SEC's Consolidated Audit Trail: Dead on Arrival

The devil is always in the details. As I was reading through the proposal to establish a market-wide consolidated audit trail recently put forth by the US Securities and Exchange Commission (SEC), one small passage caught my eye that could possibly spell doom for the entire project.

The proposed rule’s fifth requirement states that each exchange and its members synchronize their “business clocks,” which sounds innocuous enough. It is easy to understand the logic behind it. When SEC officials look to reconstruct a market event, they want all quote and trade data to line up evenly by a standard time stamp. However, as any dancer would say dancing is easy, it is synchronizing your steps with those of your partner that is the hard part.

This could easily be fueled by the industry bravado about its technical prowess to deal with millions of transactions per second and being able to measure performance at microsecond speeds.

The first thing the SEC needs to clarify is what, specifically, is a “business clock.” I assume it means making sure that all of the time stamps for quotes and trade messages are synchronized. But to what degree? Do the regulators want the last server touching a quote or trade message before it goes into a matching engine to be synchronized with the matching engine, or does the SEC want all of the timestamps throughout the trade lifecycle—from the buy side to the sell side to the market and back again—to be synchronized? If it’s the former, it’s a much easier task to handle.

Ideal Solution

Current technologies available to help synchronize server clocks, such as the Institute of Electrical and Electronics Engineers’ (IEEE’s) standard for synchronization of networked measurement and control systems—called the Precision Time Protocol (PTP), or IEEE 1588—work best with the fewest network hops. The ideal solution is to have every exchange member co-locate their servers with the exchange’s datacenter. That way every server connecting to an exchange’s matching engine could synchronize to the matching engine’s server clock. But I doubt that every exchange has the capacity to provide co-location services to all of its members.

However, looking at other proposals floated by the SEC, it appears that the regulator is looking for the latter, which would provide a complete picture of the state of the market. This is where potential solutions get far more expensive and might force some firms out of the market because they cannot afford the necessary precision kit needed to synchronize all the time stamps through a trade’s lifecycle.

First, you have to assume that networking costs will go up as third-party connectivity providers will have to upgrade their infrastructure to handle the synchronization demands. Since few other industry verticals require such a level of service, the industry would be paying a premium for the new services.

Then there is the issue of the various software-as-a-service (SaaS), platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS) providers. Will they be able to synchronize their offerings to meet the proposed regulation? Most of the vendors are relying on economies of scale to provide their profit margin. Would an Amazon, IBM, or Rackspace upgrade their respective cloud infrastructures to meet the demand of a single industry vertical? That is doubtful, which means that until the SEC clarifies the synchronization portion of its proposed rule, the idea of a consolidated audit trail is going to be dead on arrival.