GameStop: Now the dust has settled, what comes next?
02 March 2021
An SEC investigation, hearings in Congress, murmurs of new regulations and Wall Street rattled; not bad for a Roaring Kitty
Image: stock.adobe.com/Andrea Izzotti
The first US federal hearing on the GameStop saga saw House members tangle with witnesses 鈥 and each other 鈥 over whether the events of January mean the country鈥檚 financial mechanisms are working for ordinary Americans.
The apparent surge in retail trading in GameStop and subsequent short squeeze raised the spectre of reporting of short positions after House members described hedge funds as 鈥渂ullies鈥 guilty of market manipulation.
Whether an emboldened Biden administration will put out Trump鈥檚 bonfire of regulations, looking to secure a big win against the financial giants, has yet to be determined 鈥 this was just the first of three GameStop hearings to be held by the US House Committee on Financial Services.
But, a House memorandum that details dormant sections of the 2011 Dodd-Frank Wall Street Reform and Consumer Protection Act, obliging firms to record and publicly disclose short selling data, gives an indication of the flavour of regulations that a Biden-led Deomocratic Congress may choose to implement.
Nonetheless, the hearing laid bare a partisan and polarised country, with one House member, Bill Huizenga of Michigan, calling the entire hearing pure 鈥減olitical theatre鈥, for which he was subsequently chastised by chair and congresswoman Maxine Waters.
As the hearing, conducted remotely, ran for over five hours House members across the country probed witnesses on 鈥渟hort selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors鈥.
The speakers called to testify 鈥 some faring better than others 鈥 were Robinhood CEO Vlad Tenev, hedge fund Citadel CEO Kenneth Griffin, Reddit CEO and co-founder Steve Huffman, Melvin Capital CEO Gabriel Plotkin, Cato Institute director of financial regulation studies Jennifer Schulp and day trader Keith Gill who is credited with rallying the retail interest in GameStop through Reddit forum WallStreetBets.
Plotkin, in a statement released before the hearing, defended the short selling practices of the firm, emphasising the amount of research that had taken place before deciding to short the struggling bricks-and-mortar gaming retailer.
The trends Melvin Capital had identified 鈥 downloads are in, stores and trading games are out 鈥 were so entrenched that Plotkin said his firm had been short GameStop since its founding six years ago.
Plotkin also said the fund played absolutely 鈥渘o role鈥 in trading platform Robinhood鈥檚 decision to limit trading in GameStop stock, referring to how the stock trading platform was forced to briefly ban buy orders on several volatile 鈥榤eme stocks鈥, including GameStop, in order to allow the broker to refinance its collateral account with its central counterparty.
During the hearing, Cato Institute鈥檚 Schulp emphasised that 鈥渢he temporary volatility in these stocks did not represent a systemic risk to market function鈥.
鈥淪tock prices move in and out of alignment all the time and the market is no stranger to bubbles鈥 and the market鈥檚 mechanisms, Schulp added, including the 鈥渢ool of short selling鈥, generally work well to handle these circumstances.
Schulp said that the SEC鈥檚 investigation into January鈥檚 events has far more information at its disposal than the general public and may choose to introduce new legislation, but, Schulp told committee members, that 鈥渂y no means should these events lead to more restrictions for retail investors鈥.
As the hearing rolled on, fault lines in the House of Representatives were exposed as members grappled over who, if anyone, was to blame for the volatility.
Ed Perlmutter, of Colorado, zeroed-in on the inconsistency between Plotkin and Gill鈥檚 views on whether the share price of GameStop was long or short after Gill told the representative that when he purchased the stock he believed that the price may eventually reach $25.
鈥淲ere you in a naked position?鈥, Perlmutter subsequently asked Plotkin, to which the Melvin Capital founder replied that the system would not allow that sort of position.
Nydia Velazquez, a representative of New York, came down hard against the practice of short selling. 鈥淭oo often, I have seen abuse [short selling] and it ends up hurting ordinary workers and families,鈥 she said. 鈥淚 first saw it against the people of Puerto Rico, and now I am seeing it against GameStop.鈥
In the same vein, Jim Himes, of Connecticut, likened hedge fund Citadel to a casino and accused Robinhood of making money from that casino. 鈥淎s the house always wins, who loses?鈥 In his view, it鈥檚 the retail investors.
Himes said that although he supports the democratisation of finance he noted that on Wall Street retail investors are known as 鈥渄umb money鈥 and he pressed an increasingly beleagured Tenev on whether, in the aggregate, users on the trading platform won or lost money as a result of shorting GameStop stock. Tenev was unable to answer.
California鈥檚 Juan Vargas turned the screws on Tenev further, likening the platform to an anti-Robin Hood, stealing from the small retail investor and giving to the large investment fund.
