It is unclear whether US exchanges and the Financial Industry Regulatory Authority (Finra) will modify an existing trade repository or start from scratch to implement a consolidated audit trail (CAT). Equity markets are in for some big changes either way.
The Securities & Exchange Commission (SEC) voted to approve the CAT on July 11, and a final rule was released yesterday. Self-regulatory organisations (SROs) have 270 days, from the rules publication in the federal register, to submit to the SEC a plan to track trades in all US exchange-listed equities and equity options.
The trade data is to be linked to relevant cross-market identifiers for broker-dealers and national exchanges, along with the customers or customer advisers for whom the trades are executed.
Much of the reporting burden will fall on broker-dealers, who report trading information to different repositories depending on the type of trade and exchange. Equities traded on Nasdaq, for instance, are reported to the Order Audit Trail System (OATS).
Michael Corrao, head of equity compliance at Knight Capital, believes the new CAT will require a significant technology effort by the SEC, the exchanges and brokerage firms. I think it is going to be very challenging, Corrao said.
Firms are going to need to evaluate the need for additional resources to help meet the requirements of the rule, Corrao said. I expect firms will seek to add programmers and compliance positions for their CAT efforts.
Lawyers and finance experts told IFLR it made more sense to upgrade the OATS system than build a new CAT. The SECs final rule noted OATS had trading gaps: a lack of data from Finra non-members, market-making quotes, data from other repositories, options data and customer identities.
Broker-dealers already using OATS will still have to make major changes in their coding and reporting infrastructure if the eventual CAT turns out to be an OATS upgrade rather than an entirely new programme.
I expect the industry will not convert existing OATS programming to the CAT requirement, Corrao said. I believe it will be much easier to start with a clean slate.
Broker-dealers were relieved by the SECs decision to forgo a real-time reporting requirement in the proposed rule, and instead allow all trading activity to be reported by 8am the following morning. Concerns remain over the reporting of customer identities, though.
The SEC rule provides for policies and procedures designed to protect confidential information, but the specifics will have to wait for the SRO plan.
WilmerHale partner Elizabeth Derbes said there has been some controversy over the requirement to assign a unique customer identifier, and it is unclear how customers will be defined for this purpose, as the SEC seems to have backed off the proposed definition that focused on the beneficial owner of an account.
There was also some concern expressed in comment letters over the possibility that customer investments could be leaked to the market, allowing other investors to frontrun against a customers position.
The information collected through the proposed CAT will only be available to and used by regulators for regulatory and oversight purposes, therefore eliminating the threat of frontrunning, a BATS Global Markets spokesperson said in a response emailed to IFLR.
Impact on equities
SEC Chairman Mary Schapiro pointed to the so-called Flash Crash of May 6 2010 and the four months it took economists to organise trading information needed to analyse the cause of that days volatility as reason for the CAT.
Schapiro said a CAT would make it easier to investigate illegal trading activities, monitor market structure and be better informed on the impact SEC rules have on trading activity. She also mentioned that a CAT could eliminate the need for some current reporting requirements during the SECs open meeting on the rule.
Better enforcement of fraudulent activities and more informed policy-making could increase investor confidence.
We are optimistic that the SEC obtains the desired results of CAT reporting and that in the end investors will feel more confident and comfortable in trading in the equity markets, Corrao said.
Georgetown University financial markets professor James Angel, who has testified before Congress on high frequency trading, thinks the equities market will become more consolidated as a result of compliance costs specifically larger broker dealers will squeeze out some of the smaller ones.
The SECs rule requires SROs to establish an advisory committee to inform their jointly submitted plan on the CAT. The rule leaves a lot open for exchanges regarding form and implementation.