Looking Ahead to the Consolidated Audit Trail

Compliance technology expert and former PricewaterhouseCoopers risk partner Harshad Pitkar examines the continuing saga of the development and adoption of the Consolidated Audit Trail (CAT), as the US financial services market gears for its largest ever data transparency initiative.

The aim behind CAT and the role of the industry

The CAT will track orders throughout their life cycle and identify the broker-dealers handling them, allowing regulators to more efficiently track activity in eligible securities throughout the US markets. The primary goal of Securities and Exchange Commission (SEC) rule 613 is to improve the ability of the SEC and Self Regulatory Organizations (SROs) to oversee trading in the US securities markets.

The CAT Plan requires the establishment of an Advisory Committee charged with advising the Participants on the implementation, operation and administration of the CAT. Under the Plan, the Advisory Committee has the right to attend Operating Committee and Subcommittee meetings (unless they are held in Executive Session) and submit its views prior to a decision by the Operating Committee. The composition of the Advisory Committee includes: (a) broker-dealers of varying sizes and types of business, including a clearing firm; (b) an individual who maintains a securities account; (c) an academic; and (d) institutional investors.

Where is CAT now?

Just when it seemed that CAT matters had finally settled down, industry members received a barrage of text messages, tweets and emails on January 31, 2019, informing them that Thesys, the CAT processor selected by the operating committee, had been fired. It was confirmed later that the responsibility to build and operate the CAT was to be transitioned to a new entity to be appointed later.

Although not yet officially announced, it is expected that the Financial Industry Regulatory Authority (FINRA) will be the new CAT processor. Despite market misgivings about the ability of Thesys to deliver the project, the news still came as a surprise to most industry participants.

Thesys is a relatively small technology firm (which had successfully developed the Market Information Data Analytics System for the Securities and Exchange Commission) and was selected in 2017 as the winning bid in competition with several larger and more established players, including FINRA and Google. Thesys was an unexpected winner and its election was welcomed by many in the industry who saw this is an opportunity for a disruptive firm to use emerging technologies for a solution that would eliminate some of the issues that plague the legacy trade reporting solutions (e.g. OATS, Bluesheets).

Conversely, many others in the industry were disappointed. They believed that a win for FINRA would result in the regulator enhancing OATS to support additional CAT requirements, which would prove to be a faster, less expensive (but arguably less effective) option for the industry.

CAT’s life cycle so far

A journey through the key events in the development of CAT so far:

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What happens next?

The decision makers, CAT NMS LLC, are yet to officially announce who the new CAT processor will be. However, during a recent industry webinar (February 20, 2019), they did publish the following key updates:

• Successor plan processor not announced.

It was communicated that the successor plan processor has not yet been officially selected, but a “potential” successor has been identified. Further details regarding the new plan processor and exact transition plans were not revealed.

• No changes to industry member technical specifications.

The participants confirmed that the successor plan processor will continue to use the final industry member technical specifications published in October 2018 (version 1.0). No material changes to the specifications are expected outside of resolution and other outstanding issues.

• Error feedback and correction mechanism to be included.

It was confirmed that much-desired functionality to facilitate error feedback and correction mechanism will have to be supported by the successor plan processor.

• Updated rollout plan.

The updated rollout plan for phase 2a and 2b for large broker-dealers, which further breaks down the implementation for these two phases into four sub-phases:

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More details on the above phases and dates can be found on the CAT NMS Plan website.

In addition, the participants also confirmed that given the above, a “Regulatory conformance period” was no longer necessary. Details pertaining to Phase 2c and 2d, and updated timelines for small broker-dealers, have not yet been communicated.

Further delays ahead?

During the recent industry webinar, the participants made it clear that they do not expect any changes to the above rollout plan. However, I believe that a six to nine month delay is highly likely for the following reasons:

• Transition to a successor processor will be complex.