Blaine Leutkemeyer, a representative of Missouri, said short interest in a stock of more than 100 per cent 鈥 140 percent at its peak in GameStop 鈥 looks to an 鈥渙utsider鈥漧ike stock manipulation. 鈥淒on鈥檛 you think there should be a limit on something like that?鈥 he added.
Citadel鈥檚 Griffin acknowledged the short interest in this instance was 鈥渆xceptional鈥 but advised against seeking a legal cap on the amount of times a share can be lent and short sold.
Georgia鈥檚 Barry Loudermilk also spoke out against further regulations as a result of the GameStop saga.
鈥淭here seems to be a trend in Washington to never let a crisis go to waste,鈥 he mused, adding that there was no rush to introduce 鈥渂ig government鈥 regulations.
Perhaps attempting to strike a balance, Lee Zeldin of New York felt the GameStop saga was a 鈥減erfect example鈥 of how innovations in securities trading have brought increased access for retail investors, 鈥渇or better or worse鈥.
Making sense of round one
David Lewis, at financial services company FIS Global, spoke to SFT after the GameStop hearing and echoed Schulp鈥檚 comments on how well the market infrastructure coped in these 鈥渆xtreme circumstances鈥, noting that short squeezes, particularly ones as public as GameStop, are 鈥渞elatively rare鈥.
Regarding the perception of hedge funds as market bullies, Lewis says short selling is just one mechanism used by investors to make a profit on the falling price of an asset, but 鈥渨hen situations become as fractious as the GameStop episode fundamentals appear to be forgotten鈥.
As the market price of a share is determined by the expectations of future income available to the holder, Lewis says, if every investor in the market was only ever allowed to take a positive position with regards to their expectations of future incomes, prices would rise and yields would fall.
鈥淔or every share sold at $X, there is, by definition, a buyer willing to buy that share at $X. Markets require balance and having some gain on unsustainably high asset prices does not provide that.鈥
On whether short sellers should be required to report their positions under a resurrected regulation of Dodd-Frank, Lewis notes that short interest levels are already reported in the US, 鈥渟o the practical requirement of this is already met鈥.
鈥淎dding names to those positions adds no value at all, unless it is an attempt at 鈥榮haming鈥 the holders of those positions, which is not a market serving objective at all.鈥
Short interest provides 鈥渂alance鈥, Lewis explains, and identifies weak performing organisations, likening it to a 鈥渃anary in a coal mine鈥 which aids investors in identifying the best places to put their money.
Asked whether more transparency was needed in the US and to bring it more in line with the UK and the EU, Lewis suggests that although these two markets report short selling, there are 鈥渓imits鈥.
As the short position has to be greater than 0.5 per cent of the issued share capital of the company that is being shorted, a 鈥済reat deal鈥 of other positions remain unreported and 鈥渁 potentially false sense of security is created鈥, Lewis said.
Giving an extreme example, 鈥渋t is certainly possible that there are 100 hedge funds, each with a short position of 0.4 per cent of the issued shares that would remain unreported鈥. Therefore, any research and insight into that issuer is lost to the ordinary investor that might benefit from the red flags raised, Lewis said.
鈥淭ransparency is truly valuable, but when it is potentially badly out of focus, it can do more harm than good.鈥
Also speaking after the hearing, Fran Garritt, director of securities lending and market risk at the Risk Management Association (RMA), tells SFT that none of the RMA鈥檚 members experienced any settlement issues as a result of the GameStop short squeeze, 鈥渟o yes, it appears the market structures worked鈥.
Moreover, despite speculation over a 鈥渂roken market鈥 and naked short selling, for crowded short positions like GME, 鈥渢he metric short interest as a percentage of float can exceed 100 per cent鈥, because no one is adding back the 鈥渘ew long position鈥 created by the short sale.
In fact, Garritt notes, as Citadel鈥檚 Griffin explained in his congressional testimony, a number of the buyers of the shares sold short were institutions.
Although what occurred in January was not a 鈥渘ew phenomenon鈥, the size of this short squeeze put a 鈥渕agnifying glass鈥 on the event. 鈥淢ore than ever, stakehoIders need to stress that if short selling was capped, it would remove liquidity from the market, and widen bid-ask spreads,鈥 Garrit tells SFT.
In terms of the exchange-traded fund (ETF) market, the ability of market-makers to provide liquidity via short selling helps ensure that prices are fair and reflective of the ETF鈥檚 underlying securities, Garritt says. 鈥淲ithout the ability to short, this arbitrage mechanism would be broken, significantly impacting the ETF industry.鈥
Garritt notes that the market manipulation surrounding GameStop stock 鈥渁ppeared to be more focused on long buyers that perpetuated the short squeeze鈥 and that while it鈥檚 not entirely clear who instigated the frenzy, the net losers were the short sellers and late rally buyers. 鈥淚t is certainly hard to characterise someone as a bully when they are the ones that ultimately were the big losers from this episode,鈥 Garritt mused.
