Citadel and Robinhood call for T+1 settlement cycle
23 February 2021 US
Image: leungchopan/adobe.stock.com
Vladimir Tenev, CEO of Robinhood, an American financial services company known for offering commission-free trades of stocks and exchange-traded funds via a mobile app, is pushing for the settlement infrastructure to be modernised.
This follows the course of events from January when Robinhood had to restrict trading in stocks including GameStop because of the volatility caused by retail traders.
The surge in buying of GameStop and other 'meme stocks' was partly aimed at creating a short squeeze on several hedge funds with known positions against the high-street games retailer.
While the stock price of GameStop stock increased to several hundred per cent higher than its 2020 levels in a few weeks, Robinhood, along with other brokers in the market, had to put up money with the Depository Trust & Clearing Corporation (DTCC) to back those trades during the two days it takes for them to settle.
The speed of the price spike Robinhood made the decision to restrict the buy order for these securities so that it could make the deposit for the collateral.
Over the next couple of days, Robinhood raised over $3 billion in capital and pulled on some lines of credit so it could gradually relax and eventually remove all of these restrictions.
In a Q&A series hosted on Robinhood鈥檚 blog, the CEO answered customers鈥� questions, including how he would handle things differently if this was to occur again.
As part of his response, Tenev explains that he was pushing for the settlement infrastructure to be modernised.
He notes that the events were not uniquely a Robinhood issue but an industry issue where many broker-dealers and trading platforms prevented their customers from opening positions in these stocks.
Tenev suggests that solving the problem for the system will require 鈥渟ystemic change鈥� and fixing of the 鈥渁ntiquated settlement structure鈥�.
Tenev says Robinhood鈥檚 mission is to democratise finance for all and believes that Robinhood became popular because it represented a movement.
鈥淚t represented this idea that individual investors could have the same access to the markets and the same tools that the big guys have,鈥� he says in the blog video.
Discussing the events from January in further detail, Tenev explains: 鈥淥n 28 January, due to high collateral requirements and the regulatory deposit requirements and the need for us to put up cash as a firm, we had to temporarily restrict buying certain securities that were very popular on the internet and that disappointed customers greatly 鈥� it is something we are trying to learn from and prevent from happening ever again.鈥�
鈥淥ne of the interesting non-intuitive things is that you would think that we could just use our customer鈥檚 cash that they have deposited in their accounts to pay for these trades but actually since there is a two day settlement period, we can鈥檛 do that.鈥�
In a pre-prepared statement on 18 February, prior to the hearing before the US House of Representatives Committee on Financial Services, Tenev voiced his belief that a T+0 system would be the way forward.
The US settlement date for stocks was historically T+5, or five business days after the transaction date, before moving to T+3, and then T+2 in 2017, in line with the UK which made the switch in 2014.
In the hearing, Tenev affirms that during the week of 25 January 2021, Robinhood saw the impact the T+2 trade settlement period has on its customers and ultimately the entire American financial system.
鈥淐learinghouse deposit requirements skyrocketed overnight. People were unable to buy some of the securities they wanted. The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change,鈥� says Tenev.
According to the CEO, every day, clearing brokers like Robinhood Securities have to meet deposit requirements imposed by clearinghouses to support customer trades between the trade date and the date the trades settle.
Tenev believes investors are left waiting for their trades to clear, and the clearing brokers have their proprietary cash locked up until the settlement is final days after the trade.
The clearinghouse deposit requirements are designed to mitigate risk, but the wild market activity showed that these requirements, coupled with an unnecessarily long settlement cycle, can have unintended consequences that introduce new risks.
Tenev comments: 鈥淭here 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. Indeed, real time settlement would have allowed Robinhood Securities to better react to periods of increased volatility in the markets without restricting the purchasing of securities. It has been four years since the securities industry moved from a three-day to a two-day settlement cycle.鈥�
Additionally, Tenev suggests that DTCC has recognised the benefits of an even shorter timeframe, leveraging technology.
Meanwhile, millions of new investors have entered the market for the first time as technology transforms the world. 鈥淚t is time for the financial system to catch up,鈥� Tenev says.
He adds: 鈥淭he industry, congress, regulators, and other stakeholders need to come together to deploy our intellectual capital and engineering resources to move to real-time settlement of US equities. Accomplishing this won鈥檛 be without its well-documented challenges, but it is the right thing to do and Robinhood is eager to drive this critical effort on behalf of all investors.鈥�
Tenev is not the only one to support a movement to a T+0 platform. Kenneth Griffin, founder and CEO of Citadel, an American multinational hedge fund and financial services company, also voiced his opinion in a pre-prepared statement on the matter before the same committee hearing.
Griffin outlines that recent events have highlighted 鈥渃lear opportunities鈥� to improve the market.
One takeaway, says Griffin, is the importance of modernising the settlement process, including shortened settlement cycles and transparent capital models.
鈥淎s we have seen, longer settlement periods expose firms to more risk in the time between execution and settlement, requiring higher levels of capital. Settlement cycles should be shortened from T+2 to T+1,鈥� Griffin comments.
Griffin concludes: 鈥淭ransparent clearing house capital requirements will enable brokers and market makers to better prepare for potential capital demands and minimise the risk of associated market interruptions. Both of these enhancements are well within reach today.鈥�
Sceptics of a short settlement cycle highlight the fact that a shorter cycle would tighten the window to correct trade errors made during the initial transaction or to confirm acceptable collateral, and ultimately lead to a higher fail rate across the capital market.
