Settlement, PFOF in Focus at GameStop Hearing
Last month shares in GameStop rose 1,600% as retail investors drove up the price after users of online forum Reddit had posted that hedge funds had taken a large short position in the US video game retailer. Trading app Robinhood was forced to temporarily suspend trading in GameStop and other “hot” stocks in order to cover its clearing margins which led to allegations of market manipulation and unfair treatment of retail investors.
Congresswoman Maxine Waters (D-CA), Chairwoman of the House Committee on Financial Services, announced a hearing and the following witnesses will appear today for the virtual event: “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide.”
- Vlad Tenev, Chief Executive Officer, Robinhood Markets, Inc.
- Kenneth C. Griffin, Chief Executive Officer, Citadel LLC
- Gabriel Plotkin, Chief Executive Officer, Melvin Capital Management LP
- Steve Huffman, Chief Executive Officer, Co-Founder, Reddit
- Keith Gill
🚨 #BREAKING: Chairwoman @RepMaxineWaters Announces #Robinhood, #Citadel, #MelvinCapital, #Reddit CEOs and Keith Gill to Testify at Committee Hearing | https://t.co/dvDenXvANQ pic.twitter.com/krRC0DhV0l
— U.S. House Committee on Financial Services (@FSCDems) February 13, 2021
See here for Chairwoman Waters’ January statement on recent market volatility involving GameStop stock and other stocks.
The hearings will be livestreamed on https://financialservices.house.gov/live/.
Tyler Gellasch, executive director of The Healthy Markets Association, an investor-focused non-profit buy-side coalition, said in a letter to the committee that conflicted order routing practices exploit investors and provide incentives that exacerbate risks for the markets.
He said: “Ending conflicted order routing practices and enforcing best execution should be a significant focus for regulators and lawmakers.”
If you are interested in the policy implications of recent events around GameStop and Robinhood, you won't find a better source than this letter from Healthy Markets @TylerGellasch https://t.co/qUf42Lkudn
— Barbara Roper (@BarbaraRoper1) February 17, 2021
“We encourage this Committee and regulators to seek copies of all order routing arrangements between Robinhood and its market makers, and would similarly encourage the Committee to explore whether and how Robinhood factors receipt of payment for order flow into its order routing decisions for different types of orders and asset classes,” added Gellasch.
He also noted that in December 2019, Robinhood settled an action with FINRA for failing to have and follow appropriate processes even to attempt to achieve best execution. In January 2021, Robinhood settled a separate action with the SEC for $65m for failing to obtain best execution for its customers, failing to have and follow appropriate processes with which to do so, and for inadequately informing customers about its receipt of payments for order flow.
The Security Traders Association said in a letter to the committee that reducing the equites settlement period from the existing T+2 regime would cut risk in the financial system.
Ahead of tomorrow's congressional hearing to address the GameStop/Reddit/Robinhood controversy, industry veterans Harvey Pitt and Richard Grasso outlined short- and long-term actions that could strengthen markets going forward. Read the full article here: https://t.co/qyTQ8kyBR0 pic.twitter.com/AmTk3CnMEL
— SecurityTradersAssn. (@STA_National) February 17, 2021
The STA noted that in 2017 the US regulators shortened the settlement period for securities transactions from T+3 to T+2 after a cost and benefit determined this was the best outcome.
“Given the market volatility experienced in early 2020 and more recently, it seems prudent to revisit this topic,” added the STA. “Competition in this space could also help drive innovation to keep our markets moving forward while continuing to maintain the safety, fairness and efficiency of the market.”
Vlad Tenev, co-founder and CEO of Robinhood Markets, said in his written testimony that payment for order flow benefits customers. He said market-makers provide Robinhood with a rebate for executed orders, and in return, they provide reliable, quick, and competitive trade executions which are typically at better prices than on public exchanges.
Off Twitter for a bit … pic.twitter.com/kw1tKNXWzb
— VLAD (@vladtenev) February 18, 2021
“Importantly, we have negotiated the same rebate rate with each of the market-makers to whom we route customers’ orders, which eliminates any incentive for Robinhood to direct orders to any specific market maker,” he added. “Robinhood customers received more than $1bn in price improvement—the price they received compared to the best price on a public exchange—in the first half of 2020.”
He said Robinhood Securities’ routing system is designed to prioritize routing orders for execution to market venues based on the likelihood of obtaining price improvement in a stock over the last 30 days.
Good summary of Payment for Order Flow by Tom Peterffy @IBKR.
