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Showing my ignorance here, if I'm giving them $100 for $100 worth of GME, why does collateral come into the picture? I don't see where there's any debt to colla

Showing my ignorance here, if I'm giving them $100 for $100 worth of GME, why does collateral come into the picture? I don't see where there's any debt to collateralize in a straight trade like that.

Tsiklon 5y ago
I’m not certain if I’m completely correct here, but as I understand it - many of these trading platforms will allow you to use the money you deposit into their system immediately. The actual transaction that fulfils that deposit often takes a day or two to complete. If you deposit $100 and use it to immediately buy $100 of GME, RH and the other platforms effectively borrow money to fulfil that trade. At scale, if they have a large number of new customers making use of that facility simultaneously they may actually exhaust the amount of credit they have access to for the given amount of collateral they’ve fronted to their lender.
- SilasX 5y ago
  But they were denying GME trades even to people who had well-settled money that was deposited months ago.
variationvalue 5y ago
Because they can't use customer funds for these collateral requirements. Note though that the collateral requirements only apply to firm-wide net buys. So if you're buying $100 of GME and another person on the platform is selling $100 of GME and those are the only two trades for GME that day, those trades would net out reducing the collateral requirement. So on a day where there's a substantial net buy, money is basically being put up in twice, both by the customers and the broker.
- addingnumbers 5y ago
  The question is why are there collateral requirements at all for a straight trade, though? In this example there is enough cash in the system to resolve everything without debt. If you go to the bookstore and give them $105 for a rare $100 book +markup, and they say they can't get it because they don't have collateral, how would that make any sense? You gave them all the money they need to buy the book outright. Why collateral?
  - variationvalue 5y ago
    Ah this is a great question! The answer mostly boils down to a policy decision to maximize safety of the overall system. You can imagine a situation where a malicious actor (not necessarily a broker servicing customers) who's a part of the DTCC system and decides to buy a highly volatile stock. Since the trade settles in two days, they don't really need to put up the money immediately, just need to be sure they have it in two days. Suppose that then this volatile stock plummets in value, this actor has a big incentive to not go through with the trade, since they're going to pay money for a stock that is now worth much less. This phenomenon is called counterparty risk. And the way to mitigate the risk is just to require collateral up front, with more collateral for more volatile stocks. Note too that the rules governing this risk mitigation are very distinct from the rules governing individual accounts (even different regulatory entities). However, you could hypothetically carve out an exception for broker dealers since theoretically the customers have already put up the cash. But from a policy perspective you're now potentially betting the financial system on every broker implementing risk controls correctly. Why take that risk? Ultimately the better solution is just to reduce the settlement cycle which reduces counterparty risk. Brokers want to go to T+0 (real-time) since it removes all collateral requirements on their end, but market makers like T+1 because then they can float more intraday (which is effectively passing the costs of mitigating counterparty risks back to the brokers).
anchpop 5y ago
This is just my non-expert understanding: They give you the share immediately, but the actual trade takes two days to complete, and might not complete at the price you paid. They're in affect giving you a loan for that two-day period, and the DTCC gives them a loan. The DTCC wants to make sure robinhood won't default on their loan, so they require robinhood to post a certain amount of collateral. Usually this isn't such a big deal, because stocks don't vary much day-to-day so the collateral requirements aren't very high, but for extremely volatile stocks like GME they might need to have $100 of collateral for every $100 of buys they try to execute. They couldn't afford that so they stopped accepting buy orders. TD Ameritrade, another broker, stopped accepting buy orders for GME a day before Robinhood did for the same reason. (Robinhood has suggested that trade should settle in minutes or seconds instead of days, which would obviously be better, but that won't happen any time soon)

Showing my ignorance here, if I'm giving them $100 for $100 worth of GME, why does collateral come into the picture? I don't see where there's any debt to collateralize in a straight trade like that.

Tsiklon 5y ago

I’m not certain if I’m completely correct here, but as I understand it - many of these trading platforms will allow you to use the money you deposit into their system immediately. The actual transaction that fulfils that deposit often takes a day or two to complete. If you deposit $100 and use it to immediately buy $100 of GME, RH and the other platforms effectively borrow money to fulfil that trade. At scale, if they have a large number of new customers making use of that facility simultaneously they may actually exhaust the amount of credit they have access to for the given amount of collateral they’ve fronted to their lender.

SilasX 5y ago
But they were denying GME trades even to people who had well-settled money that was deposited months ago.

variationvalue 5y ago

Because they can't use customer funds for these collateral requirements. Note though that the collateral requirements only apply to firm-wide net buys. So if you're buying $100 of GME and another person on the platform is selling $100 of GME and those are the only two trades for GME that day, those trades would net out reducing the collateral requirement. So on a day where there's a substantial net buy, money is basically being put up in twice, both by the customers and the broker.

addingnumbers 5y ago
The question is why are there collateral requirements at all for a straight trade, though? In this example there is enough cash in the system to resolve everything without debt. If you go to the bookstore and give them $105 for a rare $100 book +markup, and they say they can't get it because they don't have collateral, how would that make any sense? You gave them all the money they need to buy the book outright. Why collateral?
- variationvalue 5y ago
  Ah this is a great question! The answer mostly boils down to a policy decision to maximize safety of the overall system. You can imagine a situation where a malicious actor (not necessarily a broker servicing customers) who's a part of the DTCC system and decides to buy a highly volatile stock. Since the trade settles in two days, they don't really need to put up the money immediately, just need to be sure they have it in two days. Suppose that then this volatile stock plummets in value, this actor has a big incentive to not go through with the trade, since they're going to pay money for a stock that is now worth much less. This phenomenon is called counterparty risk. And the way to mitigate the risk is just to require collateral up front, with more collateral for more volatile stocks. Note too that the rules governing this risk mitigation are very distinct from the rules governing individual accounts (even different regulatory entities). However, you could hypothetically carve out an exception for broker dealers since theoretically the customers have already put up the cash. But from a policy perspective you're now potentially betting the financial system on every broker implementing risk controls correctly. Why take that risk? Ultimately the better solution is just to reduce the settlement cycle which reduces counterparty risk. Brokers want to go to T+0 (real-time) since it removes all collateral requirements on their end, but market makers like T+1 because then they can float more intraday (which is effectively passing the costs of mitigating counterparty risks back to the brokers).

anchpop 5y ago

This is just my non-expert understanding: They give you the share immediately, but the actual trade takes two days to complete, and might not complete at the price you paid. They're in affect giving you a loan for that two-day period, and the DTCC gives them a loan. The DTCC wants to make sure robinhood won't default on their loan, so they require robinhood to post a certain amount of collateral. Usually this isn't such a big deal, because stocks don't vary much day-to-day so the collateral requirements aren't very high, but for extremely volatile stocks like GME they might need to have $100 of collateral for every $100 of buys they try to execute. They couldn't afford that so they stopped accepting buy orders. TD Ameritrade, another broker, stopped accepting buy orders for GME a day before Robinhood did for the same reason. (Robinhood has suggested that trade should settle in minutes or seconds instead of days, which would obviously be better, but that won't happen any time soon)