The apparent surge in retail trading in GameStop and subsequent short squeeze raised the spectre of reporting of short positions after House members described hedge funds as 鈥渂ullies鈥 guilty of market manipulation.
Whether an emboldened Biden administration will put out Trump鈥檚 bonfire of regulations, looking to secure a big win against the financial giants, has yet to be determined 鈥 this was just the first of three GameStop hearings to be held by the US House Committee on Financial Services.
But, a House memorandum that details dormant sections of the 2011 Dodd-Frank Wall Street Reform and Consumer Protection Act, obliging firms to record and publicly disclose short selling data, gives an indication of the flavour of regulations that a Biden-led Deomocratic Congress may choose to implement.
Nonetheless, the hearing laid bare a partisan and polarised country, with one House member, Bill Huizenga of Michigan, calling the entire hearing pure 鈥減olitical theatre鈥, for which he was subsequently chastised by chair and congresswoman Maxine Waters.
As the hearing, conducted remotely, ran for over five hours House members across the country probed witnesses on 鈥渟hort selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors鈥.
The speakers called to testify 鈥 some faring better than others 鈥 were Robinhood CEO Vlad Tenev, hedge fund Citadel CEO Kenneth Griffin, Reddit CEO and co-founder Steve Huffman, Melvin Capital CEO Gabriel Plotkin, Cato Institute director of financial regulation studies Jennifer Schulp and day trader Keith Gill who is credited with rallying the retail interest in GameStop through Reddit forum WallStreetBets.
Plotkin, in a statement released before the hearing, defended the short selling practices of the firm, emphasising the amount of research that had taken place before deciding to short the struggling bricks-and-mortar gaming retailer.
The trends Melvin Capital had identified 鈥 downloads are in, stores and trading games are out 鈥 were so entrenched that Plotkin said his firm had been short GameStop since its founding six years ago.
Plotkin also said the fund played absolutely 鈥渘o role鈥 in trading platform Robinhood鈥檚 decision to limit trading in GameStop stock, referring to how the stock trading platform was forced to briefly ban buy orders on several volatile 鈥榤eme stocks鈥, including GameStop, in order to allow the broker to refinance its collateral account with its central counterparty.
During the hearing, Cato Institute鈥檚 Schulp emphasised that 鈥渢he temporary volatility in these stocks did not represent a systemic risk to market function鈥.
鈥淪tock prices move in and out of alignment all the time and the market is no stranger to bubbles鈥 and the market鈥檚 mechanisms, Schulp added, including the 鈥渢ool of short selling鈥, generally work well to handle these circumstances.
Schulp said that the SEC鈥檚 investigation into January鈥檚 events has far more information at its disposal than the general public and may choose to introduce new legislation, but, Schulp told committee members, that 鈥渂y no means should these events lead to more restrictions for retail investors鈥.
As the hearing rolled on, fault lines in the House of Representatives were exposed as members grappled over who, if anyone, was to blame for the volatility.
Ed Perlmutter, of Colorado, zeroed-in on the inconsistency between Plotkin and Gill鈥檚 views on whether the share price of GameStop was long or short after Gill told the representative that when he purchased the stock he believed that the price may eventually reach $25.
鈥淲ere you in a naked position?鈥, Perlmutter subsequently asked Plotkin, to which the Melvin Capital founder replied that the system would not allow that sort of position.
Nydia Velazquez, a representative of New York, came down hard against the practice of short selling. 鈥淭oo often, I have seen abuse [short selling] and it ends up hurting ordinary workers and families,鈥 she said. 鈥淚 first saw it against the people of Puerto Rico, and now I am seeing it against GameStop.鈥
In the same vein, Jim Himes, of Connecticut, likened hedge fund Citadel to a casino and accused Robinhood of making money from that casino. 鈥淎s the house always wins, who loses?鈥 In his view, it鈥檚 the retail investors.
Himes said that although he supports the democratisation of finance he noted that on Wall Street retail investors are known as 鈥渄umb money鈥 and he pressed an increasingly beleagured Tenev on whether, in the aggregate, users on the trading platform won or lost money as a result of shorting GameStop stock. Tenev was unable to answer.
California鈥檚 Juan Vargas turned the screws on Tenev further, likening the platform to an anti-Robin Hood, stealing from the small retail investor and giving to the large investment fund.
Blaine Leutkemeyer, a representative of Missouri, said short interest in a stock of more than 100 per cent 鈥 140 percent at its peak in GameStop 鈥 looks to an 鈥渙utsider鈥漧ike stock manipulation. 鈥淒on鈥檛 you think there should be a limit on something like that?鈥 he added.
