A week later Robinhood Markets tried to clear the air by explaining why it slapped the controversial threshold in trading stocks, with Wall Street’s risky professionals still worried: how was the firm so ill-prepared for the apparent increase in collateral calls?
For the financial industry, collateral demands from hubs such as Depository Trust and Clearing Corp are anticipated. The brokerage is 101. Leading companies employ teams to study the functioning of DTCC, anticipate its requests and ensure that sufficient cash is available. Everyone grumbles, sure, but they also know what happens when companies fall short: they Melee To lifeline or close. Robinhood collected billions from backers to continue it.
“They obviously fell very short,” said David Weisberger, a market-structure consultant who built the trading systems at Salomon Brothers and Morgan Stanley. He said he wonders at Robinhood, noting that he has stated the “well known” requirements of the clearinghouse. “It was a franchise-threatening incident.”
Silicon Valley startups let users temporarily ban some purchases at the height of the January frenzy GameStop Corp. And other “meme stocks” that were skyrocketing. By the end of this week, as millions of customers were downloading their app to trade fallen ratios and new ones, risk managers were still adamant on how Robinhood was predicted.
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Reached for comment, a company spokesperson referred on Thursday Blog post by Jim Swartwout, President and Chief Operating Officer of Robinhood Securities.
“We have grown rapidly. And, we have faced challenges many times, as we have scaled to meet the moment, ”Swartwout wrote, explaining how the firm’s growth and increasing trading volumes increase collateral demands. “To say the overnight increase in volume Robinhood experienced last week would be an enormous understanding of the extraordinarily high. The increase was more magnitude than ideal.”
Chief executive officer Vlad Tenev linked the trade restrictions to the collateral of about $ 3 billion that came from DTCC’s share in early January 28, in which Robinhood has contributed to a 10-fold increase in weekly clearinghouse deposit requirements for equities. Although Tenev credits DTCC for being reasonable and ultimately accepting $ 700 million, he has at times portrayed his sources as opaque, noting that they include a “discretionary” component.
“We don’t have full information” about how the DTC reached its initial demand, Tenev told Elon Musk in an interview aired on the social-interaction app Clubhouse last weekend. “It would obviously be ideal if there was a little more transparency then we could have planned better around this.”
Rejoice with industry officials: This is very math.
‘shame on them’
In interviews, more than half a dozen senior risk officers – from some of Wall Street’s largest firms – reacted with bemusement to any claim that the magnitude of DTCC’s demands could not be anticipated. He spoke on the status of his identity in some cases, as he interacts with Robinhood.
He admitted that there was always a complaint about the difficulty of pinpointing what the clearinghouses wanted, and that could be wrong. Some officials even at a time when they pressurized short notices for millions of extra cash. But overall, the group said that large, well-run firms are not surprised by requests that threaten to empty their wallets.
A brokerage executive said Robinhood should have ensured that it had enough capital or stopped the processing of volatile shares. For example, TD Schmidt of Charles Schwab Corp. began betting on a few meme shares the day before Robinhood. The later restrictions of Robinhood were more severe, with the latter closed in the following week.
“There is an inability to work every decade or once that happens,” said Weisberger, who now runs the cryptocurrency venture CoinBouts. Self-clearing firms like Robinhood need to know what potential demands they may face. “If they studied it and gave an answer and it was wrong, shame on the people who studied it,” he said. “Shame on them if they don’t study it.”
The DTCC based its deposit demands on elements including the clearing member’s concentration in volatile shares, the volume of trades that occur, imbalances in buying and selling, and the firm’s financial position. The more the brokerage is exposed to irregular shares, the more collateral one has to post. The less capital a brokerage has, the more severe its surcharge.
The goal is to protect the broader financial system from trading defaults. To make collateral calls predictable, DTCC states that it “provides reporting and other tools to our clearing members to help them estimate their margin requirements for a particular portfolio.”
The nightmares that are designed to avoid a nightmare are that a brokerage loses so much money before a trade is completed that the firm cannot end the transaction. Without a clearinghouse, a firm’s failure can cascade through the financial system. Closing a trade simply means undoing all subsequent transactions if that share was already sold.
A broker-dealer’s collateral burden increases when he lends money to customers, and especially if they place too many bets, say, stocks that have recently increased in value several times, as in That Gamestop and others did last month. If prices suddenly crash – whatever happened – it risks that customers may not be able to repay their margin debt, then leave the brokerage to eat its losses. According to Wall Street risk managers, some of the recent stock declines may be responsible for keeping the status of Robinhood liquidating customers away from defaulting on loans.
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“Someone’s got to pay,” said Eric Budish, a professor of economics at the Booth School of Economics at the University of Chicago. If you are brokerage, “You have the capital to deal with that existential risk. I was surprised that Robinhood did not have much capital for that scenario.”
In mid-2020, margin lending amounted to about 20% of Robinhood’s $ 6.7 billion balance sheet. Robinhood tapped credit lines and raised nearly $ 3.4 billion from investors in late January.
Robinhood, founded in 2013, is hiring Wall Streeters to help startups integrate into the more traditional financial system. The firm appointed Dan Gallagher, member of the Senior Securities and Exchange Commission, Norm Ashkenes of Fidelity Investments, and Kelly Zygitis of Wells Fargo & Company in senior legal and compliance roles.
Prescription of robinhood
This week, Robinhood offered it Self-prescriptions to avoid future problems: The US stock market should abandon its two-day settlement system and switch to the real-time process.
Taking the US equity market to an immediate settlement is a huge undertaking that will require years of work. Two components of the business would likely have to be made digital: securities and cash to pay for them. It is not difficult to digitally represent security like stocks or bonds and a small-scale effort by the Paxos Trust Company to use blockchain to dispose of stock-trades received a green light from the SEC in real time in 2019.
The digitization of the US dollar to pay for the shares has been off for years, if it ever happens. Another obstacle is that of all banks, brokerages, hedge funds and trading firms that need to update their systems to make changes to buy and sell shares. The infection will no doubt be expensive.
Australia planned to do so in 2016, when Digital Asset Holdings announced a remake of the Australian Stock Exchange with ASX Inc. to cut settlement days from minutes to minutes. The project has been extended repeatedly and is currently two years behind schedule.
Meanwhile, Robinhood is fortunate to have access to capital for the venture through a rough patch season, said Joanna Fields, who heads market structure consultancy Aplomb Strategies.
“There are firms that have controls, governance structures and processes, and don’t have the ability to get that type of capital infusion,” she said.
– With the help of Jennifer Surane