Critics of Robinhood also argue that its challenges came from its own underdeveloped risk management protocols and overzealous handing out of margin accounts to retail investors in the past 12 months which made it partially susceptible to becoming a liability in the eyes of its CCP.
This follows the course of events from January when Robinhood had to restrict trading in stocks including GameStop because of the volatility caused by retail traders.
The surge in buying of GameStop and other 'meme stocks' was partly aimed at creating a short squeeze on several hedge funds with known positions against the high-street games retailer.
While the stock price of GameStop stock increased to several hundred per cent higher than its 2020 levels in a few weeks, Robinhood, along with other brokers in the market, had to put up money with the Depository Trust & Clearing Corporation (DTCC) to back those trades during the two days it takes for them to settle.
The speed of the price spike Robinhood made the decision to restrict the buy order for these securities so that it could make the deposit for the collateral.
Over the next couple of days, Robinhood raised over $3 billion in capital and pulled on some lines of credit so it could gradually relax and eventually remove all of these restrictions.
In a Q&A series hosted on Robinhood鈥檚 blog, the CEO answered customers鈥� questions, including how he would handle things differently if this was to occur again.
As part of his response, Tenev explains that he was pushing for the settlement infrastructure to be modernised.
He notes that the events were not uniquely a Robinhood issue but an industry issue where many broker-dealers and trading platforms prevented their customers from opening positions in these stocks.
Tenev suggests that solving the problem for the system will require 鈥渟ystemic change鈥� and fixing of the 鈥渁ntiquated settlement structure鈥�.
Tenev says Robinhood鈥檚 mission is to democratise finance for all and believes that Robinhood became popular because it represented a movement.
鈥淚t represented this idea that individual investors could have the same access to the markets and the same tools that the big guys have,鈥� he says in the blog video.
Discussing the events from January in further detail, Tenev explains: 鈥淥n 28 January, due to high collateral requirements and the regulatory deposit requirements and the need for us to put up cash as a firm, we had to temporarily restrict buying certain securities that were very popular on the internet and that disappointed customers greatly 鈥� it is something we are trying to learn from and prevent from happening ever again.鈥�
鈥淥ne of the interesting non-intuitive things is that you would think that we could just use our customer鈥檚 cash that they have deposited in their accounts to pay for these trades but actually since there is a two day settlement period, we can鈥檛 do that.鈥�
In a pre-prepared statement on 18 February, prior to the hearing before the US House of Representatives Committee on Financial Services, Tenev voiced his belief that a T+0 system would be the way forward.
The US settlement date for stocks was historically T+5, or five business days after the transaction date, before moving to T+3, and then T+2 in 2017, in line with the UK which made the switch in 2014.
In the hearing, Tenev affirms that during the week of 25 January 2021, Robinhood saw the impact the T+2 trade settlement period has on its customers and ultimately the entire American financial system.
鈥淐learinghouse deposit requirements skyrocketed overnight. People were unable to buy some of the securities they wanted. The existing two-day period to settle trades exposes investors and the industry to unnecessary risk and is ripe for change,鈥� says Tenev.
According to the CEO, every day, clearing brokers like Robinhood Securities have to meet deposit requirements imposed by clearinghouses to support customer trades between the trade date and the date the trades settle.
Tenev believes investors are left waiting for their trades to clear, and the clearing brokers have their proprietary cash locked up until the settlement is final days after the trade.
The clearinghouse deposit requirements are designed to mitigate risk, but the wild market activity showed that these requirements, coupled with an unnecessarily long settlement cycle, can have unintended consequences that introduce new risks.
Tenev comments: 鈥淭here 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. Indeed, real time settlement would have allowed Robinhood Securities to better react to periods of increased volatility in the markets without restricting the purchasing of securities. It has been four years since the securities industry moved from a three-day to a two-day settlement cycle.鈥�
Additionally, Tenev suggests that DTCC has recognised the benefits of an even shorter timeframe, leveraging technology.
Meanwhile, millions of new investors have entered the market for the first time as technology transforms the world. 鈥淚t is time for the financial system to catch up,鈥� Tenev says.
He adds: 鈥淭he industry, congress, regulators, and other stakeholders need to come together to deploy our intellectual capital and engineering resources to move to real-time settlement of US equities. Accomplishing this won鈥檛 be without its well-documented challenges, but it is the right thing to do and Robinhood is eager to drive this critical effort on behalf of all investors.鈥�
Tenev is not the only one to support a movement to a T+0 platform. Kenneth Griffin, founder and CEO of Citadel, an American multinational hedge fund and financial services company, also voiced his opinion in a pre-prepared statement on the matter before the same committee hearing.
Griffin outlines that recent events have highlighted 鈥渃lear opportunities鈥� to improve the market.
One takeaway, says Griffin, is the importance of modernising the settlement process, including shortened settlement cycles and transparent capital models.
鈥淎s we have seen, longer settlement periods expose firms to more risk in the time between execution and settlement, requiring higher levels of capital. Settlement cycles should be shortened from T+2 to T+1,鈥� Griffin comments.
Griffin concludes: 鈥淭ransparent clearing house capital requirements will enable brokers and market makers to better prepare for potential capital demands and minimise the risk of associated market interruptions. Both of these enhancements are well within reach today.鈥�
Sceptics of a short settlement cycle highlight the fact that a shorter cycle would tighten the window to correct trade errors made during the initial transaction or to confirm acceptable collateral, and ultimately lead to a higher fail rate across the capital market.
Critics of Robinhood also argue that its challenges came from its own underdeveloped risk management protocols and overzealous handing out of margin accounts to retail investors in the past 12 months which made it partially susceptible to becoming a liability in the eyes of its CCP.
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