The crucial role played by clearing houses in financial markets has come into the spotlight after controversial actions by US brokers such as Robinhood and Charles Schwab. restrict retail investor betting on stocks at the heart of the trade boom fueled by Reddit.
Clients reacted angrily on Thursday as brokers moved to prevent them from opening new positions in some hot stocks, accusing them of unfair treatment or even a plot by the Wall Street establishment. But brokers gave a more mundane explanation: The additional volatility in stock prices meant they had to hold more capital in the institutions that clear their trades.
What do clearing houses do?
These low-key places are normally found in the context of day-to-day market activity, but they can become the center of attention during times of volatility when they need more liquidity – or “margin” – from their members to keep them. ensure transactions are honored as customers expect.
A stock trade that has been executed can take up to two days to be legally settled, creating a risk of failure if one side of the trade defaults. A clearing house is held between the two parties to manage the risk to the market if this happens.
Every day, members of the clearinghouse, which range from small brokers like Robinhood to big Wall Street banks like JPMorgan and Citigroup, are required to set up a margin as insurance for their transactions.
The amount is calculated by the clearinghouse and is based on the amount of trades made by each member, as well as the volatility of the individual securities traded. Margin is usually collected at the start of the trading day, although there may be intraday calls during frantic times, with the aim of protecting the market as a whole from sudden trading failures.
The clearing member often has little time to make up the shortfall and the margin usually needs to be a very liquid asset, such as cash, US government bonds, or stocks. Amid market volatility in March, an American bank mandatory to find $ 9.6 billion of margin for derivative transactions in an hour.
How do brokers like Robinhood fit into this?
Much like competitors such as Schwab and ETrade, Robinhood clears its own trades and is a member of the leading US equity clearinghouse, run by DTCC.
While self-clearing saves on fees that would otherwise go to another clearing broker, it also means Robinhood takes the risk that a executed trade does not settle and must have more cash to cover shortfalls. It also faces higher costs if the clearinghouse increases margin requirements in times of volatility to protect against member default.
“The extreme volatility is a big factor behind this,” said Andy Nybo, managing director of Burton-Taylor International Consulting. “They need to make sure that they are able to meet liquidity needs, whether it is for clearing or for investors who owe money as a result of trading activity.”
As Robinhood said in a blog post on Thursday, the requirements “may be substantial in the current environment”. He declined to comment further.
Between Wednesday and Thursday, DTCC’s margin call on the U.S. stock market rose from $ 26 billion to $ 33.5 billion, the clearinghouse confirmed.
DTCC said the frantic trading of stocks such as GameStop and AMC Entertainment “has created substantial risks for the companies that clear these transactions. . . especially if the clearing member or its clients are predominantly on one side of the market. “
How did the brokers react?
Security mechanisms built into the market infrastructure on Wall Street led to periodic shutdowns of business activity on Thursday. In order to ensure that they had enough money to cover the margin and capital requirements, Robinhood and others like Schwab and TD Ameritrade halted trading on some of the names at the heart of the volatility that demanded the most. large amount of cash to be set aside after each transaction. .
This limited its margin requirements to continue to increase. By allowing users to close positions, he still allowed trades that would reduce his immediate need for cash.
Robinhood also increased the margin requirements for clients who had not paid their full trade value up front, having reduce its margin requirements in December to try to stimulate commercial activity. This meant that some customers suddenly had to find money to cover their transactions.
Behind the scenes, Robinhood has moved to raise a Fresh $ 1 billion in capital from its existing investors, which it announced ahead of trading on Friday. The company said the fundraising was a “strong sign of investor confidence that will help us continue to serve our customers better.”
Anthony Denier, chief executive of Webull, another company that has been forced to restrict trading in certain stocks, said in an interview with Yahoo Finance that his clearing company “just couldn’t afford” the cost of closing. new transactions.
“It has nothing to do with a decision or some sort of closed, cigar-smoke-filled room of Wall Street companies coming together to the dismay of the retail trader,” he said.