This article first appeared in the magazine of the STA’s 84th Annual Market Structure Conference, which was held Sep. 13-15 in Washington, D.C.
For many years, the notion of a consolidated audit trail was just that, a notion -- pondered by regulators and discussed at industry conferences, almost as an academic exercise.
But now, the Consolidated Audit Trail -- proper noun, with capital C, A, and T -- is real, and timelines are looming.
“The CAT is a top-of-mind concern for a lot of people in the broker and exchange community,” said Jerry Hanweck, Founder and CEO of his eponymous risk-analytics firm. “What will be the cost of the CAT, how is the CAT going to be implemented, and what does the CAT mean for me?”
Last November, the U.S. Securities and Exchange Commission approved a plan to create a single, comprehensive database to enable regulators to more efficiently and thoroughly track all trading in U.S. equity and options markets. In January 2017, the consortium of Self-Regulatory Organizations charged with developing and implementing the CAT selected Thesys Technologies as the CAT Plan Processor, and the contract was signed in May.
That’s the backstory. Market participants are much more interested in what’s ahead as the CAT moves toward reality. And while the full rollout extends over the next couple years, there will be tangible movement on the CAT front before Thanksgiving.
Coming Up
Thesys, as CAT processor, is meant to publish technical specifications for order life cycle data on November 15. Also on that date, the SROs begin reporting to the CAT. In May 2018, Thesys will publish technical specifications for submission of customer information. Large broker-dealers must begin reporting trades in November 2018; small broker-dealers follow suit one year later.
Market participants and observers generally support the concept of the CAT, i.e. that regulators should have a single view of the marketplace rather than cobbling together different feeds in an attempt to create a full picture. But as always, the devil is in the details, and cost, logistics and security are among CAT aspects that need to be ironed out in the coming months.
Even without full information on how CAT will operate, brokers and exchanges are advised to start preparing now, if they haven’t already started. “Firms should not be waiting for the tech specs,” Robert Walley, principal in regulatory and capital markets at consultancy Deloitte, told Markets Media in a July 21 interview. “They should be sourcing their data and getting an understanding of the challenges of the data. They need to understand what’s reportable from the rule, and they need to start designing and building.”
Predecessors to the CAT include the Order Audit Trail System (OATS), established by Finra in 1998, as well as the Blue Sheets, which contain trading and account holder information that allow regulatory agencies to analyze a firm’s trading activity. Both had utility in their day, but they were not built for today’s complex, high-speed electronic markets.
“There are issues with the legacy trade-reporting environments,” Walley said. “The CAT should retire those legacy platforms.”
CAT NMS LLC, the governing entity for the project, is jointly owned and operated by the SROs, and there is an advisory committee that includes broker-dealers and institutional investors. CAT NMS selected Thesys Technologies LLC as Plan Processor, and the advisory committee is charged with creating, implementing and maintaining the Consolidated Audit Trail and CAT Central Repository.
For its part, Thesys, an eight-year-old provider of high performance trading technology, formed Thesys CAT LLC to focus exclusively on building and maintaining the audit trail. Thesys CAT has about 25 employees, spanning technologists, compliance professionals, business analysts, and project managers, according to Ed Watson, the unit’s chief operating officer.
In a broad sense, previous regulatory technologies didn’t pay enough attention to the right things. That’s according to Mike Beller, chief executive officer of Thesys Technologies, who said the firm focused on three key points in its bid for the CAT business, and continues to focus on the same points as it develops the CAT.
One, Two, Three
“One, make it easy for reporters to report,” Beller said. “That’s where most of the cost is to the industry, not in the building of the system. And feedback has to be immediate and comprehensive -- you don’t want to find out weeks later there was a problem.”
“Two, make the system useful to regulators,” Beller continued. “Regulators should be able to do their jobs with this system because it has the analytics they need to make good decisions about what’s going on in the markets. The system has to do more than just retrieve data.”
“Three, it has to be secure,” he added. “From the very beginning, we innovated in how to make it very secure. We built in security from the ground up, rather than as an afterthought where you put a fence or wall around the whole thing and hope nobody gets through.”
“The CAT is going to be big, and if it’s not done right, it could be a burden,” Beller concluded. “We got involved because we believe it’s possible to build a system that is as unintrusive as it can be, and makes a difference in terms of the regulator being able to see what’s going on and improve the markets. That is our vision.”
On a granular level, Thesys CAT has been conducting industry outreach for the reporting technical specifications -- this has been via one-on-one meetings with the SROs, and open calls via industry groups such as the Security Traders Association (STA) and the Securities Industry and Financial Markets Association (Sifma) for other market participants. Watson said one specific initiative has been clarifying, or ‘level-setting’, terminology for the industry.
