Tags: CAT

Killing Our Frankensteins

More than two centuries ago, the gothic novel, Frankenstein, also known as The Modern Prometheus, was anonymously published in Britain. A few years later in 1823, readers would discover that the gifted author was Mary Shelley, who at the age of 18 began writing the novel in a competition among peers about who could write the best horror story. The character of the monster, brought to life by Dr. Victor Frankenstein, remains one of the most recognized icons in horror fiction. It is also one of the few fictional characters who have managed to find a place in the Merriam-Webster dictionary. According to Merriam-Webster, Frankenstein is “a monstrous creation, especially: a work or agency that ruins its originator.”

Our industry, at times, creates its own Frankensteins. We promulgate rules, policies and practices that when introduced into this hypercompetitive and highly-technological marketplace, may result in unintended negative consequences that seem to take on a life of their own. Thankfully our markets possess a natural ability to self-correct in such situations; however, this self-correction process can itself be costly and highly disruptive.

A Frankenstein Around the Corner

The listed options market is a highly competitive, quote-driven marketplace. From a technology perspective, it is extremely efficient as proven by its ability to manage the risk and quoting activity associated with the more than 900,000 strikes on approximately 4,000 underlying, or root, securities. The technological requirements, particularly during periods of high volatility, are massive and costly to maintain. Those costs are about to increase with the impending industry-wide implementation of the Consolidated Audit Trail (CAT).

While official data is not yet publicly available, figures being mentioned in the public domain are that of the 100 billion data points being captured on daily basis, more than 40% are related to options activity. If these figures are correct, then a 40% allocation of CAT expenses to the listed options markets would be a Frankensteinian event.

The most simplistic description of the CAT is that it is a giant data warehouse, one that will store information on quote updates and trades that occur in the equity and listed derivatives markets. The cost of building the CAT warehouse will be determined by how much data it needs to store. The cost allocation per firm will be related to how much data is sent to the CAT. This reality presents issues for options market participants because the ratio of quote updates to actual trades, which normally have revenue associated with them, is several times higher compared to equities. Industry experts estimate there are more than 17,000 quote updates for every trade that occurs in listed options. In equities, the ratio is less than 40:1.

This past summer, the exchanges began reporting listed option quotes on the 900,000 strikes to FINRA CAT. While official data is not yet publicly available, figures being mentioned in the public domain are that of the 100 billion data points being captured on daily basis, more than 40% are related to options activity. If these figures are correct, then a 40% allocation of CAT expenses to the listed options market could be a Frankensteinian event.

Options Listings Participant Plan

With its implementation approaching, a clear first benefit of CAT would be a rationalization of how strikes are listed. The benefits associated with strike rationalization go beyond the cost implications of CAT. These benefits include reducing costs tied to monitoring risk, enhanced allocations of capital and creating a more simplistic market for investors.

The proliferation of strikes is primarily attributed to the absence of a coordinated process for determining the appropriate number of strikes per underlying issue, exacerbated by the growing popularity of short-term options commonly referred to as “Weeklies.” The Options Listing Procedures Plan, or OLPP, is a national market system plan that defines procedures for introducing new options series into the listed marketplace. Unfortunately, OLPP is silent on certain key aspects which prevent it from making modifications or adjustments.

In our letter to the Securities and Exchange Commission earlier this year, STA expressed our belief that the listed options industry can resolve the excessive proliferation of strikes; however, doing so requires an initial dialogue among and between interested parties. Due to antitrust laws, the options exchanges are prohibited from engaging in any collective activity without proper authorization from the SEC. Given the importance of this issue and the potential Frankenstein it would create in a CAT reporting regime, STA continues to recommend that the Commission take whatever action is needed to provide the necessary authorization to the exchanges. Our industry is better off avoiding such types of creations because eradicating them after they have been created is both difficult and costly.

Other article of interest: “Measuring the Influence of Regulation

Talking Points – July 2019

Who We Are

STA is comprised of 24 affiliate organizations covering the entire US and Canada. The STA national board of governors is comprised of past presidents and industry specific leaders. Our membership represents INDIVIDUALS from varying business models – buy-side, sell-side, hedge funds, exchange traders and market makers- dealing in equity and derivative trading.

