Robinhood is failing to live up to its name. The online share trading service is supposed to champion small, retail investors. It was a key platform for their audacious short squeeze on hedge funds betting against struggling store chain GameStop.
Yet Robinhood endured a difficult week that included a backlash from customers, raised eyebrows at the Securities and Exchange Commission and an emergency cash injection.
The zero-fee broker suspended trading in a handful of stocks such as GameStop on Thursday, citing regulation and investor protection needs. But the curbs may equally point to strains imposed by huge trading volumes on its disruptive business model.
Most brokers pay an external clearing house to reconcile trades between buyers and sellers. To cut costs, Robinhood has its own in-house clearing service, which is fine in gently rising markets. Robinhood then makes money from selling order flows to high-frequency traders, a practice under regulatory scrutiny.
Heightened volatility evidently caused trouble. It usually takes about two days for a trade to settle. In that time, clearing brokers have to post margin with Wall Street’s central clearing hub, the Depository Trust and Clearing Corporation (DTCC). Asset price gyrations and trading surges — as with shares of GameStop — prompt the DTCC to demand more collateral.
The industry collateral requirements for the entire equity market went from $26bn to $33.5bn in one day. For JPMorgan, with common equity tier one capital of $205bn, the increase is an inconvenience. But if you are an upstart online broker, it is a problem. Robinhood ended up having to raise $1bn from its own investors.
Robinhood’s bigger rival E*Trade, now owned by Morgan Stanley, said it “limited client activity” on GameStop and AMC on Thursday. Charles Schwab and TD Ameritrade also both adjusted margin requirements on select stocks.
Robinhood is seen as democratising share trading but may not always have the balance sheet to back up this philosophy on trades. Food for thought as the company, notionally valued at more than $11bn in August last year, contemplates going public.
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