A centralizedsystem for tracking equities and options trades is within sight, almost four yearsafter a Regulation NMS rule requiring it was adopted.
The consolidatedaudit trail, or CAT, will make a huge trove of trading data available to the SECto investigate market failures in unprecedented detail. Regulators view it as anecessary tool for understanding today's equity and options markets, which transactat sub-second speeds across dozens of trading venues.
However,some analysts question whether the CAT's design goes far enough to capture the interconnectednessof equities trading. Many industry observers also say the CAT's strict reportingrequirements will force broker/dealers of all sizes to undertake costly upgradesto their databases and recordkeeping systems.
Rule613, a later addition to Reg NMS, mandated the system's creation in 2012. The proposal'sslow progress toward public comment has frustrated market watchdogs and reform-mindedpoliticians; in a March 3 Senate subcommittee hearing, Sen. Mark Warner, D-Va.,bluntly told SEC officialsthat his patience was wearing thin. The SEC released the CAT proposalfor public comment less than two months later. The proposal is "a major marketmilestone," SEC Chair Mary Jo White said in a prepared statement issued April27.
An SECspokeswoman declined to comment on the record for this story.
The Order Audit Trail System, or OATS, is the currently usedaudit trail founded by FINRA's predecessor, the National Association of SecurityDealers. But it was built alongside the electronification of markets in the mid-2000sand needs replacing, said Alexander Tabb, partner and COO of the research firm TabbGroup.
Broker/dealers and the exchanges would collect data constantly,then upload the information to a central repository once a day. If a serious marketfailure occurred while the CAT was in place, regulators could investigate its causein unprecedented detail. "It is really a post-event surveillance engine,"Tabb said. "It will allow regulators and [exchanges] to really peel back theonion and understand what happened."
Blazing a trail
The audittrail would record information about each trade and message that occurs in the stockand options markets, including the identity of counterparties. Data would be collectedfor stocks traded in lit exchanges, like those operated by Intercontinental Exchange Inc., Nasdaq Inc. and BatsGlobal Markets Inc., as well as securities traded over the counter,according to the SEC's press release.
Exchangesand broker/dealers would record the information throughout a trade's lifecycle,from origination through routing and execution or cancellation.
The exchangeshave been tasked with selecting a plan processor to develop and maintainthe CAT from among the three final bidders: FINRA; SunGard, now a part of ;and trading data firm Thesys Technologies.
Tabb and others praised the proposal for the sheer volume ofdata it will provide, but conducting the analytics to make the data useful couldprove difficult. While the SEC will conduct some analysis in-house, Tabb noted thatthe plan processor chosen to build the CAT will also provide a data analytics package.The plan processor's role in analyzing the data, not just building and maintainingthe repository, has not been described in detail, he added.
David Weiss, an Aite Group analyst who covers market structure,said the SEC has not used data collected by its real-time monitoring system, theMarket Information and Data Analytics System, or MIDAS, to great effect.
"[The CAT] could be incredibly useful, but to what end?We had a flash crash, we have lots of mini-flash crashes, and there's not a lotdone about that," he said. "One really can't point to an incredible consumptionand processing of data on the part of the SEC."
The sophisticationof the data provided by the CAT could be a double-edged sword — its granularityis what will allow regulators to investigate market failures, but the cost of providingsuch detail will fall on broker/dealers' shoulders.
The computingsystems needed to comply with the CAT will be costly for broker/dealers of all stripes.Many smaller brokers excluded by OATS would come under reporting requirements forthe first time, the commission noted in the proposal's text. The larger tradingfirms' costs will come from the complexity of upgrading their existing databasesand messaging systems.
The dataa broker sends to the CAT must be timestamped, at a minimum, to the millisecond.If a firm typically trades at a faster speed, as high-frequency trading firms do,their data must adhere to that speed instead. Traders that still execute manualtrades can send data broken out to the second.
The proposedrule would also require all traders and exchanges to set their clocks to within50 milliseconds of a standardized time source, Georgetown professor James Angelsaid. "You have to be at least as precise as one millisecond — however, yourclock might be 50 milliseconds off," he explained.
The costof recording data scales with the level of detail required, he added.
Manybrokers are not collecting the data to the millisecond, according to Tabb. "Creatingthe mechanisms to do that could be significant, especially for the larger institutions,because they've got a lot of systems," he said. While a millisecond is nowa long period of time in securities trading — Nasdaq does billions of dollars' of equity trades in that period— buying recordkeeping technology of that speed could be particularly costly forsmaller brokers.
Mostsmaller broker/dealers would experience significant costs in reporting to the CAT,according to the proposal's text. Preliminary estimates made by the SEC peg thecost of reporting data, spread across the roughly 1,800 participating brokers, at$1.5 billion per year.
Brokerswould also continue reporting to OATS until it is phased out, a process that couldtake two and a half years. Duplicative audit trail data reporting could cost broker/dealersin excess of $1.6 billion per year, the proposal's text indicated.
Someparticipants will have more time to prepare than others. Small broker/dealers, definedby the SEC as those with less than $500,000 in total capital, would have three yearsfrom the CAT's adoption to prepare, while larger brokers would have two.
Despite the scope of the data on stocks and options to be collected,some say the exclusion of futures means a major component of today's equity market,exchange-traded products, cannot be monitored fully.
Just like the hedge for a single stock is an option, tradersuse futures to hedge their ETF trades, Weiss explained. "If you don't havefutures now, let alone three years from now, you're not getting the full view onthe hottest stock index products being traded now," he said. In March alone,investors poured $32.86billion into ETFs.
To form a fully consolidated data set that reflects modern multiassetstrategies, Weiss added, foreign exchange, Treasuries and other fixed income needto be included. But a major barrier stands in the way of that holistic approachto capturing market activity: the separation of market oversight into the SEC forstocks and options, and the Commodity Futures Trading Commission for futures.
"They're different groups, and when was the last time youever saw Washington agree to dissolve one of their own?" Tabb said, referringto the need for a consolidated regulatory body. "It makes perfect sense forfutures to be wrapped up in this, but it's just not going to happen."