Brokers are not allowed to touch client money to submit the deposit. That the purchases are settled cash on the user's account makes no difference, because none of that money Robinhood could use to clear the deposit.
It's client money until the trade settles at T+2, at which point it's the counterparty's money. It's never Robinhood's money (unless they're the counterparty, but I don't believe they do propriatary trading)
Robinhood is on the hook to do their part in settling the trade and delivering the shares to their client and cash to the seller.
Obviously once funds are used to execute a trade, they are no longer client funds. It seems obvious that the cash at that moment would be held separately as the shares settle. That's discretely identifiable hard cash that is fully funding that specific share purchase.
I completely grok the various ways that cash that "looks like" it's in the account might not be; deposits that haven't actually cleared, prior trades that haven't actually settled.. and in those cases the brokerage is actually extending credit to their client, and that credit can run dry.
But if I have hard cash and a trade executes, that cash is gone from the account. The counterparty risk at that point is the shares not being delivered, which seems to me like it would be collateral that the seller needs to be posting to DTCC (likely DTC already holds the shares). The buyer needs to show they have the hard cash, and they can easily do that.
I guess I can't get around the fact that if the purchase is fully funded with hard cash that's in the account, that is cleared cash that can be sent off to DTCC/NSCC during the end-of-day settlement via FedWire.
I think the margin stuff is pretty much a red herring. The customer's cash doesn't belong to Robinhood. Robinhood is required to provide its own cash as collateral, because it's ensuring the market against itself. Those collateral rules aren't just for margin purchases.
Would love to be corrected here if I'm wrong, but I'm not sure margin has really much to do with what's going on, and it seems to be most of what we're talking about.
They call this a "margin" account but FINRA has rules about how margin accounts work. Minimum maintenance is 25% for long shares, and minimum equity is $2000.
I could envision how Robinhood's margin practices and Robinhood Instant contributed greatly to the need to draw on credit lines and raise additional funds from investors.
I think we're talking past each other. I'm saying that, according to the rules, even if Robinhood had absolutely no margin buying whatsoever, they'd still have substantially the same collateral problem. They can't use customer funds for DTCC collateral.
I believe this is the correct understanding, with the minor explicit callout that every dollar RH had to use to cover pre-cleared ACH deposits was a dollar they couldn't use to put towards backing their DTCC collateral.
So in one way, the influx of new users and new inbound money could not have come at a worse time, even though I also believe it likely was rather inconsequential in comparison to the DTCC requirements.
> even if Robinhood had absolutely no margin buying whatsoever, they'd still have substantially the same collateral problem
They'd have a less concentrated position in GME, a smaller CNS long, and lower peak net settlement debits. All of those factors affect capital commitments. They also wouldn't have to commit their own capital for Robinhood Instant accounts with customer check/ACH deposits that haven't cleared. Currently, Robinhood Instant means that Robinhood uses up to $1k of its own funds per account to clear trades...not DTCC collateral, but rather just to pay for the trade.
In the absence of margin, Robinhood doesn't have a collateral problem in the sense of effecting transactions that may not clear. Rather, it has a liquidity problem. Big difference.
The risk to Robinhood from GME buying in margin accounts is that they would have a very large net long as a firm, and then one day the stock gaps down so quickly -- perhaps overnight -- that there is no time/opportunity to close out margined positions before they lose more than their accounts' total equity. That could leave Robinhood holding the bag on 75% of the loss assuming minimum maintenance margin.
That's why I don't believe margin to be a red herring. It directly and indirectly affects the amount of the required deposit and the clearing obligations of the firm, and also imposes a very large risk upon Robinhood in the event of a scenario where GME closes in the after-hours session at $300 on a Friday and then reopens at $0.40 on Monday morning because the company filed for bankruptcy (just an example). That scenario in turn reduces the likelihood that Robinhood can borrow from banks and investors to infuse itself with the cash required to keep its business running.
