bank’s Integrity Risks Policy[i]), and in line with internationally accepted standards. It is also consistent with EBRD’s policy dialogue with its countries of operation as to the development of capital markets and indeed with the transition of our countries of operation towards sustainable market economies, which is central to the purpose of EBRD itself.[ii]
The regulatory background
Most if not all jurisdictions with active capital markets have adopted rules against insider trading. In the United States, where the emphasis is on market efficiency and rapid dissemination of price sensitive information, regulators are focussed on prohibiting misuse of non-public information that has been wrongfully obtained or used.[iii] In the EU, the policy emphasis is more on parity of information among investors and market “fairness”, and it is enough that a person has an informational edge over the rest of the market and has used that to make a profit (or avoid a loss) for that person to have potentially committed an insider dealing offence.
As many of EBRD’s listed investments are held in securities listed on regulated markets in the EU jurisdictions, and given the geography of its operating region, EBRD took the EU Market Abuse Regulation (“MAR”) as its guiding source. Following MAR, EBRD defines MNPI as information of a precise nature, which has not been made public, relating directly or indirectly to issuers or financial instruments, and which, if made public, would be likely to have an effect on the prices of those financial instruments or related derivatives.
A person who possesses MNPI and uses that information to trade in a listed security has committed the offence of insider dealing. As per EU jurisprudence, there is a “rebuttable presumption” that where a person (including a legal person) deals in a listed security whilst in possession of MNPI they have used that information.[iv] MAR makes clear, however, that an institution may trade while in possession of MNPI if those making the trading decision at the institution are separated from that MNPI by an effective information barrier. It is not sufficient, however, for an individual to simply attest that they did not rely on MNPI when making a decision to deal.
Practical implementation challenges
It is of course easy to say in theory that you (or your organisation) will not trade on inside information. It can be far harder, however, to implement a procedure that will work in practice.
At EBRD, the issue can manifest itself in numerous ways. EBRD, for example, sometimes holds listed equity or debt in an entity or group to which it has also extended a bilateral loan. At times, reporting received under the loan might be considered to constitute MNPI with respect to the borrower’s listed securities. Alternatively, due diligence might be ongoing for a significant strategic investment for which an existing listed client was seeking financing from EBRD. Knowledge of that project could constitute MNPI, potentially constraining the Bank’s ability to trade its listed position in that client.
Issues can also arise outside of the transactional sphere. EBRD has been expanding its policy dialogue and legal reform efforts in the jurisdictions where it operates to improve the climate for private investment. It is not inconceivable that at some point EBRD could have knowledge of an imminent regulatory development that could itself meet the definition of MNPI.
In each such case, given the rebuttable presumption that a person or institution that holds MNPI has used such information in deciding to trade, the burden of proof shifts to the person making the decision to trade to establish that they did not in fact use that information.
Strengthening the Compliance Framework
EBRD is, of course, not unique in confronting the problem of receiving MNPI from numerous different sources. All large financial institutions struggle with the issue, and it is one of the drivers of the ever-expanding compliance industry.
In practice, most large financial institutions handle MNPI by ensuring separation of their “private side” (advisory, lending, etc.) and “public side” (trading) functions behind robust information barriers that permanently segregate relevant departments and business lines (requiring separate decision making, separate IT access and separate physical locations). In other words, they rely on the existence of an effective information barrier (one of the safe harbours provided under MAR).[v]
EBRD faced a choice between seeking to implement information barriers between different project teams within the “private” side of the institution (in particular within Banking) and taking an approach that is more closely aligned with that of regulated firms, by relying on a single information barrier between the “public side” (being those personnel within EBRD’s Treasury function whose role is to place orders in the market to effect the purchase and sale of listed securities) and the rest of EBRD.
Implementing information barriers between banking teams has the attraction of permitting maximum flexibility as each team could pursue its objectives without being constrained by the activities of others within EBRD. But Banking teams at EBRD are leanly staffed. Country and Sector teams work closely together, and investment decisions are also generally taken by centralized committees that oversee deals across the private side.
After wide-ranging discussions with senior management, legal advisers and comparator IFIs, and taking into account various factors including those outlined above, it was agreed that the “single information barrier” approach was preferable. Accordingly, prior to the private side directing a trade in a listed security, internal checks are carried out to determine whether any teams on the private side have MNPI, with results reported back to the Banking team and Compliance. If any MNPI is identified, the transaction cannot proceed until either the MNPI is disclosed or otherwise becomes stale.
EBRD implemented this approach as part of a pilot programme from early 2016, starting with bond investments and then extending to listed equity. The pilot process helped identify and address any teething difficulties and acclimatise relevant EBRD personnel to the updated approach. Finally, in June 2019 the new permanent MNPI Procedure was rolled out across EBRD.
