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Investors usually don’t have to think much of clearing houses – when they do, it’s usually a bad sign.
This crucial piece of financial market plumbing was the center of attention after Robinhood and a number of other brokers outraged individual investors – and a few lawmakers – on Thursday by restricting trading in the highflying GameStop Corp. GME,
and the stocks of other heavily short-circuited companies.
While the action sparked a number of conspiracy theories centered on alleged collusion between hedge fund managers and brokers, brokers appeared to have little choice as the clearinghouse, scared by GameStop’s volatility and other actions, increased the amount of collateral available to brokers. post to ensure that transactions would be settled.
While for an investor making a trade may seem like an instant deal, there is more. In fact, it usually takes two days for the trade to settle and the money and securities to change hands.
Clearing houses sit between buyers and sellers, ensuring that the transaction is completed if one side fails. Clearing houses require their members – banks and brokers – to be well capitalized, to post collateral and to pay into a default fund.
When trading becomes volatile, the risk of default increases, especially when investors buy stocks on margin or with money borrowed from their broker. Clearing houses naturally get nervous and may require brokers to increase the amount of collateral they owe pony to clear their trades.
It was in play Thursday. WeBull Financial LLC chief executive Anthony Denier told the Wall Street Journal that the broker’s clearing house has been advised by the Depository Trust & Clearing Corp., which serves as the central clearinghouse for clearing operations, that it would need to provide more guarantees.
As a result, WeBull, like Robinhood and other online brokers, decided on Thursday to restrict trading on GameStop and other volatile stocks. The New York Times reported that Robinhood used lines of credit to meet its collateral obligations, while raising around $ 1 billion from investors to enable it to facilitate transactions on GameStop and other popular stocks.
For a detailed look at what was at stake – and how the Dodd-Frank legislation put in place after the 2008 financial crisis to mitigate the risk of systemic failure played a role – dive into the following Twitter thread :
On Friday, brokers eased restrictions on purchases of GameStop and other stocks. GameStop rose 32% in Friday afternoon’s action, setting it on track for a nearly 300% weekly rise as it changes hands near $ 260 a share. It finished 2020 below $ 19 a share.
The US stock market as a whole was stumbling, however, with major benchmarks on track to suffer large weekly losses. The Dow Jones Industrial Average DJIA,
was off its session low but remained down 540 points, or 1.7%, while the S&P 500 SPX,
lost 1.7%. The Dow and S&P 500 were on track for weekly declines of around 3%.
The rallying of heavily bypassed stocks targeted by an army of individuals via Reddit’s WallStreetBets forum and other online platforms, has appeared to cause pain for hedge funds. Analysts blamed the wider liquidation in part on the forced liquidation of profitable long positions by hedge funds and other investors who needed liquidity to cover losses if short positions were lost.
But a more crucial concern for investors is whether the speculative frenzy around GameStop could trigger a cascading wave of losses that could threaten the financial system.
Chester Spatt, a finance professor at the Tepper School of Business at Carnegie Mellon University and a former chief economist with the Securities and Exchange Commission, said he was optimistic that the issues surrounding the short squeeze were confined to a relatively narrow sector of the market.
“But it is important that intermediaries take action so that losses suffered by retail investors do not enter the system, and that is why I think measures like those taken yesterday were important,” he said. he declares.
Meanwhile, Deutsche Bank macro-strategic strategist Jim Reid noted the results of a flash poll of the bank’s customers, which he said drew 700 responses, but showed little consensus on the degree threat that the situation posed to financial stability (see graph below).
German Bank
“The high number of responses in a short period of time to this poll indicates that the subject is gripping the financial markets and the wide range of opinions suggests that the markets have still not accepted the consequences (if any) of a epic week. again, ”he said.
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