Reporting correct customer data for the next phase of the requirements of the US Financial Industry Regulatory Authority’s Consolidated Audit Trail (CAT) system will end up being a time-consuming and costly exercise in data management for US broker-dealer regulatory reporting, trade compliance and IT managers.
US broker-dealers are likely spending all their time addressing interfirm and TRF linkages and think of April 2021 and July 2022 as too far off to worry about, yet trade compliance experts caution that waiting too long to prepare is a bad idea. With the time for lining up budget requests for 2021 just around the corner firms need to allocate funds for the customer account information preparation. Those funds will be for data cleansing software, payment for CAT reporting agents, and additional middle office staff.
Interfirm linkages represent the data about which order one brokerage firm sent to another to be executed while trade reporting facility linkages represent the information on over-the-counter orders sent to one of three trade reporting facilities (TRFs). The data between firms and the data between the brokerage firm and the TRF must match. The data on interfirm and TRF linkages was required to be accurate by October 26, 2020 for equities trades and must be correct by January 2021 for options trades. Information on executed equities and options trades had to be accurate starting in June and July 2020 respectively. FINRA will penalize firms which don’t meet its litmus test of an error rate of less than five percent on initial CAT reports and two percent on resubmitted corrected reports. Broker-dealers have three days from the time the trade is executed to correct any wrong data previously submitted to CAT.
Customer account information is the final phase of the CAT reporting system, which started to take shape after the May 2010 market crash and in 2012 the Securities and Exchange Commission adopted Rule 613 requiring national exchanges and brokers to report on executed equities and options trades to a central repository. In November 2016, the SEC approved a national market system (NMS) plan to create a single database known as the consolidated audit trail to enable regulators to more thoroughly track all trading activity in US equities and options. CAT will receive and retain the trade and order lifecycle of listed equities and options and over-the-counter equity securities.
Self-regulatory organizations, such as exchanges, and broker-dealers must submit order lifecycle information to the central repository for each trading day by the next morning. FINRA wants to retire the legacy OATS reporting system as soon as broker-dealers achieve an industry-wide error rate of under five percent for initially submitted reports and less than two percent for corrected resubmitted reports over a 180-day period. So far, the brokerage industry seems to have managed to fall under those thresholds, but interim linkage data remain a big cause for concern for having a high error rate. While there is plenty of overlap between CAT and OATS, CAT includes more data fields, more events, and options for the first time.
The requirements for accurate reporting of customer account information come in two phases — the April 2021 deadline for large trader orders and the July 2022 deadline for all other customers. The customer account information is stored on a separate database from the transactional database; called the customer account information system (CAIS), the database is run by Kingland Systems. “The transactions and customers to which they belong are linked through transformed identification codes (TIDs) and CAT customer IDs (CCIDs) assigned to the customers,” explains Christopher Bok, chief compliance officer for New York-based OTC Link LLC, a registered broker-dealer and operator of an alternative trading system. “The transactional database will allow regulators to determine whether order and trade data submitted by CAT reporters requires further review.” The customer database is designed to allow regulators to more quickly determine the underlying account details. The CCIDs will be created by FINRA, while the TIDs, with hexagonal values, are created by the broker-dealers based on the social security number, tax identification number or employer identification number of the customer. The CCIDs and TIDs are designed to mask the identity of the customer in the event of a cybersecurity breach to the CAT system.
For the April 2021 deadline, CAT requires broker-dealers to report customer-issued 13-character large trader identification codes (LTIDs) which the broker-dealer must obtain from its customer, who in turn obtains them from the SEC. LTIDs or ULTIDs associated with FDIDs must be reported in the LTID phase of CAIS when the FDID has an associated LTID or ULTID; the FDID is reported in both equity and or option/allocation events. “Broker-dealers may not have consistently identified their LTIDs and ULTIDs under the Electronic Blue Sheet reporting regime,” says Joanna Fields, managing principal of New York-based Aplomb Strategies, a regulatory consultancy. “LTIDs might not have been assigned during their customer onboarding process or not updated in the event of a change, such as a merger or acquisition, which would require a new LTID.” Electronic Blue Sheet (EBS) reporting refers to the reporting on demand required by the SEC for transactions which occur during a specific timeframe.