Consolidated Audit Trail – Recent Developments

*There have been a number of positive developments since the SRO’s decision to terminate the contract with Thesys’ CAT.

SEC no-action letter under the Investment Advisers Act of 1940 on MiFID II

*STA believes that a meaningful number of market participants anticipate the Commission granting an extension and/or expansion on the existing “no-action” relief. A decision to allow the relief to expire in July 2020 risks to be highly disruptive if firms are not provided adequate time to adjust to the regulatory regime.

*Expiration would have a particular impact on those broker-dealers who may decide to register their research departments as investment advisers to accommodate cash payments. *Additionally, we believe that the demands on SEC resources to process an initial influx of RIA registrations and to facilitate ongoing audit and supervision reporting would be meaningful.

March 8th Chairman Clayton & Brett Redfearn, Director T&M Fordham Presentation

Thinly Traded Securities – UTP

*It remains STA’s view that shareholders in small to mid-size securities which lack a robust secondary market benefit from the presence of market makers and block traders who can, among other things, provide enhanced liquidity to increase the depth of the market. While the factors in enhanced liquidity provision are numerous, there are certain core ones which could be improved through regulatory actions: quote quality; volatility; and reduction in costs.

*While, STA understands and appreciates that the goal of suspending UTP is to enable “innovative market structure solutions” we still have concerns regarding a venture or thinly traded exchange regime which allows for the suspension of UTP as part of its construct.

STA letter to SEC on proliferation of strikes in option market place

*In a April 5, 2019 letter to the SEC, STA relayed its view that the proliferation of series of options for quoting and trading has overly complicated the options markets and necessitated excessive (and thus inefficient) consummations of technology.

*We noted the Options Listing Procedures Plan (“OLPP”), a national market system plan which defines procedures for introducing new options series into the marketplace is either silent or requires additional guidance in areas instrumental to its overall effectiveness.

PDF version here

Talking Points – June 2019

Who We Are
STA is comprised of 24 affiliate organizations covering the entire US and Canada. The STA national board of governors is comprised of past presidents and industry specific leaders. Our membership represents INDIVIDUALS from varying business models – buy-side, sell-side, hedge funds, exchange traders and market makers- dealing in equity and derivative trading.

Issues
Regulatory Capital Rule: New Standardized Approach for Calculating the Exposure Amount of Derivative Contracts:
*STA believes that Basel III Standardized Risk Weighted Assets, “RWA” calculations on capital requirements are having an unnecessary & detrimental impact on market maker liquidity. We are supportive of a new approach for calculating the exposure amount for derivative contracts.

SEC Rule 606, aka, “Order Handling Disclosure Rule”
*As with any large scale industry project, regulatory guidance prior to implementation is often needed. As the Oct 1, 2019 compliance date for data collection approaches, the industry seeks SEC guidance on a range of areas, including but not limited to options calculations.
*STA believes that any guidance – even that which is simplistic in nature – at this stage will not allow segments of the industry to meet the Oct 1st deadline. STA therefore believes it is reasonable to request that should the SEC maintain the Oct 1st deadline it consider issuing “no-action” letters.

STA letter to SEC on proliferation of strikes in options markets
*In a April 5, 2019 letter to the SEC, STA relayed its view that the proliferation of series of options for quoting and trading has overly complicated the options markets and necessitated excessive (and thus inefficient) consummations of technology.
*We noted the Options Listing Procedures Plan (“OLPP”), a national market system plan which defines procedures for introducing new options series into the marketplace, is either silent or requires additional guidance in areas instrumental to its overall effectiveness.
*We requested the SEC “expressly authorize and direct the exchanges to participate in a working group to discuss and determine if the strike listing process should be improved and if so, what recommendations should be considered.”
*STA expects to file a supplemental letter with specific recommendations on changes to the OLPP which would improve its functionality and formalize certain core actions, such as regular meetings among the administrators and a means for industry participants to provide input.

Consolidated Audit Trail – Reporting Issues Specific to Options.
*Specific areas where guidance is requested include:
• Option Market Maker quote submission to the CAT will be performed by the exchanges. What happens if an exchange fails to submit the MM quotes?
• What are the reporting obligations and exemptions in Open Outcry Markets?