Someone else posted an article saying that additional collateral across all firms due to the r/WSB squeeze is a bit less than $8B according to a DTCC spokesman. Not sure how much of that is attributable to Robinhood. That sounds like a lot of money but it's really not, in the world of financial institutions -- especially in today's cash-happy low-rates environment. To put it in perspective, Melvin Cap got $2.75B overnight, from two people.
My own personal gripe about this whole thing is that the way Robinhood carried out its business was chiefly damaging to its own customers. I also believe they shouldn't be allowed to offer "Robinhood Instant" because it doesn't appear to line up with federal requirements for margin accounts.
Yeah, I'm trying to use more question marks and hedging "as I understand its" here. I've pentested huge clearing systems before. But I'm not going to lie and say I understood what the hell they were doing (also, the people at those firms made fun of clearing as the most boring conceivable stuff to look at).
But (1) lots of experts keep saying that Robinhood can't use customer cash as collateral to DTCC, and (2) DTCC's published rules seem to say that Robinhood owes collateral margin or not.
So like, I'm willing to bet that the margin stuff is a red herring, but I'm not willing to WSB-bet it.
The whole premise of client asset segregation is that failure of the broker should not put the assets of a client in jeopardy. This isn't a technical detail of "the regulations", it's the entire foundational premise.
The trade is not "done" until it settles. As discussed throughout, that's T+2. Prior to settlement, the trade can fail (e.g. your counterparty turns out not to have the money/stock to fund their side of the trade).
If you really want to read the detail, it's called Rule 15c3-3.
15c3-3 does not say that a broker can not use client funds to purchase securities for the client that the client is trying to buy.
It says the broker can’t use client funds to purchase securities for proprietary trading.
Everyone has totally misread the rule and then is stating a total falsehood as if it’s unequivocal truth. It’s maddening.
> The Commission adopted Rule 15c3-3 in 1972, in part, to ensure that a broker-dealer in possession of customers' funds either deployed those funds “in safe areas of the broker-dealer's business related to servicing its customers” or, if not deployed in such areas, deposited the funds in a reserve bank account to prevent commingling of customer and firm funds.[7] Rule 15c3-3 requires a broker-dealer to calculate what amount, if any, it must deposit on behalf of customers in the reserve bank account, entitled “Special Reserve Bank Account for the Exclusive Benefit of Customers” (“Reserve Bank Account”), under the formula set forth in Rule 15c3-3a (“Reserve Formula”).[8] Generally, the Reserve Formula requires a broker-dealer to calculate any amounts it owes its customers and the amount of funds generated through the use of customer securities, called credits, and compare this amount to any amounts its customers owe it, called debits.[9] If credits exceed customer debits, the broker-dealer must deposit that net amount in the Reserve Bank Account.[10]
> Possession and Control Monitoring is related to SEC rule 15c3-3 - The Customer Protection Rule. The Customer Protection Rule prohibits a brokerage firm from commingling fully paid for customer securities with non-fully paid for customer securities and/or firm securities.
> When a client of the firm purchases securities through the firm and pays for those securities in full, the firm must "lock-up" or "segregate" those securities for the protection of the client. The segregation of fully paid for customer securities protects those client owned securities from the firm's creditors in the event that the firm can no longer continue as a going concern - that is, the firm goes belly up.
> SEC rule 15c3-3 also prevents the brokerage firm from using full paid for segregated shares to satisfy any delivery commitments that might result from the firm's trading activities. If, for whatever reason, the firm does use segregated customer shares to satisfy a firm delivery a 'SEG Violation' or Possession and Control violation occurs.
> The reserve formula calculation is performed weekly to identify customer related payables and receivables. If the calculation results in a net payable to customer, the broker-dealer is required to reserve this amount in a special reserve bank account. This special reserve bank account is for the exclusive benefit of customers and funds can only be withdrawn with the support of an updated reserve formula calculation. In theory, on the date the reserve formula is calculated, combining the securities held in possession or control plus the funds included in the reserve formula should equal the amount the broker- dealer owes to the customer.
Everything in the rule is about not using customer funds for proprietary purposes. Not co-mingling customer and brokerage funds. Meaning the brokerage can’t make their own trades with customer money.
