Are Meme Stocks Improving Flawed Markets?
Investors and traders that get trade ideas from social media and other non-traditional sources are often ridiculed by the more established players. The unpredictability of the much-maligned “stonk” jockeys has been disruptive to the previous market rhythms, patterns that had been more easily capitalized on by Wall Street veterans. But, like most disrupted industries, the “new normal” can be better than the old. One of the outcomes of the increase in the volume of these stocks by those using popular trading apps is that weaknesses have been uncovered in the industry. There are hearings now being held at the highest level in Washington and steps put in place at government and quasi-government institutions to manage some uncovered risks to the system.
Improvements are in the Pipeline
The brokerage industry had a problem it didn’t know about. The problem was uncovered in late January as a series of large margin calls were issued amid the unavailability of a handful of stocks that money managers held significant short positions in (significant versus outstanding shares). An announcement this week from the Depository Trust Clearing Corp. (DTCC) recognizes that there is a problem and plans to reduce the risk of the problem occurring in the future.
DTCC is a subsidiary of Depository Trust Company (DTC) which is the “mother-ship” of all clearing agencies. DTCC’s central securities depository provides settlement services for virtually all equity, corporate and municipal debt trades and money market instruments in the U.S. They’re registered with the SEC, a member of the Federal Reserve System, and a limited-purpose trust company under New York State banking law. Just as the Federal Reserve Bank is the central bank for banks, DTCC is the central clearing company for clearinghouses.
This central clearing company which provides settlement services for most electronic delivered securities in the U.S., just proposed halving the time it takes from a stocks purchase to delivery into your account. Changing the standard from two-day settlement to one-day (T+2 to T+1) has been moved up on the DTCC priority list. The impetus was the GameStop margin and settlement isssues that caused brokerages like Robinhood to restrict trading, this has led to Congressional hearings and a class action lawsuit.
DTCC, outlined what a T+1, settlement period, would entail and include for the securities transaction industry. They’re looking for a two-year rollout of the plan as implementation presents technical and logistical challenges.
The Real Difference
The current T+2 time-frame to settle transactions has been in place since 2017, when it was shortened from T+3 for stocks. The goal of the industry has been to minimize the time to settlement. The longer the period, the greater the likelihood that one of those involved in a transaction might default on its contractual obligation.
A discussion posted on the DTCC website addressed what the benefits are to reducing the settlement time. Murray Pozmanter, head of clearing agency services and global business operations at DTCC shared his thoughts on the issue. “The time to settlement equals counterparty risk, which can become elevated during market shocks. It can also lead to the need for higher margin requirements, which are critical to protecting the financial system and investors against a firm default,” said Mr. Pozmanter. “We have been working collaboratively with a wide cross-section of the industry to build support for further shortening the current settlement cycle over the past year, and we have outlined a plan to increase these efforts to forge consensus on setting a firm date and approach to achieve T+1,” he promised.
In addition to counterparty risk, there is a very real cost to tied up cash for each day settlement is extended. The DTCC said an average of $13.4 billion is held in margin every day to manage risk in the trading system. They believe that the needed margin could potentially be reduced by 41% if they moved to T+1 settlement.
Take-Away
The CEO of Robinhood, Vlad Tenev has blamed the two-day trade settlement for some of the clearinghouse issues that he says caused restricted trading in $GME, $AMC and other tickers. Robinhood raised $3.4 billion in about 72 hours to strengthen its balance sheet to reduce trading restrictions during the crisis.
There has been a class-action lawsuit filed and others being organized naming Robinhood as the defendant. In testimony to the House Financial Services Committee on the matter, Tenev said, “The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change.”
The change to reduce this risk seems to now be on its way. The underlying problem was brought to light by the unique style of many app and social media-driven traders. Steps are now being taken to reduce the chances of it occurring to others.
Suggested Reading:
Technology Confounds Wall Street Pros
Financial Markets Lift Household Wealth to Record Levels
COVid,
Sex, and the Business Cycle
Sources:
Advancing Together: Leading the Industry to Accelerated Settlement,
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