On Thursday evening, April 20th, FIF held its quarterly event at the top floor of Thomson Reuters Times Square. Approximately 200 FIF members registered for the event, which focused on the hot topic of AI and Machine Learning and how it will/is affecting the financial services industry.  The knowledgeable panel featured Tim Baker of Thomson Reuters, Eng Lim Goh of HPE and Michael O'Rourke of NASDAQ. Following the panel discussion, the attendees and panelists enjoyed a networking reception in a beautiful space overlooking Times Square.  FIF would like to thank our panelists, the attendees and our sponsors: Hewlett Packard Enterprises and Thomson Reuters, for a successful event and an enjoyable evening.

FIF Managing Director, Bill Hebert, spoke on a panel discussing Operational Efficiencies in the Financial Markets at the FIS Connect Conference, held in Kissimmee, Florida from April 10-April 13. The conference was well attended, boasting over 2,000 attendees.

Written by Thomas Jordan, President, Jordan & Jordan

On March 23^rd, while Jay Clayton (Nominee for Chairman of the Securities and Exchange Commission) was testifying before the Senate Committee on Banking, Housing and Urban Affairs, 188 industry participants were attending a meeting of the Financial Information Forum (www.FIF.com) on the Consolidated Audit Trail (CAT).

How are these two events related? The Wall Street firms that are most familiar with the CAT (a consolidated database of all details involved in every stock transaction in the U.S.), such as the requirements for reporting to CAT and the tight timeframe for implementation, are working hard to be ready. Those that aren’t preparing, or are banking on its repeal, may be in for a rude awakening.  Generally, Wall Street doesn’t expect CAT to go away, and here’s why.

We know that Mr. Clayton’s potential boss, President Trump, signed Executive Order 13771 (Reducing Regulation and Controlling Regulatory Costs) on January 30, 2017, to offset the number and cost of new regulations. The Order requires agencies to repeal two regulations for each new one enacted.

While the SEC Rule 613 that originally proposed CAT was formally adopted in July 2012, the plan for CAT implementation was more recently approved under the National Market System (NMS) in November 2016. The question is, if Rule 613 or the CAT NMS Plan were proposed today, would it meet the requirements of President Trump’s Executive Order?

Potential Chair Clayton made clear in his testimony that the U.S. Capital Markets are the envy of the world and that well-functioning capital markets are important to every American. There is zero room for bad actors.

The CAT is intended to support this goal, as noted by the SEC in approving the Plan: “The Commission believes that the Plan is reasonably designed to improve the completeness, accuracy, accessibility and timeliness of order and execution data used by regulators. The Commission believes that the Plan will facilitate regulators’ access to more complete, accurate and timely audit trail data. The Plan will also allow for more efficient and effective surveillance and analysis, which will better enable regulators to detect misconduct, reconstruct market events, and assess potential regulatory changes. As a result, the CAT NMS Plan should significantly improve regulatory efforts by the SROs and the Commission, including market surveillance, market reconstructions, enforcement investigations, and examinations of market participants. The Commission believes that improved regulatory efforts, in turn, will strengthen the integrity and efficiency of the markets, which will enhance investor protection and increase capital formation.”

Does CAT meet the “Two-For-One Trump Test”?

The data that must be reported to CAT goes far beyond that which is currently OATS-reportable (FINRA’s Order Audit Trail System), as it will include options transactions, allocations reports and detailed customer information; and, CAT requires reporting by industry members that were previously exempt. Given how extensive, invasive and expensive these reporting requirements are, does the CAT NMS Plan and the underlying requirements set forth by Rule 613 meet the “Trump Test” calling for the elimination of two regulations for every one introduced?  Well the good news is, if it is done right, CAT can eliminate OATS, COATS (FINRA’s Consolidated Options Audit Trail System), PHLX Rule 1022, as well as other exchange rules and key portions of Electronic Blue Sheets (EBS) and Large Trader Reporting (LTR).  Over the long term, as CAT continues to accumulate data and incorporate other asset classes such as debt securities and additional transaction types, it can eliminate all of EBS, LTR and many other current regulatory reporting requirements.

Getting It Right

This requires thoughtful interpretation of rules, carefully designed specifications and realistic schedules. Along with a concerted effort by the industry and the regulators to work together, here are some key considerations:

• A defined reasonable timeframe for the retirement of regulatory reporting rules/systems which are duplicative of CAT reporting, especially focusing on OATS, EBS and LTR. The industry is working aggressively to ensure all prior needs are included or added to the CAT requirements or excluded where it is agreed there is no discernible benefit. The biggest fear is that some legacy system must survive because one or two minor data points were overlooked in building CAT. Duplicative reporting to legacy regulatory systems and to CAT must be as brief as possible to lessen the cost and burden to the industry.
• All the Participants must deliver proposals to the SEC by May 15 describing their approach/criteria to eliminate or modify their duplicative reporting systems.  While reporting Industry Members (broker dealers) are clearly focused on retirement of OATS, we wonder if FINRA’s plan will include the fields more recently added to meet Rule 4554 requirements for ATS Reporting.
• EBS cannot be retired in the near term because the scope of EBS is wider than the coverage CAT will provide in its early phases. EBS requires a historical data set that CAT must build over time, as well as certain asset classes such as fixed income that will not be included in CAT initially. While there are over a dozen fields of data required by EBS that were not mentioned in the CAT plan such as branch/registered representative number, solicited codes, broker-dealer codes, employer name, contra party, etc., working together as an industry will ensure that all fields deemed necessary going forward for regulatory purposes are included in the initial specifications.  That said, use of CAT by the regulators to query more recent equities and options transactions will offload some of the burden on industry members in responding to multiple EBS inquiries from the regulators and can initiate the start of a 6-year historical retention requirement. 
• LTR elimination will require discussions with SEC staff to determine what additional fields, if any, must be included in CAT to support the Commission’s objectives in identifying and monitoring large trader activities.
• The specific requirements for allocation reporting have not yet been defined; we await reasonable regulatory decisions on capturing timestamps in the workflow so they are consistently reported and provide any real value or insight into market activity.  

