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Comment by cmckn | Hacker News Reader

As I understand it, Robinhood had a cash problem because of the various collaterals required for high-risk securities during the clearing process. When each share traded needs a high amount of collateral (1:1, even), and you have a high number of those trades happening, you might not have the cash to pony up.

I think this is a downside to their business model (and probably moreso their scale and age). There are many upsides to their business model.

The interview I saw with their CEO on CNN was laughable. I would have a lot more respect for the company if the CEO could get in the weeds a bit more. The reality is that what Robinhood and most retail brokers provide is a convenient illusion, hiding the complexity of trading securities. Why can't they say that?

Edit: I almost certainly don't know what I'm talking about; but hey, this has been a fun story to follow, eh?

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Definitely a fun one.

A recurring theme when these things happen is people being incensed as they peek at the way things work. We scream "obvious market manipulation" and then learn how normative this is.

This story has been exceptionally good to follow because the mechanisms, as well as one half of the trades are all relatively simple and public. This isn't a scheme with super-complicated instruments and acronyms making their first appearances in the news. It's a simple strategy. Simple stocks. Simple shorts. Simple companies.

These /wsb nutters just found stocks that was aggressively and irresponsibly shorted. I've heard 140% of the total shares in existence. In theory (because who knows how tf it actually works irl), they now need to buy shares in order to sell them at the contracted price. There are only so many shares for sale, and the buyers have no choice. The /wsb nutters (and now also everyone who hates hedge funds) are holding to spite them.

Meanwhile, brokerage CEOs are hinting (and more) at market integrity-level issues yesterday. Solvency of clearing houses and other infrastructure stuff that we only hear about during a scandal.

This kind of makes sense, there are theoretical market conditions where prices go to infinity... which is the ultimate stretch goal for wsb right now.

> In theory (because who knows how tf it actually works irl), they now need to buy shares in order to sell them at the contracted price.

This assumes that the old shorts haven't already been closed. Existing shorts could very well just be those that've been created within the last couple days at the current overvalued price.

> Meanwhile, brokerage CEOs are hinting (and more) at market integrity-level issues yesterday. Solvency of clearing houses and other infrastructure stuff that we only hear about during a scandal.

Yup, the Chairman of Interactive Brokers was pretty explicit.

> We are worried about the integrity of the marketplace and the clearing system

https://www.cnbc.com/2021/01/28/interactive-brokers-restrict...

Riddle me this, if you know...

How is it possible that a $20bn company threatens the stability of clearing houses. Tesla moves by $20bn regularly. How does one affect the clearing house as a whole differently from the other?

It's been explained by other people in the comment section already much better than I could do.

It looks to me as if there are more stocks sold short than people are willing to sell back. The brokerages have plenty of money, but if 140% of stocks are shorted, delivering them all to their rightful owners is obviously difficult.

If that is in fact the case, the only ones who could prevent a full-blown market meltdown is Gamestop if they issued the missing 40%.

I don't actually know, but I think shorts are covered by borrowing stock, which is a rule that exists to fix this problem... though the fact that it's possible to short more stock than exist suggests borrowing stock doesn't mean what it sounds like.

More generally though, the talk was about clearing problems all stock trades, not just these. I can understand how a meltdown related directly to the stocks in question could happen. I don't understand why this threatens the solvency of the whole clearing house. Even if all 140% are due at once (they're not) @ $0, someone owes someone else $25bn - $30bn.

This is my current understanding:

It doesn't affect the clearing houses, it affects the brokers.

The clearing houses told the brokers (WeBull, Robinhood) that they need $x of capital to secure the trades, and they simply didn't have that cash.

This is only occurring because of the overall volatility and volume of trades going through particular brokers. Some brokers have been unaffected, presumably because they have more cash on hand.

I don't really understand why they would need to put up a margin in order to execute/clear a fully paid buy order on the exchange. Users promised $x in exchange for stock. RH have their $x. RH needs to make good on the exchange or clearing house. Seems to me that risk runs the other way... Other brokers/clearing house participants might be unable to pay RH users because leverage + a unexpectedly high stock price.

I understand why RH would shut down leverage. After that point, I don't understand why/how stock purchases represent a risk to anyone but the buyer. How is the non-leveraged side creating a risk of nonpayment? I really don't know how any of this works though, so let's leave this all aside. Lets grant that RH/users are at risk of being unable to cover trades.

So what? GME buys on RH create a scenario that risks RH running out of money. So what? Why/how does this risk the clearing houses? It's a $20bn stock. A 2% move in any of the big companies is a $20bn.

because the volume is so high that it was a multiple of the total shares in existence yesterday.

im simplyfing but RH could have had to put up to 300m - 1B collateral just to cover the gamestop trades. (they can't use their customers money for this)

I think the PR strategies of these companies is something along the lines of, say the vague things which have no risk of backlash as opposed to explaining what happened which has higher risk of backlash.

An interview with Webull CEO Anthony Denier explained much more about the underlying mechanics of clearing houses, collateral requirements, and the Deposit Trust Company (DTC). https://www.youtube.com/watch?v=4RS4JIEVyXM

> As I understand it, Robinhood had a cash problem because of the various collaterals required for high-risk securities during the clearing process. When each share traded needs a high amount of collateral (1:1, even), and you have a high number of those trades happening, you might not have the cash to pony up.

Something like that. But note that it isn't related to margin trading - Robinhood has to post their own cash as collateral with NSCC/DTCC, they can't use their customers' cash. So if a customer wanted to opt out of the margin account this wouldn't actually help.

(I don't know what this rule is for, but it's in the rules.)

Robinhood wasn't fulfilling orders though as far as I understand it? More like lead generation for Citadel, their market-maker? That seems like an issue for Citadel to be concerned with rather than Robinhood.

Robinhood is their own clearing broker. They send some market orders through people like Citadel Securities because it improves the price, but not all of them.

(Note, RH was fined by the SEC for possibly not improving the price as much as they could. But they were not giving you a bad price, it was still better than the NBBO price!)

Apple trades an order of magnitude more per day than any of the stocks that were halted. Somehow the clearinghouses have no trouble with the Apple volume.

> Apple trades an order of magnitude more per day than any of the stocks that were halted. Somehow the clearinghouses have no trouble with the Apple volume.

The clearinghouse had no problem with GME volumes either. They just required collateral. Had Robinhood not been able to meet its obligations yesterday and thus gone under, that collateral would help settle its trades with other brokerages.

Collateral requirements are re-calculated daily. That means there is risk between the last collateral calculation and where an asset is trading today. That risk is a function of volatility. So for a stock like Apple, the DTCC may only require 2% of the value of the trade be put up as collateral. For a stock like GameStop, it may require 100%.

It’s because considerably less capital is required to clear an Apple trade, because it is a much less volatile stock.

Firstly, this isn't true. Just this week AMC was trading tens of billions of dollars worth of shares per day, which is about equal to AAPL. GME is seeing >twice as much.

Second, the insane amount of volatility and concentration in these tickers makes the clearinghouses charge the brokerages way way more. You have fees (quoted in %) for expected change and also lack of diversity.

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