There isn’t a single word against using customer funds to purchase customer shares.
It’s a rule against using customer funds for non-customer activities.
If anything the problem that Robinhood ran up against was net capital requirements under 15c3-1.
Yes. I don't really understand what is being argued here.
There are three stages; execution, clearing and settlement.
Execution is the formation of the legal-binding agreement, e.g. a contract to exchange money for stock. For these cases, this is happening via matching on an exchange between a buyer and a seller. If the time of the trade is T, then happens at T+0.
Clearing is the paperwork activity that takes place after execution that include the due diligence steps of making sure that trades match, as well as other stuff that can reduce the amount of settlement activity. This happens in the period from T+delta through T+2-delta.
Settlement is the actual exchange, and is the point at which legal ownership of the stock changes. This happens at T+2.
It is obviously true that the brokerage uses client money for settlement; otherwise how would the broker ever fund any trades by its clients?
Is also obviously true that prior to the moment of settlement the client money is ... the client money, and subject to segregation. In other words, from the broker perspective, it's always client money until it's off their books.
The time when the NSCC wants to see adequate collateral is exactly during the clearing period, when the actual counterparty risk exists. That collateral absolutely cannot be from client money due to the segregation rules because the whole purpose of the collateral is to reduce the risk of a broker failure causing clients to lose money.
RH's collateral requirements blew up because some substantial proportion of their clientele was attempting to go long GME during a period of vast price volatility, and the NSCC's procedure for determining those requirements takes into account primarily the size of the net long position and the volatility for each member.
Net result: RH has to go raise capital in a hurry; RH stops its clients from going any further long GME.
So I'd say the truth came out in an interview late Sunday evening between Elon Musk and Robinhood CEO Vlad Tenev. [1]
> Tenev explained that while he was sleeping, at 3:30 a.m. PT on Thursday, Robinhood's operations team received a file from the National Securities Clearing Corporation (NSCC) that as a clearing broker, Robinhood Securities needed to put up around $3 billion "an order of magnitude more than what it typically is."
> So, it was unprecedented activity. I don't have the full context about what was going on, what's going on in the NSCC to make these calculations," Tenev added — prompting Musk to joke if someone was “holding you hostage right now.”
> Tenev said that after putting their heads together and calling the higher-ups at the NSCC, they got that figure down to $1.4 billion, from the initial $3 billion. "We were making some progress, right, but still a higher number," he added.
> Next, Tenev said they had to explain how to "manage risk in these symbols" by restricting activity in the volatile stocks. After that, the NSCC said the charges on the deposit were $700 million, which Robinhood "paid promptly."
You don't even have to read between the lines here. Robinhood isn't the problem here. Massive long retail demand is crushing shorts, which is potentially opening the clearing houses to multi-billion dollar losses. The way to stem the losses is to stem buying pressure and get the stock to come down.
So call up Robinhood and demand $3 billion in collateral (an order of magnitude higher than the day before) unless they stop the buying pressure on the shares. When Robinhood agreed to limit buying, the NSCC was willing to drop the collateral requirement to $700 million.
This isn't about a share-for-share clearing / transaction cost for each buy order entered. Those buy orders are cash funded and zero risk for Robinhood and zero risk to NSCC / DTCC. This is about extorting Robinhood to stave off the bankruptcy and subsequent contagion of a 140% short interest on a stock that's gone up 70x in just a few months.
Look, I agree that Robinhood can't use customer funds to pay extortion demands from the clearing houses. My point is that Robinhood clearing fully cash-paid buy orders does not incur additional clearing costs to Robinhood. It's not a per-order transaction fee. It's a slush fund which is used to pad against defaults.
> "Now, why is that so high? Like this seems like, it sounds like an unprecedented increase in demand for capital. What formula did they use to calculate that?" Musk asked.
> To contextualize the number, the app's CEO noted that RobinHood had raised about $2 billion in total venture funding. He added that the formula was “not fully transparent” and “not publicly shared.”
