September 03, 2021
In late January, dozens of brokers were forced to halt buying activity in heavily-shorted stocks such as GameStop and AMC Entertainment. This prompted outrage from retail investors and investor advocates from both sides of the aisle. It also informed the decision for some of Washington’s top lawmakers to convene to discuss the events involving market volatility and the GameStop short squeeze.
The first hearing afflicting that discussion was held on February 18, 2021. It featured testimony from the CEOs of Robinhood, Citadel Securities, and Reddit. It also included Keith Gill, AKA Roaring Kitty, a prolific retail investor who made over $49 million buying options in GameStop. In full, the hearing lasted over six hours. So you don’t have to labor through watching hours of people forgetting to mute their mics on Zoom, we’ve broken down the three big points from Washington’s first GameStop hearing.
Payment for Order Flow took center stage
Much of the GameStop hearing revolved around a supposed conflict of interest between brokers and order flow providers. Specifically, it probed whether or not Robinhood was influenced by one of its biggest order flow providers–Citadel–to halt trading in any stock. The answer was a resounding no, but the discussion about Payment for Order Flow (PFOF) still took center stage. As is the case for many brokerages, PFOF is a major way how Robinhood makes money.
PFOF has arguably empowered zero-commission trading. Instead of charging the end-user a commission for each trade, PFOF has essentially subsidized retail investors. The only problem is that PFOF has become a massive line item for some brokerages like Robinhood. In the second quarter of 2020, Robinhood’s PFOF revenue was worth over $180.3M. The majority of that revenue came from one order flow provider in particular: Citadel Securities LLC.
People were quick to suggest that Robinhood halted trading in companies like GameStop to appease Citadel, which bailed out a hedge fund with a prominent and expensive short position in the company. Though Citadel categorically denied the claim, various members of Congress reiterated concerns that this relationship creates asymmetry between the broker and the customer’s interests.
Settlement times might actually change
When you place an order to buy or sell a stock, you might be surprised to know that you don’t own that stock immediately. On the back end, the movement of money and stock happens over a period of two days through clearing houses and an intermediary called the Depository Trust & Clearing Corporation (DTCC). This complex system is the backbone of the American financial system. However, the CEOs of Robinhood and Citadel both concurred that settlement times should be reduced from their current two day (T+2) timeline to either one day (T+1) or instant settlement (T+0).
This doesn’t affect users, but there’s a few reasons why it makes sense to change settlement times. For one, it can reduce capital requirements on brokers and shift risk from broker-dealers like Robinhood. Several lawmakers suggested shifting some elements of the DTCC’s operations onto an enterprise blockchain, something which has been weighed in the past.
Robinhood wasn’t the only broker that halted buy orders
Settlement times might share part of the blame for the DTCC ultimately needing to demand collateral from Robinhood for trades. However, collateral requirements are what Robinhood CEO Vlad Tenev insists is the core reason behind the halting in buying activity in some stocks. Though the bulk of the GameStop hearing revolved around the role that Robinhood played in halting trading, there were a handful of brokers who halted trading. One clearing house which enables brokers like Public.com, M1 Finance, and other sites also halted trading around the same time.
Ultimately, we are left with more questions about the financial system and the ways in which all these interlocking problems ultimately contributed to interrupting trading. Financial committee chair Maxine Waters says that there will be at least one more hearing, with regulators, about the events of January. Stay tuned, we’ll keep you posted on the ongoing developments of these hearings.