The participants and the successor plan processor have been discussing the transition details and its associated complexities for a while now, even though the official announcement was made on January 31. In spite of this, critical questions remain unanswered, which may lead to further delays. Will the successor plan processor take over and use the technology infrastructure, architecture and software (technology assets) already developed by Thesys? In my view, the successor processor will probably leverage some components of the technology assets and build others based on its preferred standards and protocols. Even if the successor processor decides to leverage all of the technology assets, it will not do so without a detailed review and assessment of functionality, stability, scalability and security. Regardless of which option is chosen, the transition to the successor processor will be time-consuming and complex.

• Large number of outstanding issues.

Although technical specifications have been finalized, more than 100 issues have been raised by industry members, which have yet to be resolved. Expedited resolution of key issues (e.g. finalized guidance on FDID) is critical in completing the development effort.

• Error correction and feedback mechanism can be complex to build.

As mentioned above, the participants have confirmed that the successor plan processor will be required to include functionality to support error correction and a feedback mechanism. This is a much-desired functionality by the industry, but will be complex to build properly. Ensuring robust functionality within the specified timeframe seems aggressive and potentially unrealistic.

What should the industry do?

The industry has faced uncertainty with CAT from day one and recent events have not helped. However, in spite of all the obstacle, two things are certain:

• Delay or not, CAT is not going away. Also, OATS will not be enhanced as part of the CAT rollout.
• CAT reporting requirements were going to be complex, they are complex and will continue to be complex. No time is long enough to develop a robust reporting solution (firms have been reporting OATS for 15 years and still get it wrong).

Given the above, the industry should consider the following:

• There will be no more delays.

The proposed elongated rollout plan helps, but the go-live dates still look aggressive. Firms should continue development as planned for Phase 2a and 2b as if there will be no more delays.

• Focus on building strong data quality framework.

The concept of a data quality framework for trade reporting has not previously been embraced. This explains the issues that firms have to face on a daily basis with existing reports (e.g. OATS, LOPR). Given the increased volumes and complex requirements for CAT, these issues will only be magnified in the absence of a good data quality framework. A strong and robust data quality framework will greatly reduce breaks and errors, and will also speed up testing and user acceptance testing (UAT) efforts.

• Focus on simple flows first.

From day one, my suggestion to industry members has been to focus first on simple order and trade flows. Regardless of the type of firm, a majority of the order volume at large and small broker-dealers consists of simple order flows (e.g. where an order is routed away without any splitting or bunching, or an order is crossed internally). Given that these simple flows contribute to a majority of the volume, handling them successfully will be a big win. Complex order flows (e.g. multiple entity/desk/system hops, splitting/bunching), which typically account for 10 to 20 percent of the order flow, should be handled separately. In my experience, firms tend to focus too much on complex order flows and end up creating a complex code base to handle all order flows, which leads to issues and delays. I am not proposing that complex order flows should be ignored, but they should be handled separately once simple order flows have been developed successfully.

• Be engaged, proactive and aggressively voice concerns.

Lastly, I strongly believe that every change brings about an opportunity. Industry members should try to use the latest change in the plan processor as an opportunity to address key concerns. The successor plan processor seems to be more accommodating to industry requests than the predecessor. We have already seen the inclusion of the error feedback and correction functionality, which is a step in the right direction. Industry members should aggressively participate in industry forums and voice concerns about outstanding issues and desired functionality.

Harshad is a seasoned leader with more than 16 years of experience in helping firms define, identify and implement technology strategy and solutions to further strengthen their risk and regulatory functions. Prior to founding RegEdge, he spent several years working for Big 4 consulting firms, most recently as a Partner in PwC’s risk and regulatory practice. Before consulting, Harshad worked at a large high frequency trading firm across front office, middle office and back office functions. He brings a unique mix of deep/hands-on subject matter expertise to the table from his industry experience and a breadth of knowledge on peer practices and evolving trends from consulting experience at numerous banks and broker-dealers of all sizes around the world.