I'm sorry, but you just conceded the whole discussion (turns out: it was definitely clearing collateral calls!) but then moved the goalposts to a conspiracy in which the clearinghouses were protecting the shorts.
A lot of people are claiming “customer funds have to be segregated” and that “funds can’t be used to actually buy the security and are not released from the customer account until the trade settles”.
I think these are massive oversimplifications to the point of being useless or outright false.
I suppose if you wanted to learn a little bit about how the regulations are actually written, you could start here:
These are just some of the requirements that brokers have to “reduce securities to possession or control” for both fully-paid or excess margin securities.
Here’s my (mostly uneducated) opinion on what is really happening. It has roughly nothing to do with Robinhood not being able to execute Buy orders because they couldn’t post the funds required. Because fully-paid securities (non-margin) are paid for with customer funds, not floated by the broker while they settle.
The problem was that too many shares have been lended out to short sellers out from under long positions that are now trying to sell.
The hedge funds that borrowed and sold those shares simply
don’t have the cash or credit to buy the shares back at the current market price that the rightful owner has rightfully now sold. Failing that the broker needs to find someone else willing the lend a share the the hedge fund. And who would want to lend a share of GME to an insolvent short seller?!
So there is a deficiency, but the deficiency is because of hedge funds which are now $30B underwater while unrelated parties are trying to sell shares that have already been sold.
Yes, this is a long way of saying there’s a short squeeze. But you know the saying “owe the bank $1 million you can’t pay, that’s bad news for you. Owe the bank $100 million you can’t pay, that’s bad news for the bank!”
It’s a game of musical shares. The brokers that let the hedge funds load up on 140% short interest now need to either force-liquidate the hedge fund shorts to get back the share that’s being traded and needs to be delivered to Robinhood, or they need to find someone else to borrow the share from.
When the broker fails to deliver the share at the time the original holder sells it, the broker is now on the hook for any price movement that occurs until they can deliver. Which of course the hedge fund can’t afford, so it’s lose-lose.
In the end Robinhood disabled the buy button because all the shares being sold have been loaned out and shorted, there’s not enough shares available to borrow, and the hedge funds are way past bankruptcy at this point and hoping for some massive price reversal or else they take a lot of people down with them.
The counterparty risks at this point are extreme. It’s not Robinhood that’s the problem, it’s the people selling Robinhood shares that they can’t actually show a clear title on. I think what Robinhood is worried about mostly at this point is contagion when the hedge funds holding 140% short interest can’t afford the $30B bill.
I'm really skeptical that robinhood shut down buys because they were the ones worried about counterparty risk. That's kinda out of character. And then extended that concern to 50 other stocks.
There’s zero risk to Robinhood to settle a full-cash Buy of a security, except for counter-party risk not being able to deliver the shares free and clear.
Lack of truly real available GME shares are literally the whole issue at hand here, since literally more than all of them have actually been loaned to the Hedges to short.
The funds are deposited and under the full control of Robinhood.
This theory that Robinhood has to match their customer fully cleared funds with their own dollars, which can’t be backed by the customer funds, in order to actually take delivery of the shares and only then can the customer account funds be debited.... It’s been repeated constantly without evidence, and I’d really like to see the evidence.
You're saying this, but the rules (which are convoluted) appear to require fund segregation, and, moreover, when MF Global was accused of doing what you're talking about, it was a major NYT and WSJ story.
> The story states that a London clearinghouse forced MF Global to pay roughly $300 million to back some of its bond holdings during its last week.
There's a mountain of difference between sending customer money to purchase customer's own securities, versus raiding customer accounts to pay a margin call against your own bond holdings.
You cannot raid customer funds to pay for proprietary (broker's own) activity. Of course using customer own funds to pay for customer's own orders is not restricted. There's nothing to collateralize for a fully cash funded share purchase. Collateral can only possibly be an issue if the customer is trading on margin.
The Broker isn't allowed to borrow against client money either - it's client money, partitioned off from the broker's fungible funds, and not the Broker's to offer as collateral.
But debt is the natural answer, and Robinhood did get as much in loans as they can[0].
