The Consolidated Audit Trail soon will be a reality in the U.S. equity and options markets. Markets Media spoke with Jess Haberman, a Senior Vice President and Compliance Director at Fidessa, in a Sept. 8 interview for a snapshot of how things currently stand and an assessment of the looming challenges for market participants.

Haberman, a 16-year Fidessa veteran, started his career with the National Association of Securities Dealers (now FINRA), and also held compliance positions with several broker-dealers. As one of the biggest regulatory projects that the industry has ever undertaken, Haberman said CAT will require more effort than previous initiatives because it impacts many more industry participants, including front and back office providers and every broker-dealer and exchange that receives or creates orders in equities and options.

 

What are some unresolved issues pertaining to the CAT?

One non-technical issue that needs to be addressed is billing. This is an expensive undertaking so it is not surprising that there is some controversy about funding. The exchanges and FINRA filed rules specifying how much their members will pay. These SRO rules create a tiered fee structure in which the fees charged to exchanges and ATSs would be based upon the level of market share while the fees charged other Industry Members would be based upon message traffic. Some broker-dealers think that the proposed allocation of costs is unfair and weighted heavily in favor of the exchanges. Remember the exchanges will also need to make CAT reports and are seen by some as competitors to broker-dealers.

The arguments set forth by those Industry Members, especially SIFMA on behalf of their members, were compelling enough that the SEC suspended the rules filed by the SROs, meaning they cannot be put into effect, and ordered proceedings to determine whether or not to approve them.  Meanwhile the CAT processor is doing a lot of work, but hasn’t gotten paid. So far this has not put implementation dates at risk.

Another somewhat controversial issue is the SRO plan for retiring duplicative requirements, like OATS and the electronic blue sheets. Broker dealers want these duplicative requirements retired quickly because they are expensive to maintain. The SROs published rules specifying how these systems will eventually be retired; perhaps they can be characterized as proceeding with caution. In response to industry comments  the SEC recently ordered other proceedings to determine whether or not to approve these rules.

Otherwise CAT is going full steam ahead. Consider that it has been more than five years since SEC Rule 613, which required the SROs to create a CAT plan, was approved. The CAT plan was approved on November 15, 2016, and since then the CAT Processor was chosen – IBM and Thesys. A new company then had to be created and staffed. This led to  the publication several months ago of technical specifications for exchanges and FINRA who must start reporting in two months, beginning November 15, 2017. The SROs are in the process of finalizing and testing their software, and have started to report test activity to the Processor’s user acceptance testing (UAT) environment.

On September 7 the CAT processor published the first draft of the technology specifications for other industry participants. That was a significant milestone. These are first-draft specs so they are understandably incomplete. There will likely to be a lot of feedback and discussion between now and November 15, when finalized technical specifications are due to be published. Most broker dealers will have to start reporting to CAT in 14 months, on November 15, 2018.

What about CAT might the industry be underestimating?

I’m not sure whether it is a matter of underestimating but more one of timing. Industry participants know CAT is a very large undertaking that will require significant resources in the form of staffing and money. Participants may be inclined to push off decision making until next year, closer to the implementation date. But budget planning for 2018 is likely to start soon, and firms need to take into account their needs for CAT as part of that process. If firms are going to develop the reporting software themselves, they need to start now.

When firms begin to make preliminary estimates for CAT staffing and resources, a good place to start is by looking at the current expense of OATS. Participants can determine how much they currently spend on OATS for both staff and other costs and know they will need at least that much, and likely significantly more to support CAT. And they can’t just move staff around because they’re going to have to support both for at least a year or two, possibly more.

Even if firms outsource the software development required to create the new reports, they should consider staffing increases well in advance of November 2018. Firms will need to  have to have procedures in place to make sure that these new CAT reports are complete, accurate and timely. And FINRA rule 6880 requires members to start testing with the Central Repository not later than August 15, 2018, noting that such testing can start as early as May 15, 2018. Even if third party vendors have created the software and are testing on behalf of broker-dealers, firms should make sure the test scenarios are complete and cover their business. To do that firms will need to be familiar with the CAT technical specifications. That can start now and firms may want to provide feedback to the CAT Processor, particularly around challenges they face with OATS reporting, to ensure that the technical specs will address the issues they’ve experienced with OATS..

The other thing firms should do now, even if they plan to outsource software development,  is take an inventory of every system they use to accept or create, execute and route orders and quotes in OTC stocks and NMS stocks and options, allocate shares to accounts, and maintain customer account information.

They will need to make sure the “owners” of those systems create the required reports or determine otherwise how the reports will be created. And they should consider whether the data from these disparate systems can be combined for CAT reporting and other purposes.

What are some elements of CAT that are new to the industry?

The CAT processor is going to know everything about the purchase and sale of stocks and options including the name, address and social security number of the customer. That type of private information wasn’t required for OATS.

Other new elements pertain to allocations, market-making and US options.

How will CAT affect workflows on trading desks?

While most activity in the market is low touch and as a result straightforward, some orders are still handled by a human trader and these high touch workflows are still very manual. These workflows may need to be reconsidered and possibly changed.

Consider that CAT will require linking the orders sent to exchanges and other market centers to the customer order the trader is working.  Today, traders sometimes enter representative orders manually into Execution Management Systems that are routed to external markets. When trades come back they are allocated to customer orders residing on another system, the Order Management System. There is sometimes no electronic link between the two systems and as a result it will be challenging to create the required CAT reports for the representative order sent to the exchange. That representative order will need to include the customer order ID, which will be challenging especially if that representative order wasn’t filled.

Either the Execution Management System will need to be changed to accommodate new fields representing customer order information that the trader will need to manually enter, a less than optimal solution that traders are not likely to embrace and would be prone to user error, or electronic linkages will need to be created between the OMS and EMS (or firms will need to migrate to other systems used that already utilize these linkages).

How would you sum up the CAT state of play?

After years of deliberation CAT is moving quickly to the implementation phase. Firms should consider engaging internal stakeholders to determine staffing and funding for next year, review technical specifications and provide feedback to the CAT processor, inventory systems that will be required to produce CAT reports and perhaps most importantly, determine if any workflows need to change.