How Blockchain Technology Can Ease the Burden of TRACE Reporting

The Trade Reporting and Compliance Engine (TRACE) is a regulatory tool implemented by FINRA that facilitates the mandatory reporting of over-the-counter (OTC) transactions for eligible Fixed Income securities. The purpose of TRACE is to make Fixed Income transactions more transparent to level the playing field for all participants. TRACE comprehensively provides real time data to investors on price information while simultaneously assisting regulators with monitoring of the market, prices, and execution quality. Securities Eligible for TRACE reporting include any debt issued in US Dollar denominated securities issued by a US or Foreign private entity, and any US Dollar denominated securities issued by a US executive agency or Government-Sponsored Enterprise. Eligible transactions need to be reported within 15 minutes of the transaction from both parties. The required information to report includes price, size, time of execution, counterparty, amount of commission, and settlement date.

TRACE violations are easy to commit. It can be as simple as a trader being away from his/her desk for over 15 minutes with trades pending for them to accept causing a mismatch in execution time. Another common example is a miscommunication between counterparties on whether the settlement date is T+1, T+2, or T+3. TRACE errors can be fixed within 15 minutes of execution, but once the fifteen minute period is up the violation is reported to FINRA. Increasing amounts of violations being reported can lead to fines. The burden of fixing trades generally falls to middle office personnel who support the trading desks involved in the transactions. These employees are not generating revenue for the firm, but rather are focused on cost and risk minimization. They come under extreme pressure when they don’t correct trader’s errors that lead to fines. Citadel recently settled with FINRA on a fine of $275K for a series of basic TRACE violations. They were fined for the same easy mistakes a lot of firms make such as: over reporting Treasury transactions because they reported internal transfers of those securities, not selecting the “No Remuneration” indicator on a trade done with no commission or markup/down, and reporting the counterparty type as customer instead of affiliate. These are all pain points for traders and middle office personnel that can be solved with blockchain technology.

The DTCC published a whitepaper in 2019 titled “Guiding Principles for the Post-Trade Processing of Tokenized Securities” showing that they understand the impact that blockchain is going to have on the world, and that they are willing to adopt the technology to better improve their processes. This is encouraging as DTCC is a major part of the financial system, and they are clearly willing to embrace this new technology to enhance trade settlement processes. FINRA has yet to attempt to apply blockchain technology to make monitoring the market more efficient. Using blockchain and distributed ledger technology, TRACE reporting would be simplified. All of the information required by TRACE to make markets more fair and transparent could be readily available through transparent blockchain technology. It would be easier for traders and middle office personnel not to have to make nuanced decisions about whether a security is TRACE eligible or not, but instead rely on code to make the decision for them. The same blockchain mechanisms that are able to help The DTCC address settlement issues will help TRACE reporting. T+0, instantaneous settlement is helpful for TRACE reporting because now no one needs to worry about a mismatch of trade or settlement dates with their counterparty being reported to TRACE. A mismatch in counterparty, price, size, and all other trade details are also unlikely because of instantaneous settlement.

In 2020 Morgan Stanley was fined $300K, Barclays $650K, and in 2021 Citadel was fined $275K. The rise in fines levied in recent years has led to an emphasis on correctly reporting to TRACE and on fixing past TRACE violations. It is only a matter of time before institutions like FINRA and major banks begin implementing this type of technology to smooth out middle and back office processes. Blockchain will allow post execution processes to provide utility to traders as it lowers risks and costs downstream. The technology is ready, but the industry is lagging in implementing it so far.