What is a large trader? As the name implies, it is a customer of a broker-dealer that executes a lot of trades — either two million shares or $20 million worth of shares traded in a calendar day, or 20 million shares or $200 million in a calendar month. The middle offices at broker-dealers are responsible for keeping track of volumes to ensure they don’t miss reporting larger trade orders. What makes the April 2021 deadline for LTID reporting so challenging is that it also coincides with Phase 2C of equities reporting, which includes allocation events and representative orders. CAT requires every allocation event for individual trades be reported and all customer orders tied to representative orders. Introducing broker-dealers and retail brokers typically don’t have allocation events, which must now be handled by their clearing firms to report under CAT. “Trade allocation events represents a new reporting category and there are no vendor solutions so broker-dealers will have to do the work in-house,” says Steven Goune, practice head of risk, regulatory, finance and compliance for Capital Markets Advisors (CMA), a New York firm specializing in regulatory compliance, risk management and financial technology. Representative orders will be harder for larger firms to report because they aggregate multiple orders from large institutional clients to a single representative order.
Broker-dealer middle offices must make certain they locate the right trade to the right underlying fund and that the large trader ID code is linked to unique 40-digit alphanumeric identifiers for each underlying trading account or entity IDs called FDIDs. “Brokerages might rely on multiple order management systems from different vendors and not have a process in place to consolidate all of the information,” says Fields. The larger the firm, the higher the chance for errors. “There could be a single LTID and multiple FDIDs or multiple LTIDs and FDIDs or duplicative LTIDs,” says Peter Gargone, chief executive of n-Tier, a New York-based firm focused on data management for regulatory reporting. “The LTIDs might not match with the FDIDs or an FDID could be missing. For firms which have several hundred accounts matching the LTIDs to FDIDs might not be hard, but it could become problematic for firms with several thousand clients.” Although the CAT system will store the LTIDs, it will not store the FDIDs. Instead, the CAT system will convert them into CCIDs. Gargone, whose firm is a FINRA-approved CAT reporting agent, says that n-Tier’s clients can use its software to validate data across different systems for CAT reports, CAIS reports and EBS reports from internal reference data, trading, and settlement systems.
So what should brokers do to ensure correct LTID reporting? Fields recommends that firms review their account opening and updating processes to make certain they assign LTIDs and ULTIDs immediately and link the account opening process with the middle office to keep track of trading volumes in the event a client becomes an LTID. Broker-dealers could end up completing an exercise in controls management, requiring additional staff, predicts Fields. Depending on the size of the broker-dealer and the accuracy of its data, making all the necessary technological and procedural changes could easily come to over US$1 million, predict some brokerage IT managers. “It’s advisable to start the data scrubbing process to make sure the LTIDs match with the FDIDs for the subaccounts for CAT reporting and EBS reporting,” says Gargone. There is plenty of room for mistakes such as duplications and inconsistencies. “An LTID record without an FDID is invalid and one FDID can have multiple LTIDs, while one LTID can be associated with multiple FDIDs,” says CMA’s Goune. CMA has rolled out a CAIS data utility that extracts customer identification data and transactional data from internal databases and can link the LTID code with the FDID codes.
As if keeping track of larger trade orders weren’t hard enough for broker-dealers to deal with, they must also report information on every other customer who is likely a smaller fund manager or retail client. “Given that there are far more customer accounts to deal wih that are not large trader accounts the July 2022 deadline will be a far greater compliance challenge,” says Josh Barry, chief software architect for regulatory reporting technology firm S3 in Austin, Texas, which is also a FINRA-approved CAT reporting agent. The fact that they trade less frequently or in smaller values won’t be relevant to FINRA if the brokerage firm doesn’t have the correct updated information. “As is the case with other financial firms, broker-dealers often store client data in multiple repositories depending on the type of asset, branch, business line or region,” says Bok, who co-chairs the CAT Reporting Committee for Financial Information Forum, a New York-based securities trade group. The customer data might not be compatible between repositories; names might be different and so might addresses and birthdays depending on the number of data fields and data models used. Name changes and address changes are the most common forms of customer updates; some customers might even decide to leave their brokerage and transfer their accounts to other firms.
