“companies like Robinhood have to post money to a clearinghouse to make sure you’re good for the money. And when GameStop shares went wild last week, the clearinghouse demanded more money than Robinhood could come up with”
Now let me rewrite it for a system where the little guy isn’t screwed.
“companies like Robinhood have to post money to a clearinghouse to make sure you’re good for the money. And when GameStop shares went wild last week, the clearinghouse demanded more money than usual, but which Robinhood could easily come up with, since their clients had deposited that money weeks, months or years ago. Robinhood had it on hand because that’s their entire job.”
Unless people are buying on margin. In which case, to get the cash the brokerage would have to sell the stock that is being used as collateral for the margin.
DTCC wasn’t asking for money from Robinhood’s clients; DTCC wanted money from Robinhood. DTCC is a central clearing facility that guarantees that all the trades submitted to it will clear and settle. To participate as a DTCC member, Robinhood has to deposit its own money with DTCC, called a “Fund Deposit” under DTCC’s rules. The Fund Deposit is above and beyond the money that Robinhood’s customers will routinely remit to and receive from DTCC to settle their trades. All of these Fund Deposits from all the broker-dealer DTCC members together make up what DTCC calls the “Participant Fund.” The Participant Fund is a backstop to ensure that members’ transactions all clear and settle as they are supposed to.
Ordinarily, customer trades should be cleared and settled when Robinhood takes money (or securities) out of its customers’ accounts and gives it to DTCC on settlement date. You seem to think this is the only way that trades can clear and settle at DTCC but that’s not true. If, for whatever reason Robinhood’s customers can’t settle, the money comes out of Robinhood’s Fund Deposit. If Robinhood’s Fund Deposit is insufficient to cover the settlement obligations, DTCC takes the money out of the Participant Fund, and, effectively, the losses are shared by all the broker-dealers that are DTCC participants. If the Participant Fund is insufficient to cover settlement obligations, DTCC can keep demanding money from all of its members until they have all run out of money.*
The precise amount of a firm’s required Fund Deposit is complicated to determine (and I’m not an expert) but it generally goes up the more the firm and its customers trade and the riskier those trades are. This is basically what happened to Robinhood. Its customers were trading more and more Gamestop, which DTCC perceived as riskier settlement risks.
As I discussed above, if Robinhood’s customers are buying extensively on margin, DTCC would possibly be concerned that Robinhood’s customers would have trouble settling their trades. Furthermore, people can technically buy securities in a cash account even without actually having cash in their account. If they do so, they just need to make the deposit to their broker in time for the broker to make the deposit to DTCC for settlement. I don’t know if Robinhood allows this and I doubt that it does. However, this would pose an additional source of settlement risk to DTCC. Robinhood’s trading for its own accounts (called proprietary trading) would also be a settlement risk to DTCC. And critically, DTCC does not get information from Robinhood that tells it whether the trades to be settled are for Robinhood, its customers’ funded cash accounts, cash accounts pending funding, or margin accounts. That is, DTCC does not have the information in real time to assess exactly how much the increased trading in GameStop stock was increasing Robinhood’s settlement risk. The tool that DTCC had to manage Robinhood’s settlement risk, without risking the Participant Fund’s assets, was to demand more capital from Robinhood every time Robinhood traded the stock.
Note: There was some non-specific fearmongering press about how the whole financial system was close to collapse during the GameStop debacle. The articles didn’t bother to explain what the risk was, however. If I had to guess, I think they were speculating that GameStop settlement failures were so large that DTCC would have to call in so much capital from broker-dealers that the broker-dealers would start to fail and that this would cause some calamitous dominoes of failing broker-dealers failing to settle, which would lead to more DTCC capital calls, which would lead to more broker-dealers failing until the whole system collapsed. This was never a real risk. Broker-dealers’ collective excess net capital far exceeded the entire value of all GameStop shares at its very peak. No matter how many settlement failures DTCC had to make up out of the Participant Fund, their members collectively had plenty of capital to make sure that DTCC could settle all the trades. These capital calls would have hurt DTCC members’ profits but they weren’t really a systemic risk. The system was nowhere close to collapsing.
I think inexperienced GameStop traders misunderstood how the market worked but I don’t think anyone believes that the GameStop market operates like a consumer retail market. No one tries to create a short squeeze on washing machines.
Yes, DTCC can demand more money from Robinhood than its customers will give it for the trades. It can, and did, demand more than Robinhood had, which is why Robinhood had to borrow billions of dollars to meet deposit requirements.
You may think that if Robinhood simply ended margin trading, it could have eliminated all settlement risk. First, it wouldn’t have worked. If Robinhood eliminated margin, it would have led to margin calls from its customers, which would led to customers selling GameStop stock, which would have caused prices to drop, which would have increased margin calls in a negative feedback loop. At the end, you would have a bunch of customers who had outstanding margin debt that they probably couldn’t have paid, potentially causing the exact settlement risk you are trying to avoid.