Will the Reporting Burden be Decreased or Increased?

That depends on who you ask, and when you ask.

Under the requirements of Rule 613 and the Plan, all broker dealers with total capital of more than $500K must submit data to CAT’s central repository by November 2018. Many firms that are currently exempt from reporting under existing regulations such as OATS, will be required to report in this timeframe.  And, by November 2019, even the smallest broker-dealers will be required to report to CAT.

There are approximately 4022 broker dealers with 1800 anticipated to have CAT reporting responsibilities (per the CAT NMS plan Cost Analysis). Approximately 1000 firms report to OATS today, which means that there are roughly 800 broker dealers, options market makers, ELPs, and Floor brokers who are exempt today from OATS that must report under CAT.

Recommendations have been made by industry members to alter the implementation phases so all firms that are currently OATS reporters will be included in the first round of member reporting, and all non-OATS reporters will be included in the second round, regardless of firm size. Other industry recommendations would allow firms that meet high quality standards for reporting data to CAT, be relieved of their duplicative reporting obligations, even prior to formal retirement or elimination of regulators’ legacy reporting systems.  We are hopeful that the CAT requirements may continue to evolve such that these and other practical recommendations may be incorporated to hasten retirement and/or reduce the burden of regulatory reporting on industry members.

Many of the larger firms that currently have multiple reporting obligations believe that, over the longer term, CAT will provide benefit to both the industry and the regulators. Ultimately, CAT will enable elimination of a variety of regulatory reporting systems as they are replaced with the comprehensive CAT system; however, until such time, the costs and burdens to implement CAT will be significantly increased, and magnified if duplicative reporting is necessary for an extended period of time. Therefore, the most important priority of the larger industry members is the expeditious elimination of duplicative reporting obligations and rapid transition to CAT as the “consolidated” single regulatory reporting source, which firms hope will streamline the process and provide cost savings over the longer term.

The smaller industry members who are currently exempt from many forms of reporting are faced with a different reality, and will likely seek assistance from their service providers.

Opportunities for Expanded Services

Best positioned to offer CAT-reporting services could be Order Routing Vendors (expand from OATS), Clearing Firms (expand from EBS) and Service Bureaus. We expect that new industry utilities will be created to support CAT reporting. By leveraging existing processes, such as FIX platforms to receive all orders, cancels, executions etc., the cost can be minimized when delivered on a consolidated basis. New services can also consume CAT data to support other regulatory functions such as reporting pursuant to SEC Rules 605/606, firm surveillance and TCA.

Breaking New Ground

CAT requirements for reporting of detailed customer information will push the industry into territories that have not previously been explored.  While the use of a “firm-designated id” rather than a universal code for each trading account and beneficial owner does represent a reasonable compromise made by the SROs, FINRA, SEC and the industry, this aspect of CAT reporting remains a major concern from a data security and an implementation perspective.   Every firm has a daunting task to ensure that their customer databases are able to link the complex relationships and identifying information that must be reported to CAT – information such as persons with documented trading authority for each account, trustees and beneficial owners, interested parties, etc. All firms have historically been challenged to ensure accurate customer linkages across front, middle and back office systems where multiple identifiers are often utilized for the same customer.   This can require significant analysis and reconciliation.I suggest that all firms focus on their customer account information immediately, to ensure they are fully prepared to upload all active accounts to CAT when required (currently scheduled for October 2018 for large industry members). 

Moving Forward

I am encouraged for the potential outcome. FIF, SIFMA and STA are working with the regulators on a pro-active basis. There is a very competent CAT Advisory Committee in place, providing input to the SROs. The new SEC Commissioner nominee understands the importance of thorough but cost efficient regulation.

This may not “Make Regulation Great Again” but it is a positive step for the industry and investors, if we implement CAT correctly.

On Tuesday, March 28^th, FIF held its annual in-person Advisory Board meeting in New York City.  The Advisory Board / Committee includes 13 participants representing a variation of member firm profiles and subject matter expertise in regulatory, technology, trade execution quality, front and back office processing, and other areas.

Committee members and FIF Management were very pleased with the results of the dialogue and broad based input from those present, specifically with regard to current and future initiatives, strategic partnerships with other industry associations, and the support and growth of FIF membership.

FIF has formed a Mark-Up/Mark-Down working group to address the implementation of recent enhancement to Mark-Up/Mark-Down Disclosure Rules (MSRB Rule G-15/G-30 and FINRA Rule 2232).  If you would like to be added to the working group, please contact the Program Office at fifinfo@fif.com.