The GameStop frenzy has returned

Thu May 16 2024
Rajesh Sharma (2059 articles)
The GameStop frenzy has returned

The resurgence of meme stocks is evident. Is Wall Street prepared for what lies ahead?

In a timely coincidence, the resurgence of GameStop mania this week aligns with the financial industry’s urgent efforts to address a significant issue in the market’s infrastructure that caused turmoil among investors during the initial meme-stock frenzy last year.

Starting on May 28, the industry plans to shorten the settlement period for stock trades from two business days to just one. This change, which addresses a key regulatory requirement, is expected to be implemented. Settlement is a crucial process where shares are discreetly delivered to buyers, while sellers receive their well-deserved cash.

In order to avoid a recurrence of the well-known incident on Jan. 28, 2021, where brokerages such as Robinhood Markets restricted investors from purchasing more shares of GameStop and AMC Entertainment, the upgrade has been implemented. The shut-off caused a significant uproar among investors, leading to congressional hearings and lawsuits. It even became a central element in the Sony Pictures film “Dumb Money.”

On that day, Robinhood halted purchases of meme stocks due to its inability to fulfill a $3 billion margin call from the Depository Trust & Clearing Corp., the entity responsible for overseeing U.S. stock trades. After receiving substantial DTCC margin calls, other brokers also implemented comparable restrictions.

Brokers are required by the DTCC to provide additional funds during periods of market volatility. In January 2021, several brokerages faced a compounding issue as they witnessed a significant influx of buying activity in meme stocks, with minimal selling. This surge in demand led to an increase in their margin requirements, as per DTCC’s calculations.

Accelerating the settlement process aims to minimize the financial burden on brokers when it comes to posting funds to the DTCC. Clearinghouses maintain cash reserves as a precautionary measure to mitigate the potential risk of default by either the buyer or seller involved in a stock trade prior to its settlement. By reducing the time to settle trades, the DTCC can significantly decrease the risk involved and potentially save billions of dollars by reducing the size of its cash cushion.

“It will enhance the resilience, efficiency, and organization of our market plumbing,” stated Securities and Exchange Commission Chair Gary Gensler via an agency spokesperson.

According to Bill Capuzzi, the CEO of Apex Fintech Solutions, investors who are not experts in economics will see a faster cash return from their stock sales. Apex Fintech Solutions is responsible for clearing trades for popular investing apps like Webull and SoFi.

If you sell it today, the funds will be deposited into your account by tomorrow. You have the option to purchase a boat or any other desired item. According to Capuzzi, this reduction in waiting time is beneficial for retail investors.

GameStop, AMC Entertainment, and several other meme stocks experienced significant gains this week as Keith Gill, the investor famously known as “Roaring Kitty,” made a comeback on social media after a long absence.

Last year, brokers were instructed by the SEC to transition to next-day settlement, commonly referred to as T+1 settlement in the industry. The agency announced May 28, 2024, as the date of the transition, a decision that caused some discontent among Wall Street groups. The trade groups had advocated for a later switch, specifically over Labor Day weekend, in order to provide the industry with additional time for preparation.

Switching to T+1 could have far-reaching implications, potentially emerging as the most consequential policy change stemming from the 2021 GameStop trading frenzy.

Several other SEC proposals, including one that is still pending, could potentially disrupt the current practices of brokers in handling orders from small investors. If Donald Trump wins the November presidential election, the proposed revamp of regulations governing brokers would probably be removed from the SEC’s agenda due to strong opposition from the financial industry.

As the T+1 deadline approaches in less than two weeks, financial institutions have been working diligently to ensure their systems are prepared. One of the challenges they encounter is the use of outdated technology. Wall Street banks continue to use Cobol, a programming language that was popular in the 1960s and 1970s, for their back-end systems.

Overseas, there are significant complications arising from the T+1 transition.

European and U.K. markets will maintain their current settlement period of two business days, even as the U.S. transitions to a T+1 settlement cycle. This could potentially create issues for European fund managers who have investments in U.S. stocks, due to a discrepancy in timing. When local investors purchase shares of the funds in Europe, it will take two days for the funds to receive the investors’ cash. If the inflows lead the funds to purchase U.S. stocks, they will be required to provide cash to the U.S. within a single day.

European regulators are currently in talks about transitioning to T+1, but it is unlikely that this change will occur in the near future.

“It would have been much more convenient if all markets had moved simultaneously,” remarked Adam Conn, head of trading at Baillie Gifford, a U.K.-based asset manager.

Rajesh Sharma

Rajesh Sharma

Rajesh Sharma is Correspondent for Stock Market of South East Asia based in Mumbai. He has been covering Asian markets for more than 5 years.