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Robinhood’s decision to temporarily limit purchases of GameStop and other highly volatile stocks in late January was the overwhelming focus of today’s Chamber Financial Services Committee hearing.
At the hearing, Robinhood CEO Vlad Tenev said that the extreme stock volatility that led to Robinhood’s restriction was a “five sigma” event with a “1 in 3.5 million” chance of happening. This made the situation virtually impossible for the company to plan, said Tenev. “In the context of tens of thousands of days in the history of the US stock market, an event of 1 in 3.5 million is basically unmodelable.”
As we covered earlier, the high volatility of GameStop and other so-called “meme stocks” last month meant that Robinhood was suddenly forced to provide much more guarantees to the stock clearing houses that actually process his trades. Tenev said on Thursday that these collateral obligations increased ten-fold between January 25 and January 28, with GameStop rising from $ 76 per share to more than $ 347, and then dropping to $ 193.
“Despite unprecedented conditions, what happened is unacceptable to us,” said Tenev. “To our customers, I am sorry and I apologize. We are doing everything in our power to ensure that this does not happen again.”
Where is the money?
Tenev repeatedly reiterated that Robinhood never had a liquidity problem in terms of covering his users’ real positions. But the company lacked immediate capital to cover these guarantee requirements, which meant that its only alternative was to temporarily limit sales of those shares until it could raise more funds (or until the shares became less volatile).
Some members of the Chamber’s Financial Services Committee were not impressed with the discussion of what “liquidity” means to Robinhood. “His customers wanted to buy the stock,” said representative Van Taylor (R-TX) at one point. “You wouldn’t let them do that because you didn’t have the capital to allow them to do that.”
Tenev was also criticized for failing to clearly and quickly communicate the reasons behind these restrictions to customers. Congresswoman Carolyn Maloney (D-NY) noted that Robinhood’s initial blog post on January 28 announcing restrictions contained “no disclosure about capital requirements” and just “vague language on trade restrictions”. The initial impression, she suggested, was that Robinhood was “[making] the rules as you go. “
Since it was forced to halt negotiations, Robinhood has attracted more than $ 3.4 billion in additional investment that Tenev said “protects the company from market volatility and new black swan events”. And while apologizing, Tenev also said that “other companies have done similar things by restricting the purchase [of these volatile stocks], which suggests that it is a systemic problem, rather than an exclusively Robinhood problem. “
But Rep. Alexandria Ocasio-Cortez (D-NY) pointed out that “when Robinhood prohibited its customers from buying additional shares of certain shares, other brokers simply adjusted the margin requirements on those shares.” This, she suggests, could mean that “the problem is not clearing houses, but that you simply did not manage your own margin rules or failed to manage your own internal risks.”
Some members of the committee also focused on Robinhood’s business model, which generates most of its revenue from selling its “order flow” to market makers like Citadel (who then derive some of the profit from price improvement they can provide on exchanges) “When you’re not paying for it, it’s not free,” said Deputy Brad Sherman (D-CA) of Robinhood’s commission-free negotiations. “You are the product, someone else [i.e., Citadel] is the customer. “
“If removing revenue from payment to the order flow would cause removal of commission-free trade, doesn’t that mean that trading on Robinhood isn’t really free to start with, because you’re just hiding the cost?” Ocasio-Cortez added in some direct questioning.
Deregulate or regulate again?
Although Tenev apologized for the mistakes Robinhood made, he also blamed what he called outdated and dying rules of trade deals that put a lot of pressure on the system. In the current T + 2 stock settlement schedule, market makers actually have two full days to officially settle a transaction (ie transfer the shares / money) after it is made. When the price of a share is especially volatile, the clearinghouse needs more guarantees to cover potential price changes that could occur on either side of the trade in that two-day interval.
“The existing two-day period to settle the negotiations exposes investors and the industry to unnecessary risk,” said Tenev. “There is no reason why the largest financial system in the world cannot settle trades in real time … If we had real time settlement capacity and the infrastructure was modernized, we would not have similar problems.”
Ken Griffin, Citadel’s CEO, barely asked for a real-time business deal in his testimony to the committee. But he said relaxing the rules for a one-day turnaround “would reduce the risk of the counterparty holistically.” While instant or same-day trade compensation was good, Griffin said he would essentially require “all systems … to work all the time, every day, with no room for error.”
Congressman Andy Barr (R-KY) pointed out through his questioning that current capital requirements were put into place in the 2010 Dodd-Frank reform project on Wall Street. “If anyone has problems with [Robinhood]”he said. Congressman William Timmons (R-SC) added that Dodd-Frank is” arguably the culprit for this exorbitant capital requirement that you were unable to meet. . Well-intentioned legislation is somewhat responsible. “
Other members of the House, such as Congressman Rashida Tlaib (D-MI), vigorously defended a 0.1% financial transaction tax, which would discourage speculative bets on meme stocks and limit algorithm-based high-frequency trading. She noted that Hong Kong has implemented a financial transaction tax that is twice as high, limiting high-frequency trading without hampering significant growth in that market.
But Jennifer Schulp, Director of Financial Regulation Studies at the Cato Institute, focused on the free market, told the committee that these taxes “often fail to raise money and distort trade in an unforeseen way. A tax on financial transactions may seem like a small tax. imposition, but often undermines the long-term goals of individual investors by affecting the institutions that trade. “
Although Schulp allowed a tax on financial transactions to decrease total market volatility, she added that she did not think it would have that effect in the particular case of GameStop’s recent stock movements, which were mainly driven by heavy purchases.
Diamond hands
To represent retailers who helped boost the GameStop bubble, the committee listened to Keith Gill, aka DeepFuckingValue on Reddit. He first invested in GameStop in mid-2019 (when the stock was valued at less than $ 10) and strongly publicized the stock’s value on the subreddit WallStreetBets. “The market was underestimating GameStop’s legacy business prospects and overestimating the risks of bankruptcy,” he said. “I grew up playing video games and shopping at GameStop, and I plan to continue shopping there. GameStop stores provide real value for players and real revenue for GameStop.”
Gill, who has now made millions with an initial investment of about $ 50,000, said he still thinks GameStop is an attractive investment at its current price of around $ 40 per share. His optimism is due in large part to GameStop’s potential to become a more focused e-commerce strategy. “As for me, I like the stock,” he said. “I am more optimistic than ever about a potential recovery and continue to invest in the company.”
Less represented at the hearing were the many other investors who bought the shares at or near their peak in late January, only to see their investments collapse in a few days. Congressman Jim Himes (D-CT) raised the case of Salvador Vergara, who took out a $ 20,000 personal loan to invest in GameStop just to see his stock value drop by 80% in days. “We need to think about it,” said Himes on how to deal with retail investors’ access to the market.
The committee also listened to Reddit co-founder and CEO Steve Huffman, who said that Reddit found no evidence of foreign bots or agents playing a significant role in trying to unduly increase any action through the subreddit WallStreetBets. “We will respond to requests from regulators, but we believe that the community was within the limits of our own policies,” he said.
“It’s a real community,” Huffman continued on WallStreetBets. “Self-deprecating jokes, memes and sometimes crass language reflect this. There is significant depth in the community based on the affinity that users demonstrate for each other.”