Citadel鈥檚 Griffin acknowledged the short interest in this instance was 鈥渆xceptional鈥 but advised against seeking a legal cap on the amount of times a share can be lent and short sold.
Georgia鈥檚 Barry Loudermilk also spoke out against further regulations as a result of the GameStop saga.
鈥淭here seems to be a trend in Washington to never let a crisis go to waste,鈥 he mused, adding that there was no rush to introduce 鈥渂ig government鈥 regulations.
Perhaps attempting to strike a balance, Lee Zeldin of New York felt the GameStop saga was a 鈥減erfect example鈥 of how innovations in securities trading have brought increased access for retail investors, 鈥渇or better or worse鈥.
Making sense of round one
David Lewis, at financial services company FIS Global, spoke to SFT after the GameStop hearing and echoed Schulp鈥檚 comments on how well the market infrastructure coped in these 鈥渆xtreme circumstances鈥, noting that short squeezes, particularly ones as public as GameStop, are 鈥渞elatively rare鈥.
Regarding the perception of hedge funds as market bullies, Lewis says short selling is just one mechanism used by investors to make a profit on the falling price of an asset, but 鈥渨hen situations become as fractious as the GameStop episode fundamentals appear to be forgotten鈥.
As the market price of a share is determined by the expectations of future income available to the holder, Lewis says, if every investor in the market was only ever allowed to take a positive position with regards to their expectations of future incomes, prices would rise and yields would fall.
鈥淔or every share sold at $X, there is, by definition, a buyer willing to buy that share at $X. Markets require balance and having some gain on unsustainably high asset prices does not provide that.鈥
On whether short sellers should be required to report their positions under a resurrected regulation of Dodd-Frank, Lewis notes that short interest levels are already reported in the US, 鈥渟o the practical requirement of this is already met鈥.
鈥淎dding names to those positions adds no value at all, unless it is an attempt at 鈥榮haming鈥 the holders of those positions, which is not a market serving objective at all.鈥
Short interest provides 鈥渂alance鈥, Lewis explains, and identifies weak performing organisations, likening it to a 鈥渃anary in a coal mine鈥 which aids investors in identifying the best places to put their money.
Asked whether more transparency was needed in the US and to bring it more in line with the UK and the EU, Lewis suggests that although these two markets report short selling, there are 鈥渓imits鈥.
As the short position has to be greater than 0.5 per cent of the issued share capital of the company that is being shorted, a 鈥済reat deal鈥 of other positions remain unreported and 鈥渁 potentially false sense of security is created鈥, Lewis said.
Giving an extreme example, 鈥渋t is certainly possible that there are 100 hedge funds, each with a short position of 0.4 per cent of the issued shares that would remain unreported鈥. Therefore, any research and insight into that issuer is lost to the ordinary investor that might benefit from the red flags raised, Lewis said.
鈥淭ransparency is truly valuable, but when it is potentially badly out of focus, it can do more harm than good.鈥
Also speaking after the hearing, Fran Garritt, director of securities lending and market risk at the Risk Management Association (RMA), tells SFT that none of the RMA鈥檚 members experienced any settlement issues as a result of the GameStop short squeeze, 鈥渟o yes, it appears the market structures worked鈥.
Moreover, despite speculation over a 鈥渂roken market鈥 and naked short selling, for crowded short positions like GME, 鈥渢he metric short interest as a percentage of float can exceed 100 per cent鈥, because no one is adding back the 鈥渘ew long position鈥 created by the short sale.
In fact, Garritt notes, as Citadel鈥檚 Griffin explained in his congressional testimony, a number of the buyers of the shares sold short were institutions.
Although what occurred in January was not a 鈥渘ew phenomenon鈥, the size of this short squeeze put a 鈥渕agnifying glass鈥 on the event. 鈥淢ore than ever, stakehoIders need to stress that if short selling was capped, it would remove liquidity from the market, and widen bid-ask spreads,鈥 Garrit tells SFT.
In terms of the exchange-traded fund (ETF) market, the ability of market-makers to provide liquidity via short selling helps ensure that prices are fair and reflective of the ETF鈥檚 underlying securities, Garritt says. 鈥淲ithout the ability to short, this arbitrage mechanism would be broken, significantly impacting the ETF industry.鈥
Garritt notes that the market manipulation surrounding GameStop stock 鈥渁ppeared to be more focused on long buyers that perpetuated the short squeeze鈥 and that while it鈥檚 not entirely clear who instigated the frenzy, the net losers were the short sellers and late rally buyers. 鈥淚t is certainly hard to characterise someone as a bully when they are the ones that ultimately were the big losers from this episode,鈥 Garritt mused.
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