The story of Robinhood this week is a lesson in how it is possible to get too big. In the financial markets this can be a major issue.
There is no such thing as too big to fail, as Lehman Brothers taught us in 2008. In the case of Robinhood, the broker, which revolutionised day trading in North America by giving new traders cheap access to financial markets, has learned an important lesson from GameStop. Whether Robinhood can go on its current form as the regulatory and political spotlight shines on the GameStop saga is an open question.
We have already seen during the current pandemic how volatile markets and a sudden rush by small traders into and out of stocks can crash trading platforms in a matter of minutes (Trading 212 was reported to have gone down yesterday). In some respects they act almost like a traditional denial of service attack on a website – the online trading platform simply becomes inaccessible.
Did Robinhood get too influential?
Robinhood’s decision yesterday to start blocking trading in some of the hottest stocks on Wall Street has led to a drop in the share prices of those stocks and upset thousands of American day traders as they sought to exploit the short squeeze on GameStop. The Armchair Trader spoke last night with one day trader who had four trade requests with four separate brokers trying to take positions in a number of the key stocks highlighted by the r/wallstreetbets Reddit forum. When we spoke last night at 2200 GMT they had still not been filled.
Robinhood is not alone in this respect – other brokers have been similarly cautious. The open question is whether you as a trader believe the operational excuses being put forward by Robinhood’s CEO Vladimir Tenev that the restrictions were imposed due to “financial requirements” and “in order to protect the firm and protect our customers…”
Many traders smell a rat as this is certainly one way hedge funds and other market participants could take the pressure off short squeezes on more than a dozen stocks. It has been a wake up call for big US hedge funds that have been comfortable up to now having their big short positions in the public domain. No longer, we suspect.
Robinhood taps massive credit line to stay upright
We think Tenev’s excuses are reasonable – the broker was quickly finding itself in an exposed position and has had to appeal to its investors for $1bn. It had to tap a line of credit from six banks for up to $600m to meet higher lending requirements. The investors providing it with new lines of credit are also going to get discounted stock in the broker, which is thought to be considering an IPO this year.
The fact that Robinhood has had to turn to its bankers demonstrates that in this case at least, there are operational challenges to be faced. But there is also the question of reputational risk to be answered. Robinhood had positioned itself as a democratic, mass market solution to trading: the very choice of its name panders to these disruptive claims. Now that the mass market it helped to create has started to flex its muscles in the market, Robinhood is being seen as a traitor to the cause by many new traders.
Other protagonists are also feeling the pain this week. Melvin Capital, one of the hedge funds caught on the wrong side of the GameStop saga, is being bailed out by two other hedge funds, Point 72 and Citadel, coming to the rescue as its short bets imploded. Steve Cohen of Point 72 and Ken Griffin of Citadel are understood to be writing Melvin Capital a cheque to the tune of $2.75bn to keep it trading.
The strange question of Robinhood Stock Traders
Facebook has also been taking some flack – the social media platform shut down one of its groups, Robinhood Stock Traders, which had more than 150,000 traders on it. Creator Allen Tran told Reuters that Facebook had told him the group was violating adult sexual exploitation rules. This looks to us like Facebook moving quickly to close groups which regulators might focus on in any follow up investigation. Facebook is extremely sensitive to any political blowback from Congress as the Biden administration settles in. It does not surprise us that it has acted in this way, but again, the action will encourage traders not to use Facebook groups in the future and partly justifies their use of Reddit.
So where does this all leave Robinhood? It is not the only broker on the block, and we know there were other brokers out there yesterday who were taking trades in hot Wall Street stocks like Nokia (Fidelity). Many others were not however. Robinhood now faces a crisis of trust with its trader base at a crucial point in its development – exactly what the implications for its upcoming IPO will be remain to be digested.