Next Steps and Future Challenges
It is of course one thing to have something written on paper. It is an entirely different matter to make sure teams are aware of the procedure, understand it and are able to follow it. A lot of work has gone into ensuring that the new procedure is fully embedded and implemented into the project cycle for considering and approving new investments and exits – both for listed projects and for unlisted projects that could give rise to MNPI that could impact EBRD’s listed investments.
A particular focus has been on training: it is important that, as the first line of defence, the business “owns” risks arising from incorrect use of MNPI and understands how to recognise it and minimise the risks of receiving MNPI that could impact transactions in listed securities. Compliance has conducted extensive face-to-face training sessions and is developing mandatory online training to enable all relevant EBRD personnel to identify MNPI and understand their responsibilities when it comes to listed investments.
Finally, a note of caution: as we realised when we benchmarked our approach against that of comparator IFIs, no two IFIs are alike (even the same IFI may look different over time as its activities and objectives evolve) and the extent of each IFI’s involvement with listed securities varies greatly, as does their internal organisational structure. That said, the general theme of navigating an agreed approach while taking into account best practice, regulatory standards, policy objectives and (for IFIs with a private sector focus) commercial considerations, is one that will hopefully resonate more widely within our legal and compliance communities.
[i] See https://www.ebrd.com/downloads/integrity/integrityriskpol.pdf
[ii] See Agreement Establishing the EBRD, Article 1: “In contributing to economic progress and reconstruction, the purpose of the Bank shall be to foster the transition towards open market-oriented economies…” https://www.ebrd.com/news/publications/institutional-documents/basic-documents-of-the-ebrd.html
[iii] Cf. Dirks v SEC, 681 F.2d 824 (D.C. Cir. 1982)
[iv] Spector Photo Group NV v Commissie voor het Bank, Financie-en Assurantiewezen, C-45/08.
[v] MAR, article 9.
The instruments used by international financial institutions (“IFIs”) to finance projects are continually evolving. In the last few years at the European Bank for Reconstruction and Development (“EBRD”), the number of projects financed with instruments that trade in the capital markets has steadily increased, including investments in listed debt and equity. In addition, a number of EBRD investee companies that were originally not listed have successfully conducted initial public offerings on stock exchanges both within and outside EBRD’s operating region.
This growing portfolio of listed investments prompted EBRD to revisit its existing controls and procedures. In particular, attention focussed on how EBRD handled inside information, a.k.a. “material non-public information” or “MNPI”. This article explains the background and highlights some of the challenges faced on the way to producing a revised Bank-wide procedure on MNPI management.
As an IFI, taking a responsible approach to handling MNPI is as much about promoting good practice, as it is compliance with regulatory standards and expectations. Indeed, we see this as part of EBRD’s commitment to promoting high ethical standards, integrity and good business practices, both in relation to its own conduct and as a key transition component in its operations (as set out in the Bank’s Integrity Risks Policy[i]), and in line with internationally accepted standards. It is also consistent with EBRD’s policy dialogue with its countries of operation as to the development of capital markets and indeed with the transition of our countries of operation towards sustainable market economies, which is central to the purpose of EBRD itself.[ii]
The regulatory background
Most if not all jurisdictions with active capital markets have adopted rules against insider trading. In the United States, where the emphasis is on market efficiency and rapid dissemination of price sensitive information, regulators are focussed on prohibiting misuse of non-public information that has been wrongfully obtained or used.[iii] In the EU, the policy emphasis is more on parity of information among investors and market “fairness”, and it is enough that a person has an informational edge over the rest of the market and has used that to make a profit (or avoid a loss) for that person to have potentially committed an insider dealing offence.
As many of EBRD’s listed investments are held in securities listed on regulated markets in the EU jurisdictions, and given the geography of its operating region, EBRD took the EU Market Abuse Regulation (“MAR”) as its guiding source. Following MAR, EBRD defines MNPI as information of a precise nature, which has not been made public, relating directly or indirectly to issuers or financial instruments, and which, if made public, would be likely to have an effect on the prices of those financial instruments or related derivatives.
A person who possesses MNPI and uses that information to trade in a listed security has committed the offence of insider dealing. As per EU jurisprudence, there is a “rebuttable presumption” that where a person (including a legal person) deals in a listed security whilst in possession of MNPI they have used that information.[iv] MAR makes clear, however, that an institution may trade while in possession of MNPI if those making the trading decision at the institution are separated from that MNPI by an effective information barrier. It is not sufficient, however, for an individual to simply attest that they did not rely on MNPI when making a decision to deal.
Practical implementation challenges
It is of course easy to say in theory that you (or your organisation) will not trade on inside information. It can be far harder, however, to implement a procedure that will work in practice.
