CAT Selection Shows Industry's Interest in Change

Surprises tend to be few and far between when it comes to regulatory decisions. It's typically fairly easy to see which way the wind is blowing, as there is plenty of lead-up prior to an official announcement.

That's why I was shocked when the self-regulatory organizations (SROs) tapped Thesys Technologies, along with its partners on the bid, IBM, law firm Latham & Watkins, and brokerage Rosenblatt Securities, to build the Consolidated Audit Trail on Tuesday. I'm fairly certain Las Vegas bookmakers don't carry odds regarding financial regulations (although I wouldn't put it past them), but if they did you'd think all the smart money would be on the Financial Industry Regulatory Authority (Finra).

Finra currently operates the Order Audit Trail System (OATS), which, for all intents and purposes, is the predecessor to the CAT. Many in the industry have speculated that once the CAT is up and running, OATS will be decommissioned. That's why many pegged Finra as the winning bidder, as picking the incumbent was the conservative, easy choice.

Finra even had a vote in the selection process! And although Finra made it very clear it was taking every possible step to make sure there was no conflict of interest, there were those who questioned if there was truly no influence.

Editor's note: An amendment to the CAT NMS plan was passed in November 2015 by the SROs requiring any SRO that is a bidding participant or an affiliate of a bidding participant to recuse itself from voting in any round of voting for the selection of the plan processor. While Finra participated in the inital round of voting that narrowed the list of bidders from 10 to six in July 2014, it recused itself from all further voting.

That's why so many people believed the CAT proposal was Finra's to lose. Even up until the 11th hour, sources I spoke to seemed to think the firm had the pick locked up.

Different Direction

It's ironic that such a shocking decision comes three days before the US inaugurates a president many experts predicted had no chance of winning just days before the election.

By no means am I comparing Thesys to Donald Trump. However, as was the case with the US election, I think there is something to be said for the SROs wanting something different from their CAT plan processor than what the industry has traditionally had.

Now, before I go any further, let me be clear that Thesys is no stranger to building technology for regulators. Tradeworx, the high-frequency trading firm (HFT) that is the parent company of Thesys, built the US Securities and Exchange Commission's trade surveillance platform Markets Information Data Analytics System (Midas). To put it simply, this is not its first rodeo.

In addition to that experience, Thesys also has a deep knowledge of algorithmic trading, which is a critical piece of the CAT. When I spoke to Tradeworx then-CEO Manoj Narang in the fall of 2014 about his firm's bid, he pointed to that as a differentiator.

"Really, there are very, very few bidders that have that kind of expertise because we live in a complicated regime of market structure with boundless fragmentation," Narang said. "Orders can get split into discretionary execution, into algorithmic execution and those algorithmic executions that go from blocks to get split up into child orders, each of which get routed in different ways. Some of them go to lit venues, some of them go to dark venues. To be able to tie all those things together, you have to have a pretty good background in algorithmic trading."

"They may be financial technology firms, but they're kind of old-guard financial technology firms that really have no specialization in these kind of newer technologies and new methods," he added. "That really gets to the heart of why the Order Audit Trail System (OATS) needs to be revamped and overhauled—because it's insufficient to account for all of the kinds of trading that happens nowadays. So the gaps between OATS and the CAT really are heavily about algorithmic trading, and we think our background as an algorithmic trading firm is something that bears directly on those deficiencies."

Granted, that logic could also work against Thesys. Some might say the CAT, which is meant to monitor HFT, shouldn't be monitored by a company that's owned by an HFT firm. Either way, there is no denying Thesys is quite different from Finra in that respect.

Secondly, and just as important, I believe there were some real concerns by the SROs about Finra having access to the raw data. When I interviewed folks involved in the CAT process back in 2014, this was an issue that was consistently brought up. The idea that compliance functions and CAT functions could potentially be running side by side didn't sit well with some in the space.

Regardless of the reason, at least a decision has been made. What has already been a long and arduous process can take a big step forward.