Investors don’t usually have to think much about clearing centers; when they do, it’s usually a bad sign.
This crucial piece of financial market plumbing focused after Robinhood and several brokers on Thursday outraged individual investors and some lawmakers by restricting GameStop Corp. trading. GME,
and shares of other companies with a short reach.
While the action sparked several conspiracy theories focused on the alleged collusion between hedge fund managers and brokers, brokers seemed to have little choice as the clearing house, feared by the volatility of GameStop and other actions, increased the amount of collateral the brokers had issued to ensure the settlement of transactions.
While for an investor, doing a trade may seem like an instant transaction, there is more to say. In fact, the transaction usually takes two days to settle and the money and securities change hands.
Clearing centers are located between buyers and sellers, ensuring that trade is completed in the event of a defect on one side. Clearing houses require that their members (banks and brokers) be well-capitalized, deposit guarantees, and deposit into a default fund.
When trading becomes volatile, the risk of delinquency increases, especially when investors buy shares at margin or with money lent to their broker. It is understandable that clearing companies get nervous and may require brokers to increase the amount of collateral they have to take on to liquidate their business.
That was at stake Thursday. WeBull Financial LLC CEO Anthony Denier told The Wall Street Journal that the brokerage clearing company was notified by Depository Trust & Clearing Corp., which serves as the central hub for clearing operations, that it would need provide more guarantees.
As a result, WeBull, like Robinhood and other online brokers, moved on Thursday to restrict GameStop operations and other volatile stocks. The New York Times reported that Robinhood took advantage of lines of credit to meet its collateral obligations, while raising about $ 1 billion from investors to enable it to facilitate the operations of GameStop and other popular stocks.
For a detailed look at what was at stake and how Dodd-Frank legislation enacted after the 2008 financial crisis to mitigate the danger of systemic failure played an important role, check out the following Twitter feed:
On Friday, runners eased restrictions on GameStop purchases and other actions. GameStop rose 32% in action on Friday afternoon, triggering a weekly increase of nearly 300% as it changes hands at about $ 260 per share. It ended in 2020 below $ 19 per share.
However, the broader stock market in the United States stumbled, with important benchmarks aimed at large weekly losses. The Dow Jones Industrial Average DJIA,
was out of the session low, but remained down 540 points, or 1.7%, while the S&P 500 SPX,
lost 1.7%. Both the Dow and the S&P 500 were on track to decline weekly by about 3%.
Concentrating on very short actions led by an army of people through Reddit’s WallStreetBets forum and other online platforms, seemed to cause pain to hedge funds. Analysts blamed the broader sale in part for the forced liquidation of long and profitable positions by hedge funds and other investors who needed cash to cover short-term loss losses.
But a more crucial concern for investors is whether the speculative frenzy surrounding GameStop could cause a wave of cascading losses that could threaten the financial system.
Chester Spatt, a finance professor at Carnegie Mellon University’s Tepper School of Business and a former chief economist at the Securities and Exchange Commission, said he was optimistic that short-term problems were confined to a relatively narrow sector of market.
“But it is important that intermediaries take steps to ensure that the losses suffered by retail investors do not permeate the system, and that is why I believe steps like the ones taken yesterday were important,” he said.
Meanwhile, macro-strategist Jim Reid of Deutsche Bank noted the results of a quick survey of the bank’s customers, saying it attracted 700 responses but showed little consensus on the amount of threat the situation posed. for financial stability (see chart below).
Deutsche Bank
“The high number of responses in a short space of time to this survey indicates that the issue is grabbing the financial markets and that the wide spread of opinions suggests that the markets have not yet agreed on the consequences. (if any) of an epic week though, ”he said.