The story behind Robinhood’s decision to halt GameStop buying
Robinhood’s decision to halt buying activity on GameStop stock on January 28 was a result of ‘extraordinary’ trading and subsequent complications posed by clearing rules, the company’s CEO Vlad Tenev told the House Financial Services Committee during testimony yesterday.
The committee meeting was convened to explore whether market manipulation took place in late January as GameStop share prices rocketed – either by Reddit users executing a co-ordinated short squeeze or by brokers halting buying activity on January 28.
Tenev said Robinhood halted buying activity on GameStop and 12 other securities to enable it to continue to meeting clearinghouse deposit requirements. He cited unnamed analysts – and provided no named citation in his written testimony – that the events surrounding GameStop ‘had about a one in 3.5 mn chance of occurring’.
Kenneth Griffin, chief executive officer at Citadel, also outlined how abnormal the trading activity in late January was. Citadel executed 7.4 bn shares on behalf of retail investors on January 27, which was greater than the average daily volume of the entire US equities market in 2019, Griffin said in his opening remarks. Citadel is one of several market-makers Robinhood uses.
Robinhood’s $3 bn deficit
The unprecedented spike in trading in GameStop, AMC Entertainment, BlackBerry and a number of other securities prompted discussion yesterday of reform to clearinghouse rules that govern how long a transaction takes to clear.
Under the current T+2 system, it takes up to two days for trades to clear – ie, for the conclusion of the transfer of cash and securities between the buyer and the seller. During that clearing period, a third-party clearinghouse requires the clearing broker – in this instance, Robinhood Securities – to put down a deposit until the trade is settled. Depending on the size of the deposit, the clearinghouse may ask for an additional deposit as a precaution.
As trading volume and share prices skyrocketed, so too did Robinhood Securities’ deposit requirements to its clearinghouse, the National Securities Clearing Corporation (NSCC). At market open on January 25, Robinhood Securities’ deposit requirement was $125 mn and by market open on January 28, that had risen to $1.4 bn, Tenev said. In addition, the NSCC informed Robinhood Securities that it had an excess capital premium charge of more than $2.2 bn. In total, the broker had a deficit of more than $3 bn.
After Robinhood took the decision to halt buying, but not selling, activity for its users in certain securities, the NSCC ultimately waived the excess capital premium charge and Robinhood transferred funds to cover the remainder of the $1.4 bn deposit required for that day. Tenev insisted that there was no other motivation for the halt to trading, amid speculation that Robinhood may have bowed to pressure from organizations such as Citadel to prevent buying activity. Griffin confirmed that there had been no discussion between Robinhood and Citadel about halting any trading activity.
Robinhood has since raised a further $3.4 bn to prevent this situation happening again, Tenev said. The broker faces a number of class-action lawsuits from its users for halting buying activity.
This calls for reform to the T+2 rule, Griffin said in his opening remarks. ‘One takeaway is the importance of modernizing the settlement process, including shortened settlement cycles and transparent capital models,’ he said. ‘As we have seen, longer settlement periods expose firms to more risk in the time between execution and settlement, requiring higher levels of capital. Settlement cycles should be shortened from T+2 to T+1. Transparent clearinghouse capital requirements will enable brokers and market-makers to better prepare for potential capital demands and minimize the risk of associated market interruptions.’ Tenev agreed.
Several members of the House Financial Services Committee – including Representatives Steve Stivers, Bryan Steil and Bill Huizenga – expressed frustration that the Depositary Trust & Clearing Corporation and the SEC weren’t invited to testify, noting the subject matter.
A rigged market?
When retail investors bought into GameStop and others, they were participating in a co-ordinated short squeeze on a number of hedge funds with aggressive short positions. Although Robinhood’s decision to halt buying activity was made to help it meet clearinghouse requirements, it also contributed to the narrative that the markets are rigged against individual investors, as several Reddit users have told IR Magazine. While individual investors were unable to buy GameStop stock at its inflated price – whether it was in their best interests or not – institutional investors were able to trade uninhibited.
Jennifer Schulp, director of financial regulation studies at the Cato Institute, refuted the suggestion that Reddit users had participated in market manipulation and said the GameStop situation is ‘proof that retail investors are revolutionizing the financial system’.
‘Retail investors are often referred to as dumb money,’ she said. ‘It’s an insulting term that needs to go out of the window… no-one could have predicted that retail investors would [carry out] a well-executed short squeeze.’
The events surrounding GameStop also prompted House members to raise the prospect of introducing short-seller disclosure – an issue NIRI has lobbied the SEC on for years and that recently captured the interest of thousands of Reddit users.
At some points in January, GameStop’s short interest was as high as 140 percent, according to reports from Bloomberg, prompting Representatives Ed Perlmutter and Blaine Luetkemeyer to raise the topic of naked short-selling.
When asked directly whether Melvin Capital had taken naked short positions in GameStop, the firm’s CEO Gabriel Plotkin said: ‘No. Our systems won’t allow for that, so it would be impossible.’ Melvin Capital is one of the hedge funds that held a large and long-standing short position in GameStop and withdrew at a significant loss, Plotkin said.
Plotkin was also asked whether short-sellers should be required to disclose their positions. ‘I think it’s a really good question,’ he said. ‘It’s not for me to decide. If those are the rules, I’ll abide by them.’
GameStop did not respond to a request for comment.