At EBRD, the issue can manifest itself in numerous ways. EBRD, for example, sometimes holds listed equity or debt in an entity or group to which it has also extended a bilateral loan. At times, reporting received under the loan might be considered to constitute MNPI with respect to the borrower’s listed securities. Alternatively, due diligence might be ongoing for a significant strategic investment for which an existing listed client was seeking financing from EBRD. Knowledge of that project could constitute MNPI, potentially constraining the Bank’s ability to trade its listed position in that client.
Issues can also arise outside of the transactional sphere. EBRD has been expanding its policy dialogue and legal reform efforts in the jurisdictions where it operates to improve the climate for private investment. It is not inconceivable that at some point EBRD could have knowledge of an imminent regulatory development that could itself meet the definition of MNPI.
In each such case, given the rebuttable presumption that a person or institution that holds MNPI has used such information in deciding to trade, the burden of proof shifts to the person making the decision to trade to establish that they did not in fact use that information.
Strengthening the Compliance Framework
EBRD is, of course, not unique in confronting the problem of receiving MNPI from numerous different sources. All large financial institutions struggle with the issue, and it is one of the drivers of the ever-expanding compliance industry.
In practice, most large financial institutions handle MNPI by ensuring separation of their “private side” (advisory, lending, etc.) and “public side” (trading) functions behind robust information barriers that permanently segregate relevant departments and business lines (requiring separate decision making, separate IT access and separate physical locations). In other words, they rely on the existence of an effective information barrier (one of the safe harbours provided under MAR).[v]
EBRD faced a choice between seeking to implement information barriers between different project teams within the “private” side of the institution (in particular within Banking) and taking an approach that is more closely aligned with that of regulated firms, by relying on a single information barrier between the “public side” (being those personnel within EBRD’s Treasury function whose role is to place orders in the market to effect the purchase and sale of listed securities) and the rest of EBRD.
Implementing information barriers between banking teams has the attraction of permitting maximum flexibility as each team could pursue its objectives without being constrained by the activities of others within EBRD. But Banking teams at EBRD are leanly staffed. Country and Sector teams work closely together, and investment decisions are also generally taken by centralized committees that oversee deals across the private side.
After wide-ranging discussions with senior management, legal advisers and comparator IFIs, and taking into account various factors including those outlined above, it was agreed that the “single information barrier” approach was preferable. Accordingly, prior to the private side directing a trade in a listed security, internal checks are carried out to determine whether any teams on the private side have MNPI, with results reported back to the Banking team and Compliance. If any MNPI is identified, the transaction cannot proceed until either the MNPI is disclosed or otherwise becomes stale.
EBRD implemented this approach as part of a pilot programme from early 2016, starting with bond investments and then extending to listed equity. The pilot process helped identify and address any teething difficulties and acclimatise relevant EBRD personnel to the updated approach. Finally, in June 2019 the new permanent MNPI Procedure was rolled out across EBRD.
Next Steps and Future Challenges
It is of course one thing to have something written on paper. It is an entirely different matter to make sure teams are aware of the procedure, understand it and are able to follow it. A lot of work has gone into ensuring that the new procedure is fully embedded and implemented into the project cycle for considering and approving new investments and exits – both for listed projects and for unlisted projects that could give rise to MNPI that could impact EBRD’s listed investments.
A particular focus has been on training: it is important that, as the first line of defence, the business “owns” risks arising from incorrect use of MNPI and understands how to recognise it and minimise the risks of receiving MNPI that could impact transactions in listed securities. Compliance has conducted extensive face-to-face training sessions and is developing mandatory online training to enable all relevant EBRD personnel to identify MNPI and understand their responsibilities when it comes to listed investments.
Finally, a note of caution: as we realised when we benchmarked our approach against that of comparator IFIs, no two IFIs are alike (even the same IFI may look different over time as its activities and objectives evolve) and the extent of each IFI’s involvement with listed securities varies greatly, as does their internal organisational structure. That said, the general theme of navigating an agreed approach while taking into account best practice, regulatory standards, policy objectives and (for IFIs with a private sector focus) commercial considerations, is one that will hopefully resonate more widely within our legal and compliance communities.
[i] See https://www.ebrd.com/downloads/integrity/integrityriskpol.pdf
[ii] See Agreement Establishing the EBRD, Article 1: “In contributing to economic progress and reconstruction, the purpose of the Bank shall be to foster the transition towards open market-oriented economies…” https://www.ebrd.com/news/publications/institutional-documents/basic-documents-of-the-ebrd.html
[iii] Cf. Dirks v SEC, 681 F.2d 824 (D.C. Cir. 1982)
[iv] Spector Photo Group NV v Commissie voor het Bank, Financie-en Assurantiewezen, C-45/08.
[v] MAR, article 9.
