In an effort to help them reconstruct events when markets become disrupted, regulators have adopted a rule that will require the most active traders to code their tickets and brokers to monitor their activities.
The rule is viewed as a stopgap measure and lays the groundwork for a more comprehensive move toward instituting a consolidated audit trail, or CAT. Industry pros called the “large trader” rule a positive move, as it gives the Securities and Exchange Commission an ability to better monitor trading activity. The SEC approved the rule on July 26 by a 5-0 unanimous vote.
In contrast to the large trader rule, CAT would provide data points instantly when recalled. It was proposed for equities and options last year, but met significant resistance due to its multibillion-dollar price tag and the upgrades in technology it would require. While CAT would provide much more information, it will also take longer to implement-so “large trader” fills the bill for now, the SEC’s thinking goes.
“In particular, the large trader regime is much more limited in terms of its scope and objectives,” said SEC chairman Mary Schapiro. When compared to a consolidated audit for trading, she said, the large trader rule should entail much less change than the proposed CAT. “Further, the large trader rule would leverage existing systems to address the Commission’s compelling near-term need for access to more information about large traders and their trading activities. It also would begin to improve the Commission’s ability to analyze such information.”
However, Schapiro said, her staff is working on recommendations for consideration with respect to a CAT and is hopeful that it will be able to move forward with a proposal in the very near term. “I expect that a consolidated audit trail plan will build on and complement today’s large trader rule, and avoid unnecessary duplication or undue burden on market participants,” she said.
Until CAT becomes a reality, large trader will have to suffice. According to one knowledgeable source, the backlog of rules mandated by the Dodd-Frank legislation has taken precedence over many other proposals due to the Dodd-Frank’s statutory deadlines. It seems CAT is one of these, and it was easier for the SEC to get large trader passed.
The large rule requires high-frequency and other large-volume traders to code their trade tickets with a unique identifier and time stamp for trades they execute. It targets both buyside and sellside shops doing significant volume. Trade information, if requested by regulators, would have to be available one day after a trade is completed.
The rule has two components. First, it would require large traders to register with the Commission through a new form, Form 13H. Second, it would impose record-keeping, reporting, and limited monitoring requirements on certain registered broker-dealers through whom large traders execute their transactions.
The rule defines a large trader as a firm or person who trades more than 2 million shares or $20 million a day, or 20 million shares or $200 million in a month. It also defines a larger trader as any person who exercises investment discretion to buy or sell NMS securities.
The large trader rule helps the SEC examine the increasing role large firms and traders are playing in the markets. The SEC is also looking for a way to track trading behavior in times of market crisis or stress. By being able to identify traders and their trading patterns, the agency can then reconstruct the events surrounding a particular market event, explain it to investors and lawmakers and take any action deemed necessary.
The need for comprehensive market data was shown by last May’s “flash crash,” where regulators had difficulty ascertaining what caused and accelerated that day’s market swoon. Large trader was originally proposed in April 2010 and will now go into effect Oct. 3, with compliance dates set for Dec. 1 for the buyside and April 30, 2012, for the sellside.
The large trader rule will likely impact bulge brackets, as well as big hedge funds, investment companies and proprietary trading firms. In a comment letter last year, market maker Getco wrote that it supports large trader and noted that the old method of tracking trading data via the Electronic Blue Sheets is insufficient in today’s fragmented and electronic environment.
When contacted about the consolidated audit trail, Getco spokesperson Sophie Sohn said the firm supports the creation of an audit trail. However, she declined to comment further on the matter.
Some feel the passage of the large trader rule without some type of audit trail wasn’t enough. According to Randy Snook, executive vice president at the Securities Industry and Financial Markets Association, the new rule should have been a “coordinated effort with the development of a consolidated audit trail.” He sees the audit trail coming, but stopped short of saying whether a new one will be built or if instead the existing Order Audit Trail System–OATS–or Blue Sheets would be used.
OATS is FINRA’s integrated audit trail of order, quote and trade information for Nasdaq and over-the-counter equity securities.
“We expressed a view OATS might be a better or more effective way to accomplish the SEC’s goals of an audit trail,” Snook said. “The SEC recommends using some form of an expanded Blue Sheets-based system. I do expect them to come up with something soon.”
Throwing its support behind an audit trail, FINRA wrote in an April comment letter to the SEC that if it was appointed as the builder of the audit trail, it could have a system that tracks equities running in as little as 18 months. It would do this by using existing reporting mechanisms and data infrastructure, such as OATS–not the Blue Sheets.
Snook added that the expansion of OATS to NYSE-listed securities is already well under way.
Using OATS has merit, pros said, as it would not only be cheaper than ponying up the $3 billion to $4 billion many expect a new system would cost, but could be modified faster than building from scratch.
Michael Corrao, managing director at Knight Capital Americas, who oversees Knight’s compliance effort for equity trading, told Traders Magazine he expects the SEC to move forward with additional audit trail requirements and that the enhancements to the existing OATS system appear to be the best alternative, rather than a new system.
“Future access to trading info would likely come from the OATS data, which is already collected,” Corrao said. “Enhancing the OATS system is preferred, rather than starting from scratch under the CAT proposal; and it is probably the best method for them to go, as it is likely the least costly to the industry.”
One trading desk head agreed. He said his firm already provides trading information to OATS and it would be easier to stick with it than get acclimated to a whole new system.
“We report through OATS already, and it’s easier for us to comply with an extension of that system,” the desk head said. “We already spend time and resources on this, so it wouldn’t be as bad as a whole new system.”
