Robinhood, GameStop Explained: Why Payment Times Matter
If you’ve been listening to Thursday’s congressional hearing on GameStop’s buying spree, you may have heard some stock market jargon that suddenly came to light nationwide. Like “settlement hours”, for example.
It’s a concept that several star witnesses at the hearing, including Robinhood CEO Vlad Tenev, referred to in their written testimony. Specifically, Tenev and other Wall Street executives are calling for faster settlement times in stock transactions.
If you’re wondering what that means, here are the answers to your questions:
What are the payment terms?
Settlement times refer to when stock transactions are, uh, settled. When a buy or sell is ordered, the money does not change hands immediately, but rather at the time of settlement, which currently occurs on a T + 2 basis, or two business days after the fact.
Why are they important to investment dealers?
This is because of the rules established by the Depository trust and clearing company (DTCC), a central trading platform through which millions of buy / sell transactions are processed. Since sellers are not actually compensated until two days later, at the end of any trading day, DTCC may require brokers to provide collateral for the net amount owed on all of its trades. When buying and selling are roughly equal, it could be nothing. But when there is a lot of buying and little selling (ahem, GameStop), it can be very important.
What is the point of these rules?
DTCC exists to protect investors and the stock market by ensuring that brokers can actually back up the trades they make. It’s all about risk mitigation and with Robinhood and GameStop things got very, very risky.
What happened there?
Some brokers, such as Robinhood, allow investors to trade on margin, which means that the investor typically pays between 50% and 90% of the purchase price while the broker backs the rest with an interest-bearing loan. Buyer. However, with volatile stocks like GameStop, which could drop sharply in a matter of hours, there is a risk that the broker – who must hold a stock until a trade clears – may not have the funds for them. purchases made at their original higher prices two days later. If this happens, DTCC must handle the fault. Thus, the higher the risk, the greater the guarantee.
Ultimately, Robinhood simply did not have the cash to pay the collateral, hence the liquidity crunch and trade restrictions.
So how would faster settlement times help?
The less time there is for potential volatility between trade orders and settlements, the less collateral the broker will need to provide.
“The current two-day period for settling trades exposes investors and the industry to unnecessary risk and is ripe for change,” Tenev wrote in his testimony.