Games of hazard: NSCC’s margin waiver sets bad precedent

Being an effective supervisor of any sort – a risk manager, a regulator, a parent – means following a simple rule: don’t reward bad behaviour.

In the eyes of many of its members, the National Securities Clearing Corporation has failed to observe that rule. The lynchpin of the US equity markets, NSCC – which processes the best part of $2 trillion worth of trades every day on behalf of investors large and small – is facing serious questions over its handling of broker Robinhood’s flirtation with bankruptcy in late January.

The basic facts of the episode are well-established: in the early hours of January 28, Robinhood, broker to some 13 million largely retail clients, many of them betting on surging meme stocks, received a $2.2 billion add-on to its margin call that far exceeded its stated capital and available funding. By early morning, the charge had been halved; by mid-morning, it had been rescinded entirely. In the intervening time, Robinhood had moved to halt purchases of the eight offending volatile stocks.

To date, thousands of column inches and three Congressional hearings probing what happened that day have yet to zero in on what drove the charge, or why NSCC was able to rescind it before the ink was dry. This month’s Risk cover story takes a deep dive into NSCC’s rulebook to try and answer both questions. 

In NSCC’s defence, the largest component of the additional charge it levied was determined by an established formula. As Robinhood’s risk ramped up dramatically, its risk-based margin requirements at NSCC exceeded its excess net capital, triggering in an extra $2.2 billion add-on, on top of its existing $1.4 billion obligation that day.

NSCC’s rulebook also gives the clearer complete latitude to revise such charges in “unusual circumstances”, defined at its own discretion. Even if the clearer’s intention was to stave off potentially greater harm from a disorderly liquidation, as the clearer’s group chief executive Mike Bodson appeared to suggest in subsequent Congressional testimony, that seems an extraordinary amount of freedom for a rules-based, model-driven risk management organisation to wield.

Several of NSCC’s largest members are understood to be demanding a review into its handling of the episode. At least one member says it formally asked the clearer’s risk team why they felt comfortable issuing the waiver, and was dissatisfied with the response they got.

“They said, ‘oh, we’ve waived it before’. Is that a deterrent to keep people from amassing positions that are too big for their capital?” asks the chief risk officer at one large member. “And then if they say [to Robinhood], ‘okay, but don’t do it again’ – what does that really mean?”

In the aftermath of the financial crisis, amid fierce cries of moral hazard, banks sitting on soured derivatives bets were rescued by a combination of taxpayer bailouts and huge monetary stimulus. A key plank of the response was increased regulatory scrutiny of over-the-counter derivatives markets, and subsequent dramatic overhauls. Markets that were mostly transparent and publicly traded like cash equities largely escaped the same fate.

That might be about to change. Gary Gensler, the ex-banker who dragged the US OTC markets towards mandatory clearing using sometimes bareknuckle tactics is set to become head of the US Securities and Exchange Commission, NSCC’s primary regulator, pending a vote in the Senate this month – just in time to hear Jeff Sprecher, boss of several of its largest exchanges, call for a review of US equity market structure and its key players in the wake of the GameStop episode.

One way Gensler could help NSCC is by beefing up the SEC’s minimum capital rules for brokers, and replacing them with a simple risk-driven approach. On whether discretion to overrule such charges constitutes effective supervision, NSCC should be given a chance to review its own rules – if not, its members and regulators might make the decision for it.

Correction, April 6, 2021: A previous version of this article stated Robinhood’s approximate client base was 31 million user accounts, rather than 13 million accounts.