The Consolidated Audit Trail (Part I): Reconstructing Humpty Dumpty

Today’s market structure is not just complex and fragmented, it is dynamic with trading activity taking place across multiple exchanges and asset classes and hyper-connected marketplaces. In addition and more importantly, the US regulatory approach does not have a single entity that is responsible for oversight across all these market centers and asset classes - the SEC oversees equities and options; CFTC oversees futures, etc. With this fragmented approach to oversight, it is exceptionally difficult to properly surveil and regulate these highly inter-related marketplaces.

The challenges of fragmentation in US securities market came to light with the Flash Crash when regulators did not possess the necessary tools to rapidly identify and assess the causal factors that contributed to the crash. The big setback was not how much the market dropped or rebounded, but how the regulatory community did not have the capacity to reconstruct what happened. What should have taken a few days, took weeks and months. None of the existing regulatory reporting frameworks including Order Audit Trail System (OATS) or Electronic Blue Sheets (EBS) contained the level of detail necessary to allow for a complete reconstruction of events.

Consequently, regulators recognized that they required one, consolidated system that could not only reconstruct the market, but also allow them the ability to analyze the data so that they could conclusively determine causal relationships. Thus the idea for the Consolidated Audit Trail (CAT) was born. The CAT will be the ‘go to’ system for regulators and exchanges to examine and analyze market activity in its totality. While it would not directly prevent future Flash Crashes from occurring, it would indirectly prevent these and other potentially disastrous events from occurring, by enabling rapid marketplace reconstruction and analysis of future events which in turn would protect the markets as a whole. The CAT initiative is SEC’s strategy to becoming more proactive and preventative and take a more comprehensive and timely approach to market events.

Another key reason for the urgency for the CAT is the lack of technology and market reconstruction capabilities in the existing reporting OATS system. OATS is a legacy reporting systems designed and developed prior to the maturation of electronic trading. As such, it has not been able been able to keep up with the changing market sophistication and requirements.
Though initiated by the SEC, the CAT is now in the hands of the SROs. The SRO’s have downsized the bidding list and are in the process of selecting the CAT Processor and finalizing all of the technical details. In July 2014, the SRO’s announced the final short-list of CAT bidders that included the following firms/consortiums:

• AxiomSL & Computer Sciences Corporation (CSC)
• CATPRO Consortium: HP, Booz Allen, Buckley Sandler, J. Streicher Analytics
• EPAM Systems & Broadridge
• FINRA
• SunGard Data Systems Inc. & Google
• Thesys Technologies, LLC.

The CAT is the largest data undertaking ever proposed for the US securities market. Clearly implying, there is a lot at stake here. A lot of time and effort has gone in to get the market to approve and support this large initiative. Now it is in the hands of the SROs to make sure that humpty dumpty stays on the wall. Keeping in mind the significance of this project TABB Group has created a three report series on the CAT program highlighting the key elements and challenges of the CAT. This TABB group focus note - The Consolidated Audit Trail: Reconstructing Humpty-Dumpty, describes the need for the CAT and analyzes the current state of the CAT process.