“The current state of a CAT reporter’s cleanliness of customer information databases will play a significant factor in the ability of a broker-dealer to comply with the July 2022 deadlines,” says Bok. Goune points out that firms which clear their own trades will track down customer data from client onboarding, middle and back office databases. Introducing broker-dealers which rely on clearing broker-dealers to do their CAT reporting will need to match up their data with the data stored by their clearing brokers. Both the introducing broker-dealers and their clearing firms will need to both create FDIDs for customer accounts other than large trader accounts.
The interactions between introducing and clearing brokers will turn into a major operational exercise where having the correct controls and reconciliation process become critical. “The introducing broker is responsible for asking its client for an LTID and for sending the FDIDs the introducing broker creates to the clearing broker,” says Goune. “The introducing broker alone is responsible for keeping track of the trading volume of its client and must notify the client to obtain an LTID from the SEC when it passes the required thresholds of trading activity. The client has ten business days after being notified by the introducing broker to submit the LTID.” Otherwise, the account will be given a ULTID. In some case the clearing firm will be doing the reporting to FINRA on behalf of its introducing broker client, but the introducing broker is still legally responsible for any mistakes. “If the introducing broker allows clients to change account information in its system, these changes will have to flow through to the clearing broker,” says Barry. “The introducing broker and the clearing broker will have to create a process to make sure all of the relevant information and updates pass from the introducing broker to the clearing broker.” Both the introducing and clearing broker must follow SEC and FINRA guidelines for storing customer data which means that each must retain all the information for at least six years after the account is closed.
US broker-dealers worried about how they will handle all of the data cleansing and reporting requirements for CAT have even more to worry about as there are two other key regulations which will also put their customer data management skills to the test. For large global US brokerage firms, which do business in Europe or trade in swaps, ensuring the accuracy of customer data could prove critical in meeting the second incarnation of the Markets in Financial Instruments Directive (MIFID II) and global swaps reporting requirements. However, in the case of MiFID II and swaps reporting, legal entity identifiers (LEIs) are the norm so broker-dealers have to make certain their clients apply to national numbering agencies to receive their LEIs and that they are renewed or changed should a corporate reorganization occur. “It’s going to be a challenging 2021 for broker-dealers in managing multiple identification codes for customer accounts with multiple reporting regimes,” explains Fields. “It will come down to improving customer data management, ensuring better operational controls, and adding middle office supervisory staff.
Brokerage compliance and technology experts recommend that the requirements for CAT and other regulations requiring reporting of customer account information be incorporated into the budget for 2021. In the case of CAT, introducing and clearing brokers which have already started reporting on executed equities and options trades will still have plenty of extra expense dealing with customer data for CAIS. “The introducing broker has to keep track of when accounts become larger trader accounts, ask for LTIDs, generate FDIDs, link LTIDs to FDIDs, and handle all other non LTIDs,” says Barry. “The clearing broker has to keep track of the same information and both the introducing broker and clearing broker must set up systems and procedures for information flow between the two firms.”
Software and operational challenges aside, finding qualified employees to work remotely during the COVID-19 pandemic could be tough. Middle-office managers will likely need a FINRA Series 24 certification as a general securities principal and lots of additional experience. “There might be a lot of unemployed brokerage operations managers out there, but they need to be knowledgeable in trade operations, regulatory reporting, and data management,” one US brokerage operations manager tells FinOps Report. ‘Broker-dealers will be looking for a needle in a haystack and it won’t be cheap.”
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