Written by Jason Dibble, Co-Founder and Editor in Chief – Published by https://curatia.com/

16 September 2021

US regulators are mulling a sweeping market-structure overhaul for a retail-investing epoch. The UK and Europe are mired in a budding post-Brexit regulatory rivalry. Beijing is cracking down on all the things, and the whole world is puzzling over crypto and ESG frameworks. Those dynamics have made regulatory compliance experts Wall Street’s most coveted oracles.

We sat down with one of the industry’s very best in Mark Davies, CEO of compliance and trade analytics firm S3, who offered his wisdom on topics ranging from what additional payment-for-order-flow disclosures the SEC might require to international TCA and the pending CAT launch.


Overview: Tell us a little bit about S3. What gives you an edge?

We’re a software firm that’s best known in the industry as the go-to solution for Rule 605/606 disclosures. But we also have a robust suite of trade-surveillance tools, best-execution analysis for fixed income, CAT reporting, and US and Canadian TCA. And we’re currently building on that experience providing TCA and best-execution services by expanding TCA into global markets.

Since we began, S3 has focused on customer service. Our approach has always been to take care of the customer, rather than to simply write software. This standard is evident not only in our client success but also in new product rollouts. We launch products our clients need and want, orienting our development calendar to our customers’ needs. A tight feedback loop helps us deliver focused, end-to-end solutions to real-world problems. It may not be as sexy as “moving fast and breaking things,” but we’d rather move deliberately and fix things for our clients.

We’re also in constant communication with regulators – something we think will be a differentiator as we enter a period of regulatory activism in which rule-makers emphasize the need for greater transparency across markets.


PFOF debate: Potential regulatory reform of payment for order flow is one of the industry’s hottest topics right now. Are enhanced PFOF disclosures the most likely outcome of that debate, at least in the near term? How would enhanced disclosures impact market makers, retail brokerages, and other firms?

There’s certainly a lot of discussion around PFOF and how to ensure everyone is getting best execution. In many cases, the SEC has taken an approach of disclosure to identify problem areas. Retail disclosure is a likely outcome.

While Gensler has threatened a ban on PFOF, that would result in substantial legal challenges from the industry. Plus I don’t think it would have the desired effect. Unintended consequences of regulation are how we got to this point of market structure. Instituting a ban on something that is commonly used by a huge percentage of retail brokerages would likely invite more of the same.

When regulators mandated enhanced 606 disclosures in 2018, we were able to rapidly scaffold an industry-leading solution. That happened because we were in constant contact with regulators to understand their requirements, as well as with clients to understand all the wrinkles that could crop up based on the various business cases around the data.

We’re confident that healthy dialogue with regulators, coupled with client conversations, will help us respond appropriately to regulatory reforms around PFOF.


OATS retirement: OATS, the predecessor to the SEC’s Consolidated Audit Trail project to track the lifecycle of orders, was retired on September 1. But there was a hiccup: The CAT wasn’t yet equipped to handle fractional shares, which have gained traction as retail investors have piled into stocks like Amazon with lofty share prices. How is that issue being addressed?

Fractional shares are an interesting phenomenon. They’re not really traded in the traditional sense, meaning you can’t take a fractional share to a stock exchange and trade it. Instead, they’re generally handled via internal bookkeeping. If someone wants to buy a fractional share of any given stock, their broker needs a way to handle the other part share.

Since before CAT was live, S3 has been very active with FINRA sorting out how CAT reporting should work in various instances. We were one of the first to use the AWS direct-connect, for example, and worked with FINRA to make sure that system was correctly set up.

More recently, S3 was working with a client who had a particular way of handling fractional shares, and FINRA had not published how a given approach should be reported to CAT. We worked with FINRA to determine the best way to handle these situations to ensure the client was fully CAT compliant.

The next CAT milestone happens on December 13, when firms begin reporting complex options trades, and small firms are required to begin reporting equity and options data. We’ve been working with a number of clients to help them meet those requirements.


Global regulatory avalanche: There’s a tremendous amount of regulatory activity at present — not only in the US but also in Europe, where Brexit and a MiFID rethink are stirring the pot, and in Asia, where Chinese regulators are cracking down on everything from political activism and crypto to video games. How is S3 positioned to capitalize on those and other developments in the international sphere and shepherd clients through an epoch of regulatory uncertainty?

For any business, expanding internationally is daunting. There are language barriers, cultural barriers, time-zone barriers, and a whole host of other issues. Firms looking to trade internationally may not face all those challenges, but all will face arguably the most daunting challenge: Playing by a different set of rules.

In that context, one of the most reassuring things we can do for a client is to let them know that even if the rules differ, we can bring a simple, consistent approach to following them and making the most of their investment.

S3’s platform starts with appropriate market data. Onto that, we add client data. Our first foray into any market starts with BestEx / TCA. For this, we match the prevailing quote to the client data at a variety of different timestamps – initial order time, route time, marketable time (which is the same as the others for market / marketable orders), execution time, etc.

