Getting Ready for the Consolidated Audit Trail

Blog entry

One of the most detailed discussions of the recent A-Team Group RegTech Summit in New York centred around the arduous ongoing journey towards implementation of the long-delayed Consolidated Audit Trail (CAT). Approved by the US Securities and Exchange Commission two years ago to the day (November 15, 2016), the CAT aims to create a single database to accurately track securities trading through the US National Market System (NMS, the nationwide system for trading equities in the US). The path has not been smooth, however – and the challenges and benefits of the new regulation were thoroughly evaluated in this wide-ranging debate.

Moderated by Tom Jordan, CEO of Jordan & Jordan, the expert array of panellists included Joshua Beaton, Head of Americas Trade & Transaction Reporting (and CAT Program Manager) at Morgan Stanley; Srini Masanam, Head of Trade Surveillance & CAT Program at Jefferies; Maria Zeckhausen, Director of Equity Technologies Americas Strategic Project Management at Credit Suisse and Salvatore Sferrazza, Solutions Architect at Google.

First adopted by the SEC in 2012, Rule 613 of the NMS regulation required the US Financial Industry Regulatory Authority (FINRA) to work with the national securities exchanges (collectively, SROs) to submit a plan for the CAT by April 2013 – a deadline that was repeatedly delayed by the SROS, until finally an initial plan was submitted in September 2014 with three rounds of amendments added over the following two years until final approval in November 2016. But the delays have continued. Under the SRO plan the first phase of reporting (for the SROs themselves) was due to begin in November 2017 with the second phase (covering most other industry members) starting in November 2018 and the third phase (covering small industry members) in November 2019. Just before the start date last year however, the exchanges requested a yet another delay – and the SEC began to lose patience, with Chairman Jay Clayton warning that he would not support yet another extension. Although the extension was not granted by the SEC, a further ‘Master-Plan’ was submitted by the SROs in May of this year, which set the first phase of reporting to finally start on November 15, 2018 – the exact same day as the A-Team Group event, making it a particularly memorable occasion.

And the panel certainly made its feelings clear from the outset.

“It’s game time,” declared Jordan. “Anyone who has been cynical in the past about CAT, it is time to put aside that cynicism. The proof of the pudding is today.”

Most importantly for most of the delegates in the room of course was not the 2018 deadline but the deadline coming up a year from now, when broker-dealers will be required to start reporting.

“People have tried to get delays, but it’s not happening,” warned Jordan, citing the example of ‘Large Trader Phase III’ – effectively an exemption of the SEC Large Trader Reporting Rule that the SEC extended to traders from October 2017 to November 2018 to give broker-dealers time to focus on meeting their CAT compliance requirements. This temporary exemption expired on the day of the RegTech Summit, the same day that the first CAT reporting phase kicked in, and Jordan stressed that: “If you’re a broker-dealer, you will be violation of the rule as of today, because nobody has it done. We’ve always had delays before, but the SEC has taken the position that they are not delaying it anymore – they are going to hold your feet to the fire.”

He continued: “If you think there is no consensus in Washington on anything right now then you’ve got it wrong. On CAT, there is consensus – people really want to get it done! Even commissioners who want to get rid of regulation support this, because with CAT you can actually get rid of other regulations as a result. So it’s moving forward, and if you are a broker-dealer you really need to be working on this urgently.”

One of the most important elements for organisational compliance is of course the significant data management challenges that come with CAT reporting. So how have organisations attempted to address this?

“At Morgan Stanley we have tried to think about this holistically – this is not the first regulatory report that we’ve done and we want to learn the lessons from other reports that we have implemented around the globe over the last few years,” noted Beaton. “When we talk about CAT we are not just talking about the controls on the data we are going to do just for CAT, but about the controls we will have in general. What are the best practices for controls on a regulatory report in general, where do they fit in terms of CAT and how do we apply those? If you don’t have these controls, you will end up with significant data problems.”

Jefferies has also taken a holistic approach. “Across the firm we have different data marks for different use cases,” explained Masanam. “How can we consolidate these data marks into one data lake that can serve all these use cases across the firm? That is our driver, and it will deliver value in the short term for CAT but also in the long-term for regulatory reporting.”

Zeckhausen highlighted additional challenges around the new types of data that are being introduced, citing additional requirements for customer-related data, while Sferazza stressed the importance of management buy-in. “Firms that are successful in their CAT programmes are really ones that have executive sponsorship from the top,” he noted. “Any legacy system is going to have data sprawling all over the organisation. It is important to consolidate all that into one place, and then you get side benefits from that. This goes way beyond CAT, and firms should look at it as a transformative opportunity.”

Another contentious issue was the problem of regulatory expectation – and especially, the lack of consideration that broker-dealers feel they have received from the creators of the CAT plan.

“The SROs do not seem to have a good appreciation for how broker-dealers operate, or any recognition that among broker-dealers there are differences – we all have our own organic systems and different ways of using them,” pointed out Zeckhausen. “Decisions that they make that might look to be getting them what they want could actually introduce significant complexity for broker-dealers in terms of implementation.”

A key example cited was the new requirement for a Firm Designated ID (FDID), defined in the CAT NMS plan as: “A unique identifier for each trading account designated by Industry Members for purposes of providing data to the Central Repository.”

“Each firm interprets this requirement differently, and it can be confusing,” said Masanam. “Why is the regulator asking for this and what are they going to use it for?”

“The FDID is a good case in point - there is a lot of ambiguity in the FAQs,” agreed Zeckhausen.

“The definition of FDID was three lines long and is probably the most egregious example, but there are dozens of fields on which we are still looking for clarification,” added Beaton. “The specifications that we received certainly have some holes in them. One of the challenges that we will all collectively have is sorting out how to proceed, given this uncertainty.”

This very confusion, suggested moderator Jordan, is why there is hitherto been such a prolonged delay in implementation – and why industry collaboration is so important in order to progress with the reporting requirements. “Why would you expect an SRO to understand the post-trade allocation process? They’ve never had to worry about that before. That’s why we have to bring the broker-dealers together,” he emphasised.

Finally, no matter what the individual complexities of implementation, a far more immediate issue is the absence of communication or understanding of the regulation to a wider audience. One of the eventual goals of CAT, for example, is to replace the existing Order Audit Trail System (OATS) – but that throws up its own challenges. It is estimated that around 1800 firms will have to report under CAT, while only around 1,000 currently report under OATS. “That is 800 more firms that don’t report right now and will have to start. It’s a big deal,” warned Jordan.

“I don’t think there is much recognition at all in the marketplace itself that this regulation is coming,” agreed Zeckhausen. “How many people (aside from those of us who work on this) really realise that when customer reporting starts, you as a retail investor with a brokerage account will see your personally identifiable information (except possibly your social security number) reported into a high value target like Equifax, with all the security risks associated with that?”

Sferrazza added: “I think all the SROs have done a pretty poor job with PR and with getting people excited about CAT. There have been a lot of sticks but no carrot. From a regulator to regulated perspective, there has not been a whole lot of incentive to go above and beyond the letter of the law.”

Together, the panel agreed that communication going forward would be a key issue in the success of the CAT initiative.

“It’s a huge issue and it hasn’t been addressed. The word has to get out there and we have to figure out as an industry how to do that,” concluded Jordan.