Who Says The CAT Doesn’t Have a “Silver Lining?” (by Patrick Flannery, MayStreet)


For broker-dealers, the Consolidated Audit Trail (CAT) may seem to be another weighty technical challenge, whose cost and implementation challenges will fall disproportionately on their shoulders (and their budgets). In fact, last week, SIFMA submitted a letter to the SEC detailing exactly how burdensome CAT will be.

The current plan, according to SIFMA, “would impose the vast majority of CAT-related costs on broker-dealers.” In its letter to the SEC, the US lobbyist asked the agency to demand that the parties developing CAT, namely, the exchanges and FINRA, explain how they justify requiring “broker-dealers to bear any of the financial burden of funding a system that exists to receive and process information that broker-dealers are required to report under SEC regulations.”

What’s more, while the data submitted to CAT will give regulators better oversight, which is expected to help promote market fairness, several securities industry insiders have begun to question what type of access broker dealers will have to this data.  As we understand, it’s unclear at this point whether broker-dealers will to be able to directly query the very data that they must bear the burden (and cost) of collecting and reporting.

Despite these challenges, things may not be as bad as they seem. For those who learn to understand the value of the data they’re collecting, and how it can be mined for market insight, there’s potential for significant upshot.

The Heavy Lifting

CAT will be a much more detailed and sophisticated form of audit trail than FINRA’s OATS system, to which firms currently report data for regulatory oversight purposes, and as a result, reporting requirements will be significantly more complex. The data that CAT will consolidate is voluminous, and for many firms, who have this data stored in disparate systems, gathering, organizing and time stamping CAT data for reporting purposes will be a substantial if not a near-colossal undertaking.

Some aspects of CAT reporting are so challenging it’s hard to see the bright side. For example, every broker-dealer, exchange and all other self-regulatory organizations (SROs) reporting to CAT will have to establish and maintain a system of unique IDs for customers, accounts, counterparties and orders. The ultimate goal:  the entire life cycle of any equity or options order can be preserved for future review. A trade, originated through a retail broker, e.g., that is routed through a broker-dealer and executed on an exchange, should be able to be stitched together and reconstructed from CAT data so that the full picture is viewable from multiple perspectives.

When an original order is received, firms will have to capture and report an ID number of the customer originating the order, a CAT order ID, an identifier of the firm receiving the order, terms of the order and a time stamp measured to CAT time-stamping requirements (currently 50 milliseconds).

Consider another example as well, of an order that’s routed away. The routing firm would have to record the CAT order ID, terms of the order, the time stamp of when the order is routed, the identifier of the firm routing the order, the identifier of the firm to which the order is routed, and if the order is routed internally, an identifier of the department or desk to which it was routed.  But just as the routing firm records all those details, the party receiving a routed order will similarly be recording the time stamp, order details and identifiers or all parties involved. The goal is to have a complete picture from all sides of the reportable event.

Confusing? Yes, but nevertheless necessary.

The Five Whys

Whether or not firms are ultimately able to query CAT directly, by collecting linkage data they will ultimately begin to gain insight into the causes and triggers of even minor reportable events. The completeness of this data has the potential to provide significantly deeper insight into how firms interact with the markets, and, more crucially, how good of a job they’re doing for their clients.

The evolution the finance industry is undergoing in using its own data to better understand market triggers and opportunities has similarities to the “Five Whys” concept attributed to Sakichi Toyoda, Japanese industrialist and founder of Toyota Industries.

Not every event has one root cause and sometimes problems are caused by deeper underlying issues. Just as Toyoda proposed that to understand automotive defects or breaks in production, managers should ask why and then drill down four more layers, understanding what scenarios triggered the problems that led to errors and defects.

Financial firms must begin to look at markets the same way.

The ability to collect and report granular level of detail about markets is a tough task, but as firms are increasingly required to undertake this challenge, they have learn to use this additional level of detail to answer complex questions. Sourcing vast amounts of data quickly will become a necessity both in terms of fulfilling CAT requirements and solving complicated challenges that could improve trading.

As a result of both regulatory mandates and the evolution of markets and technology, data is no longer a nice-to-have – but a necessity. Once there’s a more consistent system for all broker-dealers and SROs to report highly detailed trading data, firms who understand this data will get a clearer picture of the true nature of any order. The result will be improved transparency in trading and execution and a truer view of broker-routing logic.

Clearly, firms that truly master the CAT data challenge will eventually be able to not only tell their clients what a good job they are doing, but take the data and show them.

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