The approval of a new consolidated audit trail (CAT) last week by the Securities and Exchange Commission (SEC) has met with mixed reaction, with fears that the final solution may miss some forms of market abuse.
The CAT will combine securities trading data across multiple US equity markets into a single database for the first time, with the aim of helping the regulator to better detect insider trading and market manipulation.
It will require US exchanges and their members to provide details on each order in an NMS security to a newly-created central repository. The data would be reported to the repository by 08.00 the next working day – a change from the initial real-time proposal – and include details on routing, modification, cancellation and execution of all orders.
The CAT was proposed by the SEC just weeks after the 6 May 2010 flash crash, where an algo trade deployed by a mutual fund ran amok and sent US markets sharply downwards, before they quickly recovered. Its introduction was seen as particularly necessary as the SEC and US futures regulator the Commodity Futures Trading Commission (CFTC) took until October 2010 to present their findings on the cause of the flash crash.
But some market participants, in addition to two of the five SEC commissioners, have aired concerns that the final CAT solution is too far from what was originally intended and that it will take too long to implement.
“Considering that it has taken the agency three years to get to this adopting stage, and it will likely take several more years before any consolidated audit trail system is finally in place, the rule we consider today is disappointingly weak,” said SEC Commissioner Elisse B. Walter, prior to voting against the CAT’s adoption. “The ultimate effectiveness of core self-regulatory organisations and Commission regulatory efforts depends on the accuracy, completeness, accessibility, and timeliness of audit trail data. Yet, the rule fails to set meaningful minimum requirements to assure that these important goals are achieved. Instead, the rule has been altered to be less prescriptive and hence less directional.”
One of the CAT’s main criticisms is the time it will take for a final solution to be in place. The rule becomes effective 60 days after its publication in the Federal Register, with US exchanges then required to jointly submit a plan to the SEC that includes specifics on how market participants report trades within nine months.
“Initial discussions on the CAT started before the flash crash and many people think the SEC should have had something in place years ago,” said Jamie Selway, managing director at agency broker ITG. “While this is a hugely important supervisory tool, the earliest it will come into force is summer 2014, which is not ideal.”
The second commissioner to reject the CAT plan, Luis Aguilar, suggested that a better approach would be for exchanges to submit competing CAT plans based on the final SEC proposal in order to end up with the best solution.
“Allowing for competing plans would facilitate the development and consideration of more innovative ways to establish a consolidated audit trail that collects timely and accurate data in a cost-effective manner,” said Aguilar.
Another big gap in the CAT proposal, according to Joe Saluzzi, co-head at US agency broker Themis Trading, is the lack of an end-user identification that would distinguish the beneficial owners of trades.
“It is positive that the SEC has finally approved an audit trail mechanism, but the final proposal is only half-baked,” he said. “While the CAT may help to identify nefarious activity like quote stuffing, the inability to easily identify the end beneficiary of trades means high-frequency traders that use brokers’ sponsored access solutions to trade on markets will be harder to identify.”
Saluzzi also pointed out that the CAT only covers SEC-regulated equities and options and not the futures products that are overseen by the CFTC, which he believed could mean a lot of cross-asset abusive market behaviour goes unnoticed.
There is less contention on the SEC’s decision to require reporting of order information by 08.00 the next day, rather than in real time as per the original May 2010 proposal.
“It would incredibly expensive to create a record of real-time information,” noted Selway. “Moreover, many types of market manipulation depend on data analysis and recognition of trading patterns that can only occur after the fact.”
According to Selway, the SEC had already done well in implementing preventative measures, such as single-stock circuit breakers – which will be adjusted to a limit up-limit down mechanism from next February – and new requirements for market makers that prohibited the use of stub quotes.
But others argue that the CAT could go further and suggest the SEC could have adapted a multi-asset class solution that can identify and act on incidents as they occur.
According to Piet van de Velde, worldwide business development director, market infrastructure at IBM Global Banking and Markets, technological advances within the last five years easily allow the aggregation and analysis of data in real time.
IBM is combining its Netezza data warehouse appliance technology with analysis from market monitoring firm Bryok to analyse the benefits of real-time cross-market surveillance in Europe.
“Through our analysis, we have observed forms of market abuse that aren’t identifiable through more traditional single market analysis,” said Van de Velde. “We plan to take this further and combine it with even faster processing technology so that we can, over time, construct an early warning system, rather than using it as just a post-mortem tool.”
Others point out that similar technology is also used by high-frequency trading firms that base strategies on high-speed data feeds offered by exchanges.
“A high-performance market making firm needs the capability to monitor market data across trading venues as close to real time as possible, so it is absolutely possible for regulators to get consolidated order information at a reasonable cost,” said John Edge, co-founder and general manager, Redkite Financial Markets, Americas, a provider of financial market surveillance tools. “Using this data, they are also able to adjust or pull their strategies from the market.”
Edge added that these existing capabilities could be used by regulatory surveillance tools to halt trading if required.