The Consolidated Audit Trail finally is back on track. Exchanges were due to begin reporting required equities and options data into the CAT on Nov. 15, and broker-dealers are renewing preparations for reporting to CAT next year. But six years after the SEC ordered the creation of the database, challenges persist.
Despite a one-year delay and missed deadlines, the order-tracking system known as the Consolidated Audit Trail is back on track. Exchanges were due to begin reporting required equities and options data into the CAT on Nov. 15.
Executives speaking at TABB Group’s FinTech Festival on Nov. 1 spoke about the hurdles and opportunities of CAT, including the complexity of linking order data across equities and options, along with cybersecurity concerns about the protection of customer data. They also said there were opportunities to leverage the data in other areas.
“I think this has been a long-time coming,” said Adam Dix, director of regulatory reporting for Kx, a division of First Derivatives plc, who spoke on the CAT panel. “From what we see, this is going to be a reality,” said Dix. On Sept. 30, the customer specification for large broker-dealer reporting was posted. “Everyone knows that this is now final,” said Dix.
However, a Nov. 14 story in The Wall Street Journal raised concerns about CAT’s functionality, including the ability of the huge database to handle the volume of data as well as the ability of Thesys Technologies LLC, the contractor selected to build the database, “to stitch together” all the orders across the marketplace.
In “Stock-Market Supercomputer to Launch with Glitches,” the WSJ said CAT was going to launch the next day with reporting from the exchanges, “but with less functionality than previously anticipated, including limits on how many users can search it.” Though exchanges were scheduled to start reporting data, the Journal reported that “multiple users including regulators won’t be able to efficiently search its records because the volume of data is too great for the structure of the database.”
The SEC ordered the creation of an audit trail system in 2012 after it took the regulator several months to access the data it needed to analyze the sudden decline in U.S. stocks that occurred on May 20, 2010, known as the “flash crash.”
“It sounds like they still have work to do, which is disappointing eight years out,” commented Joseph Saluzzi, partner and co-head of equity trading at Themis Trading LLC in Chatham, NJ. “That’s unacceptable when we have a market structure with 13 stock exchanges; when we had a flash crash and you can’t get to the data quickly,” said Saluzzi.
In 2012, the SEC finalized Reg NMS Rule 613 ordering all the exchanges and FINRA to develop a consolidated audit trail that would collect order, quote and trade data across equities and options into a single database.
One of the main purposes of building the CAT is to help the SEC and FINRA surveil the markets and detect manipulative trading activity across the fast, complex and fragmented market structure.
Regulators are not happy with the progress, said Saluzzi, pointing to public remarks that SEC officials made at an STA event in the spring of this year. “It looks bad for them. While there hasn’t been another flash crash in eight years, what If another market event happens?” he asked. The situation puts the SEC at risk if it has to investigate another event and if it takes months to report to Congress, Saluzzi added.
Speculating on the cause of CAT delays, Saluzzi said it looks like exchanges are trying to slow down the process. The database will provide more transparency into high-frequency trading, he said. “The more eyes you put on the market, the more chances you catch someone doing something wrong,” said Saluzzi. “Maybe that person is a large revenue producer for the exchange.”
To be fair, the CAT is a massive undertaking in capital markets that has never been attempted before.
“Obviously having a consolidated database like that with equities and options will be brand-new. It doesn’t exist,” said Shelly Bohlin, Quality of Markets Section, FINRA’s Market Regulation Department, speaking at the TABB conference. While a lot of infrastructure exists for equities and options, it doesn’t exist for consolidated options and equities, she added.
CAT would capture messages for orders across all markets, from the time of order inception through routing, cancellation, modification and execution, states the CAT NMS Plan website.
Some of the complexity of CAT “is not only getting all the information into a single database but ensuring how the information is linked altogether to capture the lifecycle of an order from the time an order originates through all of its modifications and routes,” said Todd Golub, head of product management at Thesys CAT LLC, on the TABB panel.
Tracking the trajectory of an order includes “partial executions, aggregations, split orders, and all the machinations that could take place through the U.S. equity and options markets,” explained Golub. “That all needs to be collected and tied together from the beginning to middle to end.” This gets even more complicated with linking options data to the underlying equities, he pointed out.
However, Saluzzi questioned why FINRA was not selected to build CAT, and why the SEC had allowed the CAT operating committee, mainly comprised of exchanges, to make the decision. He pointed out that Thesys Technologies, the parent of Thesis CAT, was previously affiliated with Tradeworx, a high- frequency trading firm. [Note: In January 2018, Tradeworx sold off its trading business to focus solely on the growth and expansion of the financial technology business of its wholly owned subsidiary, Thesys Technologies.] “FINRA currently conducts surveillance. They are doing a great job,” said Saluzzi. FINRA builds reports by getting information from various SROs through OATS for Nasdaq-listed securities and Electronic Blue Sheets (EBS) for over-the-counter securities; whereas “CAT is supposed to make it easier, at the push of a button,” he said.
Meanwhile, the delays have caused some tension between the SEC and the exchanges.
Exchanges missed the original start date for CAT compliance on Nov. 15, 2017. Last fall, the exchanges requested another delay for CAT compliance, but that request for relief was denied by SEC Chairman Jay Clayton.
“Chairman Clayton was unwilling to support such an extension request in the absence of a comprehensive and credible work plan,” said Brett Redfearn, Director, SEC Division of Trading and Markets, in a public statement on Aug. 27, 2018. Instead of granting a further delay, the SEC urged the exchanges to work with the SROs on a credible work plan, including verifiable milestones and a detailed time line as well as governance and security enhancements. The SEC received the “Master Plan” on May 25, 2018, in which the SROs proposed five essential phases starting with equities reporting.
Next Up: Broker-Dealer Reporting
Now attention is turning to large broker-dealers that are scheduled to submit their equities data into CAT by Nov. 15, 2019. Brokers will enter orders executed on behalf of institutional clients, adding more order messages into the database.