As of Aug. 3, Watson said the participant tech specs were complete, and the industry tech specs were under construction. “A big focus has been on allocations,” Watson said. “If you’re doing multiple executions for one client, often times via multiple executing brokers, how do you bring in that different information and make sure it’s reported by the actual buyer or seller?”
“We’re not regulators, so we’re not interpreting the rule,” Watson said. “But one of the tremendous benefits of our meetings is that they help the regulators interpret the rules.”
“It’s human nature to sometimes over-complicate things. We are trying to keep things as simple as possible, but in the spirit of the rules as they are interpreted by the SROs and what the SEC’s intentions are,” Watson added. “This is a very large, complicated project, with a lot of interdependencies, and multiple stakeholders.”
Peter Santori, executive vice president and chief regulatory officer at Chicago Stock Exchange, is CHX’s voting member on the CAT Operating Committee.
“The CAT will give CHX, and all other securities regulators, a comprehensive view of the market for (National Market System) securities in one centralized repository,” Santori told Markets Media. It will also “enable CHX to conduct market analysis and surveillance of activity taking place on CHX as well as throughout the NMS in a manner that was not previously possible.”
Tech Specs
“CHX and the other Plan Participants are working closely with Thesys CAT LLC to develop technical specifications for both Plan Participants and broker-dealer CAT reporters,” Santori continued. “The Advisory Committee of the CAT Operating Committee, composed of 14 individuals that represent a cross-section of industry perspectives, has been actively working with the Operating Committee to ensure that technical specifications are publicly disseminated as soon as possible to provide CAT reporters sufficient time to meet their respective CAT reporting obligations.”
Aside from the logistics and tech specs, another important consideration is cost. Brokers and exchanges face their own costs in syncing up to the CAT, and the development and operation of the sweeping audit trail is another expense that will need to be funded by the industry.
Who pays what is currently in negotiations. This past spring, the provisional plan was for brokers to cover about 75% of the cost, with exchanges -- the SROs overseeing the project -- covering the other 25%. But broker complaints about the split were heard, and as of early July the SEC was reviewing the CAT cost breakdown, according to media reports.
“Not surprisingly, this issue has garnered a fair amount of public comment, industry feedback and Commission consideration,” Santori said in late July. “At this point, the fee issue has not been resolved, but the Plan Participants are working closely with all interested parties to ensure that the resolution is reasonable, equitably allocated among CAT Reporters and not unfairly discriminatory.”
Sifma, which represents banks, securities firms, and asset managers, outlined its concerns about the CAT in a June 16 letter to the U.S. Securities and Exchange Commission.
“Plan Participants have no justification for imposing a CAT fee at all,” the industry group said. “The self-regulatory model in the securities industry is premised on broker-dealer funding, but broker-dealers already provide the Plan Participants a significant amount of regulatory funding through membership fees, registration and licensing fees, dedicated regulatory fees, options regulatory fees, and monetary fines.”
Aside from opposing CAT fees on principle, Sifma also took aim at the proposed 75/25 split. “This is not an equitable allocation of fees for a system that is being created by and for the benefit of the Plan Participants,” the letter said.
“Going further, the scope of the CAT fees is unreasonably broad,” the letter continued. “Broker-dealers should not be required to cover any costs or expenses of the CAT other than the direct costs to build and operate the system itself. Broker-dealers should not be obligated to cover costs that the Participants incur as the cost of doing business as SROs. Yet, under the current proposal, broker-dealers would be required to cover just those sorts of fees.”
Sifma described the proposed fee structure as “designed by for-profit market participants determined to further their own commercial interests. The Plan Participants have constructed a payment mechanism that is intended to benefit their own bottom line at the expense of their competitors, which also happen to be subject to the Participants’ regulation.”
One aspect of the CAT that can be agreed upon by all is that the project is a lift and a cost for the industry at a time of constrained resources. As one recent tongue-in-cheek media headline read, “SEC Stunned to Discover No One Wants to Pay to Be Surveilled.”
Cost/Benefit
Broker-dealers need to be up to speed on multiple fronts, including customer information capture and reporting; order life cycle events data capture and reporting; clock synchronization and time-stamp capture; and process and governance.
But a few years from now when the CAT is in place and brokers and exchanges are up to speed, it should be a net benefit, both systematically and on the firm level. The latter consideration is an intriguing one, in that it can enable a firm to go on offense and leverage the CAT for its own competitive and profit-seeking purposes, not just play defense and meet regulatory demands.
“If you think about it strategically, there is an opportunity to get value out of this regulation rather than just producing another set of trade reports,” said Walley of Deloitte. “Firms can use it for client analytics, for compliance purposes such as surveillance and trading behaviors, for economics of trade routes, and for supporting their best-execution obligations. It’s a very rich data source, so it will give firms a better control environment.”
Added Walley, “And the market will be better regulated.”