Second, even if it did reduce Robinhood’s settlement risk, DTCC may not have believed that Robinhood’s settlement risk dropped enough to relieve Robinhood of its demands for additional capital.
I believe this is also due to the T+2 rule when selling a stock. I know I’ve sold stock and was immediately credited with the proceeds to buy more stock but I couldn’t pull it out of my account so I think it was “lent” to me by TDA until I got the money from the buyer’s side.
A lot to unpack here. First off, “if Robinhood’s customers are buying extensively on margin, DTCC would possibly be concerned that Robinhood’s customers would have trouble settling their trades.” is certainly true, but easily avoided. All Robinhood had to do was what TDA and Fidelity did. They could say “You can’t buy GME unless it’s with your own cash, not on margin. You can’t buy a call unless you can fund the exercise, and you can’t sell a put unless you can settle assignment in cash.” Bam, end of risk. Nobody would be buying the stock unless RH knew and could prove they had the cash to settle it.
Then, when they do indeed buy the shares, RH can remit the deposited funds to DTCC to meet its requiremed fund deposit.
DTCC does not have the information in real time to assess exactly how much the increased trading in GameStop stock was increasing Robinhood’s settlement risk
And yet, that skepticism is ameliorated as soon as Robinhood deposits the funds with DTCC. DTCC says “Hey, this guy wants to buy $1000 of GME but I don’t think he has that much money. RH, you need to put up $1000 to prove you can handle it.” Fair enough. But then what happens? RH puts $1000 on the table, says “Here’s the money you said you thought we might not have. Now do the trade.” And everything’s hunky dory.
Yeah, that’s fine, and RH’s tool to manage settlement risk is turn up the margin requirement for GME, sequester the cash just like any other transaction, and turn over the funds to DTCC. No problem.
Which should be illegal. That’s exactly the problem right there. There’s no justification for demanding $1200 for a $1000 transaction. If you say “show me the money” and I show you the money, there’s no reason for you to say “show me more money.”
It doesn’t have to end margin trading, it just has to suspend it on GME. All those people (like me) who bought months ago have already settled. We’re good. You’ve been letting me float along since GME was $19, but now that it’s $400, there’s a problem? I don’t think so. If GME crashed back to $19, you’d know I’m good for it, because I was good for it months ago when GME was that price.
You honestly think they have the ability to restrict the number of shares traded, overnight, (Surprise, you can buy 5, but not 6!) but they can’t check my account to figure out if I have the cash in it? Like, somehow all these years, I’ve been buying and selling things and no computer is checking me first whether I have the ability to pay for it first?
Look, the real issue here is pretty clear. Customers deposited money, RH spent it instead of kept it in the bank. Suddenly there’s a run on the bank and RH couldn’t put up the funds its customers had given it. Why? Because that’s one of the ways it funds “free” trading. And that ought to be illegal. It’s my money, not theirs. It needs to be there when I decide, not they decide, to spend it. Banks are under such obligations. Brokers should be, too.
You aren’t distinguishing between Robinhood’s money and its clients’ money. Robinhood’s clients may create settlement risk. Under DTCC rules, Robinhood has to use its money to ameliorate that settlement risk, not its clients’ money. This is very much be design.
Let’s take this apart. DTC settles only equities trades, not options trades. From DTC’s perspective, Robinhood always settles in cash from its customers’ funds. Some of those customers’ funds are from cash deposits that the customer made. Some are from margin loans that Robinhood made to the customers. DTCC cannot tell these apart. DTCC does not get real-time reports that tell it whether the cash DTCC is getting for settlement is from Robinhood’s cash customers or customers who are borrowing on margin from Robinhood. DTCC simply does not know. DTCC’s members own DTCC and the people they elect to represent their interests are the ones who make DTCC’s rules (subject to SEC oversight). What we can conclude here is that DTCC members do not want to have to report this information to DTCC and they have set the rules so they don’t have to. There are lots of reasons that broker-dealers don’t want to report their customers’ personal information, like who is borrowing on margin, to an entity that is run by their competitors. Therefore, DTCC does not know whether its members customers are settling with borrowed funds or with cash.
One of the protections that DTCC offers is that DTCC’s members put in their own money (not their customers’ money) as a guarantee that, if for whatever reason the member’s customers can’t settle a trade, the member will use its own money to make the person on the other end of the trade whole.
Your broader point is that Robinhood could reduce its settlement risk by not allowing further trades on margin. That is probably true but it ignores two things: DTCC can’t tell Robinhood to stop lending on shares. There is, to my knowledge, nothing in its rules that give it that power. Second, DTCC may have been worried about Robinhood’s settlement risk because of the margin it had already extended on shares and not just that it was doing new lending. Again, the tool it has to manage Robinhood’s settlement risk is to demand more of Robinhood’s capital.