PDF version here

Talking Points – August 2018

Talking Points – August 22, 2018

 

Who We Are

STA is comprised of 24 affiliate organizations covering the entire US and Canada. The STA national board of governors is comprised of past presidents and industry specific leaders. Our membership represents INDIVIDUALS from varying business models – buy-side, sell-side, hedge funds, exchange traders and market makers- dealing in equity and derivative trading.

STA Issues:

*Consolidated Audit Trail, (“CAT”): Industry Reliance on Vendors; Testing Timelines; Proposed Regulatory Conformance Period and FINRA autonomy on decisions affecting OTC securities.

*Access Fee Pilot: Treatment of ETFs; Coordination with the Canadian Securities Administrators

*Exchange and Industry Working Group on Listed Options

*Tick Size Pilot Assessment Report

 

Specific Comments:

Consolidated Audit Trail, (“CAT”):

Industry Reliance on Vendors; Testing Timelines & Proposed Regulatory Conformance Period.

*It is reasonable to expect that a majority of firms will rely on third party vendors for their data capture and reporting obligations under CAT.

*Data capture falls into broad categories: expansion of existing data capture and new data capture. The former is less complex but both require vendors to have all the data requirements and formats in place prior to any work/testing being done by firms they service.

*As it pertains to testing for CAT, this two-step work flow of; vendors testing followed by testing with firms is a sequential and not parallel process. Firms cannot begin work on delivering data to their vendors until they have received the specifications from them.

*STA is supportive of the remarks and recommendations made by the Financial Information Forum in their letter to the Commission, dated August 20, 2018, in particular,

“…FIF supports the proposed Regulatory Conformance Period, which should allow Members the necessary 6-month test period to test their systems, work to reduce reporting errors and perform additional data validation checks prior to regulatory scrutiny while meeting the Industry Member CAT Reporting implementation dates.”

FINRA autonomy on decisions effecting OTC securities and CAT

*CAT Requirements for OTC Securities are currently driven by the NMS plan which is primarily dominated by exchange SROs.  OTC Securities trading activities historically have been (and for the foreseeable future) will continue to be primarily overseen and monitored by FINRA and not by the SROs of exchanges.

*It is clear that the rules applicable to the trading OTC Securities are unlike the rules associated with trading NMS securities.  It is therefore likely that there will be certain surveillance requirements for NMS securities that are not requirements for OTC Securities and visa-versa.

*FINRA is in the best position to make the determination as to the oversight requirements for OTC securities and the corresponding CAT reporting obligations.  Under current CAT governance FINRA’s interest for OTC securities surveillance may have to compete with the interests of the SRO exchanges.

*We believe that FINRA should be able to do this autonomously through their rule promulgation process rather than through debates with the NMS plan participants.

Access Fee Pilot

Exchange Traded Funds and Products (“ETPs”)

*ETPs are unique investment vehicles which offer investors exposure to the performance of indices or desired exposures. While the equity market structure generally works well for ETPs, unique characteristics of ETPs merit consideration in equity trading rules.

*As it pertains to the Access Fee Pilot, industry feedback which expresses concern on competitive dynamics of ETPs which offer similar exposures offers recommendations which fall into two broad categories:

  • ETPs should not be included in the Pilot
  • ETPs should only be included if an elegant solution to the competitive dynamics of ETPs which offer similar exposure can be devised.

*STA believes evidence exists that when liquidity provision is encumbered, ETPs become less efficient, therefore STA believes that special consideration, perhaps even exemptions, be considered for them.

Canadian Securities Administrators (“CSA”) Initiative to Study Marketplace Rebates

*In a letter to Chair White, dated November 13, 2014, Canadian STA, (“CSTA”) brings to the attention of the Commission the opportunity to conduct a cross border study of the effect of market place rebates on market quality in dually-listed securities.

*Many respondents to the CSA’s proposal expressed concerns that without U.S. involvement, a pilot would lead to dramatic differences in the trading economics on inter-listed stocks between Canadian and U.S. markets. For this and other reasons, the CSA did not move forward with its proposed pilot study.

