Why Robinhood Disabled Buys but not Sells

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There's been enough time for the dust to settle and for Robinhood's actual reason for halting trades to come out. But the question of why only buys and not sells has not really been answered in detail, and that's mainly because it's a pain-in-the-ass and delves deep into how the deposit requirements are calculated by the DTCC for brokers.

First, what happened

On that fateful day, Gamestop stock had massive volatility, and given the cries of "Buy!" and "Hold!" from /r/WSBs, I'd assume on Robinhood, a broker targeted at retail investors, it'd be heavily imbalanced towards buy trades.

As volatility increased, the DTCC (Depository Trust & Clearing Corporation) increased the deposit requirements for brokers. Basically, when you submit a trade on a broker, the exchange of money for stock doesn't actually happen until 2 days later, and the firm that handles that exchange is called a clearing firm. Before then, Robinhood just sends records: John bought 2 GME for $600, Mary sold 1 GME for $290. If that's all that happened that day, then Robinhood would need to provide $310 dollars to the clearing firm, and receive 1 stock.

That's a credit risk - what if Robinhood doesn't have the money on settlement? The clearing firm would be on the hook. So the DTCC requires that brokers put up a deposit beforehand. On that day, the DTCC massively increased the deposit requirements for brokers

A spokesman for the DTCC wouldn’t specify how much it required from specific firms but said that by the end of the day industrywide collateral requirements jumped to $33.5 billion, up from $26 billion.

Levine

The amount required by clearinghouses to cover the settlement period of some securities rose tremendously this week. How much? To put it in perspective, this week alone, our clearinghouse-mandated deposit requirements related to equities increased ten-fold.

Robinhood

So, Robinhood legally could not submit trades on $GME until they could muster the deposits for GME that they needed. And they quickly scrounged up some capital so they could continue on Friday.

Robinhood's Clearing Firm

Robinhood actually has their own clearing firm, Robinhood Securities... for some reason, but it's still a DTCC member and must listen to what the SEC regulates.

update 12:32 - On margin?

Some people seem to be mistaking the situation. It is not about margin accounts - while yes, Robinhood "instant transfers" provides the illusion of being instant effectively with margin, it's not really the issue here.

Brokers cannot use client money to satisfy their clearing fund obligation. So whether or not the accounts had a settled balance didn't matter - as you can see from the other brokers which halted buys and did not have "instant transfers".

Again, this is about what's effectively collateral the brokers must put up so that all parties can mitigate the risk of a broker failing. Of course client money is used when the transaction settles, but, naturally, you can't use their money, which isn't yours, as collateral.

But why ONLY Buys?

The deposit requirement is

deposit = min( 99% 2d VaR + Gap Risk Measure, Deposit Floor Calc) + Mark-to-Market

And the variable to look at is the 99% 2d VaR

The volatility component is designed to capture the market price risk associated with each Member’s portfolio at a 99th percentile level of confidence. The VaR Charge is the volatility component applicable to most Net Unsettled Positions, and usually comprises the largest portion of a Member’s Required Deposit. Procedure XV of the Rules currently provides that the VaR Charge shall be calculated in accordance with a generally accepted portfolio volatility margin model utilizing assumptions based on reasonable historical data and an appropriate volatility range. As such, NSCC currently calculates a Member’s VaR Charge utilizing the VaR model, which incorporates an EWMA volatility estimation.

SEC

Remember when I subtracted John's buys of $600 with Mary's sell of $290 to get $310? That's the broker's net unsettled cash positions. The 99% VaR is basically, "99% of the time the broker's net unsettled will not be higher than X". You might remember if you took statistics about confidence intervals; this is the upper 99% confidence interval.

Bad Desmos Graphs

So, let's model our risk as a Normal curve, for simplicity's sake. Here I've graphed a normal distribution with a line representing the 95% percentile

The Y axis is probability, the X axis is Robinhood's net unsettled positions. The more positive, the more money they'd owe theoretically.

Now, what happens if more people buy than sell? Then it'd shift over to the right

Hasn't the 95% percentile moved rightward as well? Now, what happens if the market is super volatile (i.e, the std dev of the distribution increases)

Wow, now it's even more to the right!

As you can see, buys make this worse, sells make it better. Robinhood could not execute buys, because it would increase the deposits they'd need, which they legally must obligate by. Sells, on the other hand, do not have this problem. They would not push the 95% boundary more to the right.

The Decision

So really, it's not a bad decision or good decision that Robinhood halted buys of GME - it wasn't a decision, and it wasn't something they alone did.

These brokers halted buys of GME

  • Robinhood
  • Webull
  • M1 Finance
  • Public
  • E-Trade

While others only halted options

  • Interactive
  • TDA
  • Schwab
  • Tradeing212

Hmm, see a pattern? The former group includes companies like Robinhood (2013), WeBull (2017), M1 Finance (2015), while the latter has TDA (1975), Schwab(1971), Trading212 (2004).

(Okay, E-Trade is actually old too, but I guess they're just cash-strapped right now?)

Looks like young brokers with a limited capital resources to me.

Stay or Switch?

If there's something to fault Robinhood, it's that they're a young, janky broker (and also you might be getting screwed on the spread by Citadel). If they had more money on-hand they might not have had to stop buys of Gamestop. Perhaps they should have expected this and raised more capital earlier.

And that's a real reason to stay away from Robinhood. But for the love of god do not swap to WeBull or something if that's your concern.

And don't do it because you're abhorred by Robinhood's class warfare or something. Because that didn't happen - it was a mixture of SEC regulations and a cash-strapped startup (well, cash-strapped on big broker scales).

Although if you want to get mad at Hedge Funds anyway, feel free! You should always be mad at Hedge Funds. But please pick a real reason - you have no lack of choice to pick from.