Good: Zero commissions, "Price Improvement"
Bad: Fewer orders go to the primary market, reduces liquidity there, widens spreads.
Question: If price is "improved" vs. wider spread is the net result better or worse? https://t.co/K9aBQllImu
— W. Brennan Carley (@Fintech_Brennan) February 18, 2021
Tenev continued that the existing two-day period to settle equity trades exposes investors and the industry to unnecessary risk and is ripe for change as clearing brokers like Robinhood Securities have to meet deposit requirements imposed by clearinghouses.
“There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time. Doing so would greatly mitigate the risk that such processing poses,” he said. “Indeed, realtime settlement would have allowed Robinhood Securities to better react to periods of increased volatility in the markets without restricting the purchasing of securities.”
Kenneth Griffin, founder and chief executive of Citadel and founder and principal shareholder of Citadel Securities, said in his written testimony that the market maker had no role in Robinhood’s decision to limit trading in GameStop or any other of the “meme” stocks. He said: “I first learned of Robinhood’s trading restrictions only after they were publicly announced.”
Griffin wrote that retail brokers have used PFOF to reduce the costs of trading and that faster execution, better pricing and reduced fees have made the cost to invest in America lower than ever. He continued that during the period of frenzied retail equities trading Citadel Securities was the only major market maker to provide continuous liquidity.
“When others were unable or unwilling to handle the heavy volumes, Citadel Securities stepped up,” Griffin added. “On Wednesday, January 27, we executed 7.4 billion shares on behalf of retail investors. To put this into perspective, on that day Citadel Securities executed more shares for retail investors than the average daily volume of the entire U.S. equities market in 2019.”
He recommended the the settlement cycle for equities should be shortened from T+2 to T+1.
“Transparent clearing house capital requirements will enable brokers and market makers to better prepare for potential capital demands and minimize the risk of associated market interruptions,” Griffin added. “Both of these enhancements are well within reach today.”
Michael McClain, DTCC Managing Director and General Manager of Equity Clearing and DTC Settlement Services said in a blog that real-time gross settlement would have the disadvantage of reducing netting, which minimizes risk and frees up trillions of dollars of capital each year.
— Kevin McPartland (@kmcpartland) February 18, 2021
McClain said: “Every day, the National Securities Clearing Corporation nets down these trades and payments among its participants, reducing the value of payments that need to be exchanged by an average of 98-99%.”
Real-time settlement does not allow traders to pledge shares they have yet to transact as collateral so trades would have to be pre-funded on an unsecured basis, which could diminish liquidity.
McClain said: “We strongly support moving to T+1 or even T+½. The reality is that we already have the capability to clear and settle in T+1 or even the same day using existing technology, and in fact, we clear a number of T+1 trades every day. In our discussions with the industry, many firms appear ready to start revising their processes to accelerate settlement.”
Gabriel Plotkin, founder and chief investment officer of Melvin Capital Management, said in his written testimony that the hedge fund played no role in the decisions of stock trading platforms to limit trading in GameStop.
Plotkin wrote that Melvin Capital had been short GameStop since the hedge fund’s inception six years ago because it believed that selling new and used video games in physical stores is being overtaken by digital downloads.
“When this frenzy began, Melvin started closing out its position in GameStop at a loss, not because our investment thesis had changed but because something unprecedented was happening,” he added. “We also reduced many other Melvin positions at significant losses – both long and short – that were the subject of similar [Reddit] posts.”
Jennifer Schulp, director of Financial Regulation Studies Center for Monetary and Financial Alternatives at the Cato Institute, said in her written testimony that the temporary volatility in GameStop and others did not present a systemic risk to the functioning of markets.
Talking about T+1. Momentum is building, don't expect quick moves. As I note, "it’s not an easy thing to flip the switch on.” https://t.co/9qKbPh3F7S
— Jennifer J. Schulp (@jenniferjschulp) February 9, 2021
“GameStop’s market capitalization, even at its peak, was around $24bn in an approximately $50 trillion market. And short interests, which may have been targeted by some traders, represent a small, and recently shrinking, portion of equity market value,” she added. “Even the wider market effects potentially attributable to the GameStop phenomenon, like the dip in the Dow Jones Industrial Average, were mild and short-lived.”
As a result, she said the GameStop phenomenon should not result in changes that restrict retail investors’ access to the markets.
“Re-introducing undue barriers to participation that have been removed, or introducing new restrictions, has the potential to undo the benefits of wider retail participation in our equities markets,” added Schulp.
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