*STA recommends that the Commission approach the Canadian Securities Administrator to determine if an opportunity exists to coordinate efforts on an access fee pilot.

 

Exchange and Industry Group letter requesting committee on the options markets

*In a letter to Mr. Brett Redfearn, Director, Division of Trading & Markets, SEC, dated June 4, 2018, Cboe, SIFMA and STA requested the formation of a working group with the purpose of making recommendations towards improving to enhance displayed liquidity in all options classes, including greater size and smaller spreads.

*This working group was formed to address concerns regarding the current state of the U.S. options market structure generally. This working group is comprised of one representative from each the options Exchange parent organizations; SIFMA; Options Clearing Corporation, “OCC” and STA.

*Exchanges must ensure that any collective activity on their part conforms with all applicable laws, in particular with the antitrust laws.

Tick Size Pilot Assessment Report

*Section VIII of the Tick Size Pilot Plan requires the Plan Participants to submit to the Commission and make publicly available a joint assessment of the impact of the Pilot. The Participants submitted the joint assessment to the Commission on Tuesday, July 3, 2018 and a revised version on August 3, 2018. STA and many of its members are only recently aware that this report was made public.

PDF version here

Open Call Report – Industry Update on CAT

Under the CAT NMS Plan, industry outreach groups formed previously were disbanded which resulted in unofficial & fragmented outreach initiatives w/ SROs, SEC, Thesys CAT & various trade associations like SIFMA, FIF and STA. Tonight, we are here to raise awareness on what we would describe as more a robust and better organized industry initiative that began early this year with the announcement of several Working Groups such as: Cost & Funding WF; Interpretative WG; Technical Specifications and others. See Open Call Summary Report here

Open Call Report – New FINRA Exam Process

In July 2017 the SEC approved FINRA’s proposed rule change to streamline competency exams and expand opportunities for prospective securities professionals

STA Open Call – November 29, 2017 – Call Notes
“New FINRA Exam Process”
Presenter: Joe McDonald, Senior Director Exams & Continuing Education FINRA

Opening Remarks – Jim Toes, STA President & CEO
Senate Tax Bill – The Senate Finance Committee passed a comprehensive tax reform bill. The bill is now being debated by the full Senate. One item of particular concern to STA is a provision that would generally require taxpayers to use a FIFO cost basis on the sale of securities. We published a bulletin publicly and to Hill Staff voicing our objection. link

SEC Commissioner Nominees Update – Nominees for the two (2) SEC Commissioner Positions; Hester Peirce and Robert Jackson received approval from the Senate Banking Committee. They now await approval from the full Senate. Unfortunately, we do not expect this to happen this year.

House Fin’l Services Subcommittee Hearing on CAT – The House Financial Services Committee will be
holding a hearing titled “Implementation and Cybersecurity Protocols of the Consolidated Audit Trail” on November 30th at 10am. Among those testifying will be, Mike Beller, CEO of Thesys Technologies and Chris Concannon, President & COO of Cboe. link

Open Call Summary
In July, 2017 the SEC approved FINRA’s proposed rule change to streamline competency exams and expand opportunities for prospective securities professionals seeking to enter or re-enter the securities
industry. The proposal is a combination of consolidating certain registration rules and restructuring the representative-level qualification examinations by creating a general knowledge examination called the
Securities Industry Essentials (SIE). The SIE is a new, introductory-level FINRA exam for prospective securities industry professionals. The SIE assesses a candidate’s knowledge of basic securities industry information and upon passing is valid for four years. Association with a firm is not required to take the SIE however passing it alone does not qualify an individual to engage in the securities business. Individuals, who do pass the SIE and are then sponsored by a FINRA member firm, need only to take an abridged version of a qualification exam (such as the Series 7). These changes become effective Oct 1, 2018. Please refer to the below links for additional informational on the proposal and how to make a direct inquiry to Joe McDonald.

SEC Approves FINRA Exam and Continuing Education Requirement link

FINRA Securities Industry Essentials Exam, “SIE” link

This brief is meant for informational purposes only and therefore should not be considered legal advice. STA’s goal is to raise awareness and encourage industry dialogue.

