The Securities and Exchange Commission has awarded a contract to Tradeworx of Red Bank, N.J., and its high-speed trading technology arm to develop and deliver a system that will allow four of its divisions to track creation, modification and cancellation of orders in real time.
The system will allow the federal regulator to collect, store, aggregate, monitor, query, manipulate, and analyze trades, quotes and orders on stocks and options, as disseminated by national securities exchanges, over-the-counter markets and alternative trading systems, according to the request for proposals issued at the end of 2011 by the SEC's divisions of Trading and Markets and Risk, Strategy and Financial Innovation.
The system, which the divisions have begun to implement, will provide the SEC with the ability to look at all activity on public markets. The system will not include data from dark pools of capital, which now account for roughly one-third of all trading.
The "market data solution,'' as it was generically described in the RFP, is expected to be in place and in use by the end of this year.
"This basically propels the SEC from zero to 60 in one fell swoop, going from being way behind even the most basic market participant to being on par if not ahead of the vast majority of market participants, in terms of their system and analytical capabilities,'' said Gregg E. Berman, senior advisor to Robert Cook, the director of the Division of Trading and Markets
The system has been in the works almost as long as the development of the so-called Consolidated Audit Trail, which the SEC last week mandated the securities industry's national exchanges and the Financial Industry Regulatory Authority create.
The trail, which will track the entire "life cycle" of a trade from order generation through modification, aggregation, disaggregation and execution and identify the market participant who made it, originally was proposed in a fashion that would require real-time reporting of orders and cancellations.
The real-time requirement was withdrawn, before the SEC last week, on a 3-2 vote, adopted its final rule that charged the industry with creating a trail that chairman Mary L. Schapiro in 2010 said would cost $4 billion upfront and $2 billion a year to operate.
The real-time market data tracking system to be delivered by high-frequency trading pioneer Tradeworx is vastly less expensive than the industry's development of the consolidated audit trail. The first year award, according to a posting on a public site that tracks federal business opportunities, is $2.5 million.
The SEC's market-tracking system is an internal system and requires no action on the part of the securities industry itself to develop and put in place. The audit trail, by contrast, will require cooperation and system changes by exchanges, trading firms and a wide range of market participants to put in place.
The audit trail, even with the removal of the real-time requirement, will likely cost the industry more than $1 billion to put in place, according to Joseph N. Cangemi, managing director for global electronic execution at Convergex, a supplier of technology and trading services to asset managers and financial intermediaries around the world.
With that trail, there are "immense hurdles" to overcome, Cangemi said. Somewhere between 4,000 and 8,000 brokers, trading firms and other organizations will have to adjust their trading systems to report information into the consolidated audit trail. Most of these organizations have "closed borders with huge language barriers,'' he said. The audit trail will be a platform that creates a "common language" for communicating information not just on trades, but on the market participants who made them.
The SEC's real-time market data system, by contrast, only has to suit one organization. Plus, there are no there are no development costs, the firm involved has previously built the type of system requested and will be hosting it.
"In retrospect, we were looking for a system that is on par with what the most sophisticated market participants can do,'' Berman said, "what we really needed to find was someone who could build those types of systems, but not from scratch. But who had one that was ready out of the box.''
Also involved in the project are the Divisions of Enforcement and the Office of Compliance Inspections and Examinations. Roughly two dozen staff members in the four divisions will be users of the system.
The request for proposal, however, specified that the system be able to support 100 users all told, including 10 at any one time.
The primary users will be what Wall Street trading firms refer to as "quants": Programmers who understand market structure and how to make queries into huge amounts of market data and perform analyses of patterns of activity.
The SEC's quants will be looking for patterns of disruptive activity and nefarious trading practices, intentional or accidental. The system will also be used to watch for what Berman called "structural patterns between cancels and movements in the market" and, for instance, cross-cancellations between exchange-traded funds and the underlying stocks that are their components.
The "researcher's platform" will also allow the quants to analyze market microstructures, insider trading and such practices as layering and spoofing.
In layering, the trading firm or firms involved send out waves of false orders intended to give the impression that the market for shares of a particular security at that moment is deep. The technique may also use a large amount of "wash trades,'' that have no economic effect, to achieve the appearance of market depth. The traders then take advantage of the market's reaction to the layering of orders.
In spoofing, the trader or traders involved will send out an order with a corresponding cancellation, often at the opening or close of the market, in order to get a particular market reaction.
The Tradeworx system will, for instance, let the SEC scan through millions of orders, for cancellations and analyze the output, automatically.
The use of the system will be overseen by a newly created Office of Analytics and Research in the Division of Trading and Markets. Berman is the first head of the new office.
The real-time market data, according to the RFP, will include, at a minimum:
• Consolidated Tape System/Consolidated Quotation System feeds
• Universal Trading Platform 1 Trade Data Feed/UTP Quotation Data feed
• Options Price Reporting Authority (OPRA) feed
• New York Stock Exchange (NYSE), Archipelago Exchange (ARCA), American Stock
Exchange (AMEX) feeds
• Nasdaq Stock Market, Boston Exchange, Philadelphia Stock Exchange feeds
• BATS Exchanges BZX, BYX feeds
• Direct Edge Exchanges EDGA, EDGX feeds
• National Stock Exchange feed
• Cayman Islands Stock Exchange feed
• Chicago Board Options Exchange feed
The system will store executions, orders, modifications, and cancellations, as provided to market participants using the exchange feeds, "with the time of occurrence measured to the same accuracy as provided by those feeds. "
The system also is expected to "allow for uploading historical data to the extent that it is available from the exchanges.''
Like the consolidated audit trail, the real-time market data tracking system got its genesis with the May 6, 2010, Flash Crash.
Getting the data pulled together to analyze what happened on that day was a "long and arduous process," Berman said. "We recognized that we did not have at our fingertips" all the data we needed. In fact, the staffs of the SEC and sister agency the Commodity Futures Trading Commission were not able to publish their joint analysis of what transpired in the crash until September 30, 2010.
With this system, the four divisions will be able to raise red flags about activity that warrants a closer look and then, the next day, use the consolidated audit trail, when it's available, to investigate the entire sequences of events and parties involved. Data from the Large Trader Reporting rule can also be layered into that investigation.
Unlike with the consolidated audit trail, this real-time reporting system requires no industry involvement or deliverables.
"We're using commercially available data. We're not asking anybody for new information. We're not getting any new feeds,'' said Berman. "We're just using what they already provide today. So this takes us all the way up to the cutting edge, of making sure we have all the information that we can get.''
