A Barron’s article:
A little-known intermediary in the process of buying and selling equities forced Robinhood and other brokers to restrict trading in several securities on Thursday, including GameStop,
AMC Entertainment, BlackBerry, and Nokia. All have been swept up in the WallStreetBets-fueled short-squeeze phenomenon and have seen intense volatility in recent days.
Theories abounded online about Robinhood -- a mobile-first, low-cost brokerage founded on the idea of expanding access to trading to more people -- being in league with the "men in suits" at hedge funds on the losing side of those trades. Politicians on Twitter from across the political spectrum condemned the broker's move. But Robinhood's provided reason that it needed to restrict trading in those stocks until it could increase its collateral with the Depository Trust & Clearing Corporation, or DTCC, holds water.
Explaining that requires getting into a bit of market plumbing and elements of the trading process that usually don't get much attention.
When an investor orders their broker -- Robinhood or E*Trade, for example -- to buy or sell a security, the broker accepts the trade and sends it to an exchange like the New York Stock Exchange or the Nasdaq. The exchange then matches buyers with sellers, and from the investor's perspective, the transaction is as good as done. But there are still some mechanics that need to be worked out behind the scenes.
Investors may have noticed that the cash proceeds from selling a stock aren't immediately available to withdraw from their account after a trade is completed -- that usually takes a business day or two. Back in the day, that time was spent physically exchanging stock certificates between brokers. Today's trading volumes make that an impossible task. (Curious readers should learn about the 1960s Paperwork Crisis.)
Today, after a stock exchange completes a trade, it sends the information to the DTCC, which keeps track of brokers' books. The DTCC is a clearing house, an important part of the financial system. Clearing houses not only process and complete trades in an efficient manner, they help limit systemic risk. The clearing house promises to make good on all trades that happen regardless of what happens to an individual broker.
The DTCC is responsible for transferring ownership of the stock from the seller's broker to the buyer's broker -- and vice versa for the cash involved. Rather than doing that after every single one of the trillions of dollars of trades each day, the DTCC waits until it can net several trades into "one position per security, per client, per settlement date, " according to its website. The settlement date is the day when the cash and securities involved in a trade actually change hands.
At the settlement date, which falls two days after the investor places their trade, the seller's broker must deliver the stock being sold and the buyer's broker must provide the cash. The DTCC guarantees that the transfer will happen and eliminates the risk of a single broker going under rippling across the market.
In exchange, the DTCC collects a fee per trade and requires some collateral from the brokers to ensure they have the assets to complete the transaction. It's like putting a refundable deposit on a purchase that reduces the middleman's risk while the package is in the mail, with full payment due once it arrives. The DTCC's collateral requirements for brokers are calculated by a much more complex formula, based on the specific shares' notional value, volatility, and other variables.
For a relatively risk-free transaction -- in liquid, less volatile stocks like, say, Apple (
AAPL) or Microsoft (MSFT) -- that collateral requirement could be around the order of 10% of the transaction value. For a stock like GameStopthis week, the DTCC's formula might spit out a collateral requirement several times higher than that because it takes on greater risk. That's because the DTCC could be on the hook to deliver an asset that's worth a materially different amount on the settlement date than the trade date if one of the brokers involved can't complete the transaction.
When traders are using margin to buy, the broker needs to come up with the cash on its own. And when there's a large imbalance between a broker's buy and sell orders for a given security, it doesn't net out as cleanly at the end of the day, meaning more collateral is required.
All of those factors applied to Robinhood and Gamestop on Thursday. The stock traded in a wide range from $112 to $438 on heavy volume, its users were predominantly placing buy orders for the shares, and many were using margin.
And those are the reasons the DTCC asked brokers for more collateral for each such trade. The clearing house didn't want to be caught with brokers not having the funds they need to settle. Therefore, Robinhood and others restricted buying on these highflying stocks until it could come up with enough cash to pay collateral. Robinhood allowed users to sell the stocks because the selling broker puts up the shares as collateral, not cash.
Since then, the brokerage has drawn down its credit lines at several banks and brought in $1 billion from existing investors to fund additional collateral requirements. On Friday, Robinhood reopened buying of Gamestop and other recently popular stocks.
The DTCC says it processes trillions of dollars of transactions a day, including equities, bonds, mutual funds, and derivatives. It said that collateral requirements for all of its broker clients were $33.5 billion on Thursday, up from $26 billion the day before.