Most trade surveillance is basically looking for patterns around these timestamps. So once we have the market data and the client data in a given jurisdiction, we are well-positioned to grow into other areas of compliance, depending on local regulations. And our clients are equally well-positioned to benefit from a consistent, dependable approach.


ESG & crypto regulatory frameworks: In addition to the PFOF debate and the launch of the CAT, rule-makers are looking to scaffold regulatory frameworks for ESG and crypto. Those projects have taken on added urgency in light of rapid growth in the crypto space and pandemic-era “build-back-better” campaigns emphasizing clean-energy development. Do those initiatives present growth opportunities for S3?

Yes! We’re very excited about the opportunities in crypto. While both sides are gearing up for a fight regarding crypto regulation (being the regulators and the crypto believers), I don’t see a scenario where this massive asset class continues to skate by without any material regulation.

We aim to be a leader in this space. Crypto poses new and interesting challenges that present an opportunity for a compliance software firm to differentiate itself. When do you report data in an industry that literally never stops trading? How do you support market-making strategies that can be defined by stakeholders in DeFi projects on the fly? Those are interesting, cutting-edge questions that in many cases you have to think meta to answer.

There’s also an opportunity to do some good. You had an interesting piece earlier this week about rising tensions between regulators and innovators in crypto. More disclosures could be not only an inroad to institutional adoption but also a way to defuse tensions and reach regulatory détente in the space. We want to be part of that.


TCA: You’re expanding your TCA offering internationally at a time when many firms are keenly focused on transaction costs and investing outside the US to catch the pandemic reopening trade as it trickles down to emerging markets. What prompted the decision to expand in that area, when will the offering be ready, and why are you bullish on its prospects?

The points you made about firms’ heightened pandemic-era focus on transaction costs and catching the ex-US reopening trade are right. But they’re only part of the equation. Lots of firms are seeking to optimize transaction costs in the US – a market that’s already highly rationalized due to its advanced market structure. As ex-US trading ramps up, there may be opportunities to save even more in the international sphere, where market structure is less uniformly advanced, and liquidity is thinner.

Our international TCA offering is already live with one major US bank, and we have several other firms ready to go.


Austin: S3 is based in Austin — a city that’s garnered considerable attention during the pandemic as an emergent tech and finance destination. What do you love most about living there? What has the experience of working there been like, particularly with a client base that’s anchored in New York?

Austin is a laid-back place where people dress casually and frequent the city’s legendary swimming holes to escape the intense summer heat. The icy, spring-fed Barton Pool and Hamilton Pool’s 50-foot waterfall nestled into a circular grotto are two of the most iconic.

Austin is also known as the live-music capital of the world. An epic day here might include tubing down the Guadalupe River with a cooler of adult beverages, heading over to the Gristmill, a historic terraced restaurant overlooking the river, for chicken-fried steak, and then taking in live music at Gruene Hall, Texas’s oldest dance hall, where legends like Willie Nelson and Merle Haggard have performed.

Our “origin story” is a very Austin story, with a head trader at a Texas-based broker-dealer happening to read a newspaper article about some guys trying to make a go of it during the financial downturn after the dotcom bubble (us). So we’re an Austin story from the core!

Since we’ve been “remote” (from Wall Street) for our whole existence, we’ve always been very aware of where we’re from. Austin has spent the past 25 years becoming a tech hub in its own right, and we saw that very early on – we were able to find high-tech talent interested in working on challenging problems – not necessarily the same as the talent pool in New York. Since we got so used to it, it wasn’t uncommon that when visiting clients in person, we would suggest a follow-up zoom session to demo the product, rather than trying to demo it in person!

One challenge that the success of Austin has brought is the increase in Silicon Valley recruiting. All the major Silicon Valley companies are setting up huge development centers in Austin. We’re busy trying to hire industry technical people who are good with customers. So if you know anyone like that, please send them our way!


Productizing data: Are there opportunities for S3 to do interesting things by aggregating and anonymizing data it’s collected for compliance purposes and presenting it in a way that increases industry transparency? Could compliance software firms one day become data providers of a sort?

This is a very interesting question. The short answer is that if our clients expressed an interest in seeing this kind of data – say, to benchmark their results against industry norms – then we would build it out.

In that instance, our goal would be to allow all our clients to benefit from all the data. With improvements in AI and machine learning, we can, for example, envision a scenario where a bad actor is manipulating the market from one broker, and we can use that information to catch that kind of activity at other brokers, so they can address issues long before FINRA even asks about the issue.

It’s sort of the Wall Street equivalent of using aggregated user data in Google Maps to route around trafficky areas, or a weather app that lets users see reports from other users of tornadoes that have touched down in their area. So there’s definitely promise there.

That said, our first commitment is always to our clients – and in this industry, it really can’t be any other way. When they see enough value in a feature that they’d be willing to contribute their own anonymized data to it, then you know you have something. If they’re unwilling, though, it’s a non-starter for us.