A week later Robinhood Markets tried to clear the air by explaining why it hit controversial limits in the hot stock market, Wall Street risk professionals are still perplexed: How was the company so ill-prepared for an obvious increase in calls? collateral?
For the financial industry, anticipate the collateral demands of centers such as Depository Trust & Clearing Corp. is Brokerage 101. Leading companies assign teams to study the DTCC methodology, estimate their requests, and ensure that sufficient cash is available. Everyone complains, sure, but they also know what happens when companies fall short stir for a lifeline or off. Robinhood gathered billions of sponsors to continue.
“Obviously they fell very, very short,” said David Weisberger, a market structure consultant who built commercial systems at Salomon Brothers and Morgan Stanley. He said it has been baffling about Robinhood, given what he called the “well-known” requirements of clearing centers. “It was an event that threatened the franchise.”
The launch of Silicon Valley stopped users from temporarily restricting certain purchases to match the January craze GameStop Corp. and other “meme stocks” that were booming. By the end of this week, while millions of customers were downloading their app to change the beloved falls and new ones, risk managers were still caught up in how Robinhood ended up in the situation.
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A company spokesman referred to a Thursday for comment blog post by Robinhood Securities President and Chief Operating Officer Jim Swartwout.
“It simply came to our notice then. And sometimes we’ve encountered challenges as we get to this point, ”wrote Swartwout, who described how the company’s growth and increased trading volume fueled collateral demands. the volume increases overnight experienced by Robinhood last week were extraordinarily high would be a huge understatement. The increase was higher than the norm. “
CEO Vlad Tenev has linked trade restrictions to a $ 3 billion collateral call that came in early Jan. 28 from the DTCC, which Robinhood has said has contributed to a jump in ten times in the weekly stock exchange deposit deposit requirements. While Tenev has credited the DTCC for being reasonable and ultimately accepting $ 700 million, he has sometimes portrayed his formulas as opaque, noting that they include a “discretionary” component.
“We don’t have the full details” of how the DTCC got to its initial lawsuit, Tenev told Elon Musk last weekend in an interview aired on the social conversation app Clubhouse. “Obviously, it would be ideal if there was a little more transparency so we could plan better.”
The reply of the executives of the sector: they are practically only mathematics.
“Shame on them”
In interviews, more than half a dozen senior risk executives, some of Wall Street’s largest companies, reacted with surprise to any claims that the magnitude of the DTCC’s demands cannot be predicted. They spoke on the condition that they not be identified, in some cases because they interact with Robinhood.
They acknowledged that they always complain about the difficulty of identifying what exchange centers will look for and that things can go wrong. Some executives even recounted moments when they received pressure to get millions of additional cash with short notice. But overall, the group said large, well-run companies aren’t surprised by requests that threaten to empty their pockets.
A brokerage executive said Robinhood should make sure it had enough capital or stop processing volatile transactions. Charles Schwab Corp.’s TD Ameritrade, for example, began limiting bets on certain meme stocks the day before Robinhood did. Robinhood’s subsequent restrictions were more severe and reduced to the following week.
“Once every decade or so there are unlikely things to happen,” said Weisberger, who now heads cryptocurrency company CoinRoutes. Self-compensation companies like Robinhood need to know what potential lawsuits they might face. “If they studied it and gave an answer and it was wrong, shame on the people who studied it,” he said. “If they didn’t study it, then shame.”
Avoid surprises
The DTCC bases much of its deposit demands on items that include the concentration of a clearing member on volatile shares, the volume of transactions that occur, imbalances in the sale and financial position of the firm. The more a broker is exposed to erratic actions, the more collateral it should issue. The less capital you have to broker, the more severe your surcharge may be.
The goal is to protect the broader financial system from trade defaults. To make collateral calls predictable, DTCC states that it provides “reports and other tools to our clearing members to help them anticipate their margin requirements for a particular portfolio.”
The nightmare that clearing houses are designed to avoid is that a broker loses so much money before an operation is completed that the company cannot stand the end of the transaction. Without an exchange center, the failure of a company could go through the financial system. Developing only one trade means undoing all subsequent transactions if that stock was already sold.
The collateral burden of a broker-broker increases if it lends money to customers and, above all, if they bet heavily, for example, on stocks that have recently multiplied in value, as GameStop and others did last month. If prices fall suddenly, which also happened, it increases the risk that customers will not be able to repay their margin loans, leaving the broker to eat their losses. According to Wall Street risk managers, some of the recent declines in stocks may be attributable to the liquidation of Robinhood clients ’positions to avoid defaulting on loans.
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“Someone has to pay,” said Eric Budish, a professor of economics at the Booth School of Business at the University of Chicago. If you are a broker, “you have the capital to deal with this existential risk. I was surprised that Robinhood didn’t have more capital for this scenario. “
Margin lending accounted for approximately 20% of Robinhood’s $ 6.7 billion balance sheet by mid-2020. Robinhood leveraged lines of credit and raised about $ 3.4 billion from investors at the end of January.
Robinhood, founded in 2013, hires Wall Streeters to help integrate the startup into the more traditional financial system. The firm appointed Dan Gallagher, a former member of the Securities and Exchange Commission, Norm Ashkenas of Fidelity Investments and Kelly Zigaitis of Wells Fargo & Co. for legal and compliance functions.
Robinhood prescription
This week, Robinhood has offered its own prescription to avoid future problems: the U.S. stock market should abandon its two-day liquidation system and move to a real-time process.
Moving the U.S. equity market to an instant liquidation is a big undertaking that would require years of work. It would probably be necessary to digitize two components of the trade: securities and cash to pay for them. Digitally representing a value as a stock or bond is not difficult and a small effort by Paxos Trust Co. to use blockchain to settle near real-time transactions received green light from the SEC in 2019.
Digitizing the U.S. dollar to pay for shares is a free year, if it ever happens. Another hurdle is that all banks, brokers, hedge funds, and commercial companies that buy and sell stocks should upgrade their systems to make the change. No doubt the transition would be expensive.
Australia embarked on a plan to do just that in 2016, when Digital Asset Holdings announced a deal with ASX Inc. to redo the Australian Stock Exchange, so settlement days could be reduced from days to minutes. The project has been expanded repeatedly and is currently two years behind schedule.
Meanwhile, Robinhood is fortunate to have access to venture capital to resist a problem, said Joanna Fields, founder of market structure consultancy Aplomb Strategies.
“There are companies that have controls, governance frameworks and processes and that don’t have the capacity to get that kind of capital infusion,” he said.
– With the assistance of Jennifer Surane