Consolidated Audit Trail: Preparing for the next phase of regulation

The Consolidated Audit Trail (CAT) has been a major focus of the US regulatory landscape for nearly a decade. First approved by the Securities and Exchanges Commission (SEC) in 2016, transaction reporting obligations began in 2020. CAT replaces the previous Order Audit Trail System (OATS) and provides for a richer, more detailed audit trail. Compared to OATS, CAT includes:

• More asset classes, covering simple/complex options and equities.
• More events, intended to cover the entire lifecycle of an order. Not just orders and trades, but quotes, fulfillments and allocations.
• More granular timestamps.

The initial phases of the CAT rollout have been successful and the industry has adapted to the new reporting standards. However, several more intensive requirements that were previously deferred are due to begin in the next 18 months. Firms need to ensure they understand these requirements and take the necessary steps to comply with them.

Throughout the planning and implementation of the CAT, industry stakeholders have sought delays to the implementation of certain reporting requirements. The SEC agreed to many of these requests, granting temporary exemptive relief in some instances. After much industry analysis and discussion, many of these exemptions are now close to expiring. In particular, exemptive relief for the following reporting scenarios is due to end on 31 January 2025:

• Reporting of port-level default settings.
• Reporting of representative order linkages.

At the time of writing, we are 18 months away from the start of reporting obligations and, on the face of it, there’s plenty of time to prepare. However, these are two of the most complex reporting scenarios and may require extensive changes to existing trading and reporting workflows. In this article, we examine the specific challenges of each scenario. We also discuss some of the steps that both vendors and broker firms can take to prepare.

Port-level defaults

Currently, exchanges need to report all orders they receive. These records include:

• The order foundations, such as side, quantity, and price.
• Any default data of material relevance to the CAT, which the exchange appends to the order message upon reception. This might include things like order time-in-force or handling instructions.

Default data is usually stored in the exchanges’ own static data, against the sending counterparty’s specific connection port. It’s therefore described as port-level defaults.

Once exemptive relief expires, the sending counterparty will also be required to report any CAT-material port-level default attributes appended to their orders. This presents several issues:

• Broker-dealer firms argue that this requirement is fundamentally misleading since it requires them to report more information than they actually sent to the exchange. This also creates issues with reconciliation since the broker’s own records of these route messages will not match the details of what they reported to the CAT.
• There is no obvious way for broker firms to access port-level information since it’s maintained by the exchanges. Getting this information is a major implementation challenge for brokers, especially given the complex logic around how exchanges apply defaults to each order.
• Brokers also frequently send order flow to other member firms. This presents a further implementation challenge since brokers will need to obtain port-level defaults from every firm to which they send orders. And the receivers of order flow will need to create a mechanism for generating and furnishing this data.

Some regulators believe that it’s useful for brokers to have access to port-level information for auditing purposes and to demonstrate that they are providing best execution to clients. But, given that all this information is already being reported by the exchanges, it’s not clear what extra value is being added to the CAT. Indeed, it could be argued that this obligation actually weakens the goal of providing an accurate audit trail since it requires member firms to report information they did not send.

Unfortunately, there are no obvious quick-fix solutions to this requirement. Any resolution is going to require extensive collaboration and information sharing across the industry, and advanced reporting logic. All affected firms need to stay engaged with the implementation process to ensure that the industry arrives at an optimal solution.

Representative order linkages

Broadly speaking, broker-dealers have two kinds of order flow:

• Client orders, which are entered in response to a specific instruction from a buy- or sell-side client.
• House orders. These include:
  • Proprietary house orders, which are entered on the broker-dealer firm’s own behalf.
  • Representative house orders, where the firm is trading in its own name, but on behalf of a customer.

Once the representative order linkage exemptive relief expires, all representative orders reported by a broker dealer will need to be directly and explicitly associated with a specific client order. This requires major changes to representative house order workflows.

The Fidessa platform supports a range of functionality that can help fulfill this reporting obligation, including:

• Order-linking functionality from the Montage grid to allow traders to link fills quickly to specific client orders.
• The ability to add linkages to house orders post order-entry.
• Alerting functionality that allows users to set warnings or hard blocks when a trader attempts to enter an unlinked client order.
• Worked capacity workflows where firms can accumulate a position and then allocate it to a client order while maintain explicit linkage for the CAT.

Despite these technical solutions, it seems inevitable that there will need to be changes to front-office workflows. Some brokers maintain that such changes may reduce trader efficiency, increase time to market, and result in worse outcomes for investors.

Conclusion

The exemptive relief expiration for these two reporting obligations presents huge challenges to the industry. Since any further extensions seem unlikely, firms must take immediate steps to prepare. The data required for the Consolidated Audit Trail reporting is clear and the challenge for member firms is to ensure that their implementation of these requirements does not affect the service they offer to their clients.

There are some concrete steps that firms can take right now to prepare. For Fidessa customers, it’s important to understand the available functionality around CAT reporting. This will allow firms and users to start planning and testing workflow changes as soon as possible. ION’s regular customer advisories provide details of the latest news from the regulator and upcoming changes to the platform. CAT reporting documentation is also available through the ION Client Portal. Finally, all industry stakeholders (whether they’re market participants or industry members) need to remain engaged with the regulatory process. This engagement is crucial to ensuring that the experience of those most affected shapes the next phase of CAT implementation.