Your understanding of the option risk is off. If Gamestop’s customers were buying calls (or puts for that matter), they have no particular settlement risk. Either the options go up in value and they make money or the options go down in value but by no more than the premium that the investor paid up front.
I think you are concerned that Robinhood’s customers were selling options, which could have presented greater settlement risk. I’m not aware that they were selling to any significant degree. If you want long exposure to a stock by selling options, you sell puts. That means that you have sold someone else the right to sell you a stock for some set price at some point in the future. You collect the option premium with the hope that the stock goes up and that the option expires out of the money because no one wants to sell you stock at the low strike price on your option rather than the higher market price. Selling puts gives you a small potential gain (the option premium) for a potential loss equal to the value of the stock (assuming the stock price goes to zero during the option term). I don’t believe that Robinhood traders were doing this to any significant degree. It’s a low return, high risk proposition for people who believe the stock is going to skyrocket.
Furthermore, options are cleared by the Options Clearing Corporation (not DTCC), so it would be OCC that would be requesting additional capital due to any potential settlement risk. I haven’t heard that OCC demanded additional capital. It makes sense that they didn’t have to because the rational options strategy for investors betting that a stock will go up dramatically is to buy call options (as you note), which give the buyer the right to buy shares of stock at some set price. This is likely the option strategy that Robinhood investors were following. The key feature of this strategy is that gains are unlimited but losses are capped at the premium the buyer paid for the option. Robinhood’s investors likely weren’t endangering Robinhood’s ability to settle its options trades to OCC because they already paid for their options. .
Why should it be illegal? The whole point of a central clearing counterparty is that it can demand capital from its broker-dealer members to ensure that the broker-dealers’ customers are always made whole when they trade. It has created a whole system of trust in which I am pretty damn confident that when I buy a stock on a stock exchange, I am going to get my shares, regardless of who my counterparty on the trade is. What do you propose as an alternative? Because the alternative sounds a lot like I have to get a lot of information about my counterparty in order to know if I am comfortable trading with it. That is information my counterparty doesn’t want to give me.
Fair enough and I should have been clearer. I was trying to say that Robinhood’s ending margin trading on GME may not have been sufficient to ameliorate its settlement risk in DTCC’s eyes.
Cite please? I have heard absolutely nothing to suggest that there was a single point in time when Robinhood did not segregate its customers assets as it is required to do under Exchange Act Rule 15c3-3 (the Customer Protection Rule). Failure to do so is a serious violation.
The irony is that you keep saying Robinhood should deposit its customers funds into DTCC when DTCC is demanding more of Robinhood’s money. That actually would violate 15c3-3 and would put its customers’ funds at risk. But I see no evidence that it ever happened.
Every time I say Robinhood should do this or that, you reply that DTCC can’t do that. When I say DTCC shouldn’t be able to do something, you tell me why Robinhood should do that. Now you’re bringing in OCC in response to what I said Robinhood should do. You aren’t reading what I’m writing.
Like this. I never said anything about DTCC and options. I said Robinhood. Robinhood should’ve done what TD and Fidelity did and restrict certain options in certain circumstances so that Robinhood doesn’t have settlement risk. You seem hell bent on shifting the blame from Robinhood (“Ermagerd, RH settlement risk! They hadta!”), repeatedly ignoring that the other two didn’t seem to have this problem.
You brought up options settlement when you said, “They [Robinhood] could say ‘You can’t buy GME unless it’s with your own cash, not on margin. You can’t buy a call unless you can fund the exercise, and you can’t sell a put unless you can settle assignment in cash.’ Bam, end of risk. Nobody would be buying the stock unless RH knew and could prove they had the cash to settle it.” [emphasis added.]
You brought up options and seemed to suggest that it contributed to Robinhood’s settlement risk. I pointed out both that options trading, to my knowledge, didn’t contribute to Robinhood’s settlement risk and that the people who regulate Robinhood’s option settlement risk aren’t the same people trying to manage Robinhood’s equities settlement risk. I am reading and responding to what you are saying but I’m not sure if you understand the implications of what you are saying. Apparently I am doing a bad job of explaining myself and I’m sorry for that.
Any update from the smart investor-y people in this thread about what’s up with Gamestop stock these days? Is the volatility largely over and where did the price settle? Did a lot of internet traders lose their shirts or are they sitting on piles of gold coins? I have to imagine that at least some of the dust has settled.
Interestingly, GME hit 160, the number cited in this “dust has settled” post, again in December, March '22, and August '22. It’s back to 100 at the moment. I’m still waiting on the thing to die, but it doesn’t seem to want to. Is 100 the right number? Nobody knows.
100? I had been lamenting that I had a stop at 90 that triggered last fall, when it jumped up again at the end of the year, but then I lost interest. I had been feeling pretty smart when I saw it was trading around 25 recently, but now I see i missed a 4-for-1 split.