House Financial Services Committee Hearing

House Financial Services Committee Hearing
“Implementation and Cybersecurity Protocols of the Consolidated Audit Trail”
The hearing will examine the status of the CAT’s implementation and the current adequacy of existing data security protections regarding the storage and use of CAT data by entities that are part of the CAT operating committee, the CAT plan processor, and the SEC. It also will examine whether additional cybersecurity protocols are necessary to properly safeguard collected data, including personally identifiable information (PII). More details here
See STA’s November Newsletter here

Comment Letter: CAT NMS Implementation Plan

The Security Traders Association (“STA”) appreciates the opportunity to offer comments to the Thesys CAT, LLC and the Operating Committee on the DRAFT CAT Reporting Technical Specifications for Industry Members (“Discussion Document”), distributed to the industry on September 7, 2017. In addition to representing the interests of our members on matters relating to the CAT NMS Plan, STA is also a member on the Financial Information Forum (“FIF”) Consolidated Audit Trail Working Group (“FIF CAT WG”).

See full letter here

Falling-back is not failure, not even with CAT

In the military, falling-back happens all the time and for good reasons – none of which equate to quitting or failure. Rather, falling-back is viewed as a sound response to a dangerous situation and as a means to achieving victory. Don’t believe me? Well, listen to one of STA’s favorite decorated war heroes, Jason Redman who, among his many achievements, speaks before business leaders on strategies that work well on both the battlefield and in business. Distinguishing between falling-back and quitting or failure is one such lesson. As Jason points out, falling-back provides an opportunity to reevaluate a situation, to regroup into a more powerful force and then finally, reengage from a position of strength.
Unfortunately, our industry doesn’t do falling-back well. We tend to deploy a pendulum strategy that takes something to the point where it breaks, we then pivot and go twice as fast to the other apex only to break something else. This pendulum reality can be found in our individual behavior; our firms, as seen by countless instances of talented people promoted to points of failure only to be let go; and in our regulatory reporting regimes that throttle between too much and too little. Yes, we as an industry don’t do falling-back well.
On November 15, 2016 and after more than four years of dialogue with the industry, the SEC approved the highly anticipated Consolidated Audit Trail National Market System Plan better known as CAT. This pinnacle moment set in motion a series of deadlines for building and implementing what will be the largest data warehouse in the financial services industry. Phase #1, which calls for the SROs to begin submitting required data to the CAT is weeks away and Phase #2 is November 2018 when most broker-dealers will have to begin reporting. Technical specifications detailing how and what the industry needs to report are being delivered to market participants and multiple industry efforts are in place to assist in the implementation of CAT. We are at that point where the metaphorical ‘devil is in the details’ is fully exposed.
Concerns on CAT’s implementation plan are many, with some calling for a major scale back on its scope and others seeking time delays coupled with a more phased-in approach. Adding complexity to the already stressful environment under which the industry is operating, are the ever-increasing reports of cyber-attacks. STA, along with other industry groups believe there are problems with the current implementation plan and a solution needs to be more robust than requesting extensions to existing deadlines. We need the military equivalent of a fall-back strategy and now is the time to do it.
The selection of Thesys CAT to build the CAT was another pinnacle moment that occurred in January 2017. This decision, by definition surprised the industry as FINRA was the expected winner. Regardless of whether you think Thesys CAT is the right or wrong choice, the decision has been made and having this clarity affords the industry an opportunity to revisit the implementation plan without risking that CAT never gets built. Thesys CAT now owns this project and as such, has accountability and an economic interest in seeing CAT gets built. These factors place a stronger foundation under CAT that can withstand a temporary fall-back that has benefits as well.  To be clear, STA is not advocating CAT never be built. We are saying that at this junction falling-back is a better next step because moving forward is too dangerous and doing it now, will allow us to reevaluate, regroup and reengage from a position of strength.
Thank you, Jason.
Jason Redman
JR Overcome Show

STA Comment Letter on CAT

“The development of the Consolidated Audit Trail will represent an unprecedented opportunity to improve the Commission’s ability to surveil the market. It is critical to have an informed and detailed understanding of order and trade processing to design a system that is capable of achieving the objectives of CAT”

Read full comment letter (PDF) >