Continuing on my ‘busy summer’ theme and adding to the seemingly constant barrage of new regulatory requirements, the Securities Exchange Commission (SEC) has this week voted unanimously to adopt a new rule establishing large trader reporting requirements (see the release on the SEC’s website here). Of course, the aim of the new rule (as with most of these things – see the Office of Financial Research, for another example) is to better monitor the activities of large market participants and determine whether they are ‘up to no good’ or are posing undue risks to the market as a result of their trading activities. However, how the regulator gets to the point where it can track this entity data and its related trade data is another matter entirely, as is how these large traders and their broker-dealers report on this information.
For a point of clarity at the outset:
A large trader = one whose transactions in exchange listed securities are equal to or exceed two million shares or US$20 million during any calendar day, or 20 million shares or US$200 million during any calendar month (around 300-400 firms are estimated to fall into this category)
The impetus behind this move, as noted by SEC chairman Mary Schapiro this week (check out a video of her comments here), is obviously the flash crash and the need to quickly get a handle on market positions in an environment where “trades can be transacted in milliseconds or faster.” HFT has taken a serious hammering from the regulatory community, post-6 May and the regulator noted the need for a centralised repository of trade data from across the industry (rather than relying on exchanges to provide this info). As it was, it took several months for the SEC to ID the trader that was thought to have caused the flash crash.
However, these proposals are easily said, but not so easy to put into practice. On this note and during an open meeting this week, SEC commissioner Luis Aguilar indicated that there are many other steps that need to be taken before the reporting regime can be put in place, not least of which is the creation of an audit trail that “effectively consolidates trading activity across all markets.” Accordingly, Aguilar indicated that the SEC staff is in the final stages of preparing a recommendation regarding such an audit trail. Hence we can expect to hear much more about the data challenges therein in the near future.
For the meantime, there is the small matter of the SEC creating and collecting the new unique identification numbers for these traders: the (rather unoriginally dubbed) large trader identification numbers (LTIDs). How the LTID will relate to the legal entity identification (LEI) numbers that are being introduced by the OFR is not yet known. So, for now, this will be another identifier that needs to be maintained by the regulatory community and one that firms will need to map into their systems.
On a practical level, there are two primary components to the new rule: large traders must first register with the SEC via a new form (13H) and broker-dealers via whom these large traders execute their transactions are now responsible for providing new reports to the regulator on these firms’ activities. To this end, the SEC indicates that large traders will provide this LTID number to their broker-dealers, who will be required to maintain transaction records for each large trader and report that information to the SEC upon request.
As for the process of getting the ID itself: “After it files Form 13H to register with the commission, the SEC will then assign each large trader a unique LTID, which will allow the agency to efficiently identify and analyse trading activity by the large trader. A large trader will be required to disclose to its broker-dealers its LTID and highlight all of the accounts at the broker-dealer through which the large trader trades.”
So, the broker-dealers will need to have in place systems via which they can: store and track these new LTIDs for each of their clients; related these IDs to all of their accounts; monitor their other clients that may be near the threshold in terms of becoming a large trader; link these IDs to the transactions being done by these firms and monitor the timing of these trades (be they HFT or otherwise); and be prepared to report this data out to the regulator at a moment’s notice. You can perhaps start to see where the data nightmare is creeping in…
Ergo providing quicker and more detailed data for the regulator, means (yet more) cost and infrastructure changes for the industry. Bear in mind also that these requirements will not just hit US domestic firms, cross border trading means those outside of the region are also under the cosh.
On the subject of cost, the SEC reckons these new reporting requirements will result in minimal costs to the industry (not counting the consolidated audit trail costs that is). This week it noted that the system would be “largely identical to the information covered by the Commission’s Electronic Blue Sheets (EBS) system – the system the SEC currently uses to collect transaction data from broker-dealers.”
It stated that the “only” additional items that broker-dealers will be required to maintain and report are the LTID and the time a transaction occurs. It continues: “Accordingly, the rule leverages the existing EBS system, with modifications, to accommodate the specific requirements of the new rule. In addition, the rule requires broker-dealers to monitor whether their customers meet the threshold levels that define a ‘large trader’ (based on transactions handled at the broker-dealer) in order to encourage compliance by their customers with the requirement to identify themselves as large traders to the SEC.” Moreover, the rule requires transaction data to be available for reporting on the morning after the day the transactions have been effected. The SEC makes it sound so simple, but the industry is unlikely to agree.
As with the introduction of any new ID standard, systems will need to be reworked and adding thresholds and transaction data into the mix will further complicate matters. Broker-dealers will therefore have seven months to do all of this infrastructure work ahead of the deadline for reporting. It will be interesting to see whether the SEC revises its “minimal cost” estimate in the interim.