Ms. Jennifer Jiang, Chief Strategy Officer of the LatticeX Foundation, gave a detailed interpretation of the GameStop incident. The modernization of financial infrastructure and the resolution of regulatory policy problems are important elements for maintaining the stability of the next generation of financial markets.
Original title: “In-depth analysis of the LatticeX Foundation: Thoughts on the next generation of financial markets and financial stability caused by the GameStop incident”
Written by: Jennifer Jiang, Chief Strategy Officer, LatticeX Foundation
The GameStop (NYSE: GME) legend has now become one of the most groundbreaking events in the history of the U.S. and global capital markets. The continuously evolving story of GameStop and Robinhood poses many challenges and thoughts to investors, Wall Street, regulators, and the entire financial system. Ms. Jennifer Jiang, Chief Strategy Officer of LatticeX Foundation, was invited to give a detailed interpretation of the GameStop incident and explained how to maintain the stability of the next-generation financial market.
The GameStop (NYSE: GME) legend has now become one of the most groundbreaking events in the history of the U.S. and global capital markets. The continuously evolving story of GameStop and Robinhood poses many challenges and thoughts to investors, Wall Street, regulators, and the entire financial system. The key issues are divided into two categories:
Macro risk management and crisis prevention. The events surrounding Robinhood and GameStop may be the first shots of deeper and more systematic financial market risks.
Micro-regulatory issues. The combination of technology, social media and finance has brought unprecedented market weather and regulatory challenges.
Macro-financial conditions usually pave the way for micro-actions and distortions. According to reports, the SEC and other financial regulatory agencies have been involved in the investigation. The US Congress held the first round of hearings this Thursday. However, it is not clear what kind of regulatory measures should be taken by the regulation on investors or intermediaries.
Importantly, neither Congress nor regulators may impose restrictions and reforms on the market without fully understanding all aspects of the problem and ensuring that the changes can solve the underlying problem. In today’s rapid iteration of digital technology and social media, changes in regulations may bring about new unexpected situations, and their spillover effects may even have a more profound impact on the global financial market system. Therefore, it is necessary for us to conduct systematic thinking and analysis.
cause
GameStop (GME) is the world’s largest omnichannel retailer of video games. However, due to the structural shift to online gaming, its business has been shrinking (CAGR dropped by 8% in the past 4 years to FY20). In the eyes of most professional investors, almost no one doubts that it will gradually decline. Shorting stocks has been performing well for a long time, and in the five years until December 2019, GME’s stock price fell by nearly 90%.
What sparked interest in the stock?
On the American social networking site Reddit, Wall Street Bets (WSB-Wall Street Bets) is a stock market discussion forum for retail investors. In 2019, opinions on why GME is valuable began to appear on the forums. Although the initial impact was small, it gained enough attention during the lockdown caused by the Covid pandemic in the United States to trigger a new generation of retail investors (Internet natives) called “Gen of Millennials” on the stock. Interest, participants surged.
In addition, since the initial comments on stocks, the discussion forum began a positioning of “retail” and “institutions (Wall Street elite).” They believe that “institutions/elites” could have dealt with past crises (such as the financial crisis in 2007), so this incident is widely referred to as the 2.0 version of the Occupy Wall Street incident, a “financial democracy”. Spontaneous civil movement.
Why does the market fluctuate sharply in the short term?
For short-term stock price increases, facts and fundamentals are not important. All it needs is that demand exceeds supply. When suddenly a large group of energetic and angry young retail investors frantically buy stocks, the demand for stocks will surge, and they will not only buy stocks but also stock options. It is interesting to note that when the market transaction reversed significantly, some quantitative funds and institutional investors also joined the feast.
At this time, Elon Musk posted supportive tweets to retail investors on social media. By January 21, the rise of GameStop has developed into an unstoppable force. GME rose from its price of $18 on December 31, 2020 to its high of $483 on January 28, 2021, an incredible 2583% Increase.
The development of events is often unexpected. On February 1, Robinhood Markets Inc. and Webull Financial LLC and other online retail brokers suddenly began to restrict the trading of GameStop, AMC and other stocks, and these stocks fell sharply. The move led by Robinhood angered customers and triggered dozens of lawsuits against the Menlo Park, California-based startup.
Initially, many investors believed that Robinhood’s decision to restrict the purchase of GameStop stock was instigated by hedge funds or high-frequency trading companies that later bet on the stock. But in fact the reason is simpler-due to the surge in trading volume and increased market volatility, the United States Trust and Clearing Corporation (DTCC) asked Robinhood to provide a margin of $3 billion. As a non-listed start-up company without strong balance sheet support, Robinhood immediately faces the high pressure risk of defaulting, liquidating, and even being forced to be merged or sold. Robinhood raised US$3.4 billion from its private equity investors twice within a week. Together with restricted transactions, it met its obligations to the clearing agency, and transactions in the entire market were at least not interrupted due to default.
The evolution of the incident has so far surpassed the “retail-Wall Street” confrontation, and the market focus has shifted to the back-end infrastructure of previously unknown financial markets. A group of financial technology companies led by Robinhood called for the modernization of stock clearing. The obsolete financial market infrastructure and its hidden risks are beginning to emerge from the tip of the iceberg: the entire transaction chain, fair dealing by retail brokers and market makers, the zero transaction cost business model of fintech companies, and the daily handling of more than DTCC, the clearing house for 1.7 trillion U.S. stock exchanges.
Analysis of the main issues
In many ways, the shift of financial activities to non-bank financial institutions has brought new and little-known risks. These trends and challenges are exacerbated by the industrial struggle between technology and finance.
U.S. financial market infrastructure: The increase in the value of GameStop, coupled with the source of pressure in Robinhood’s clearing transactions, essentially comes from the complexity and operating mechanism of the U.S. financial system since the 1970s—delayed settlement, leverage, and investor non-compliance. Direct ownership mode. Especially since the beginning of 2007, with the increase of LIBOR-OIS spreads, the counterparty risk in 2008 and the complexity of the U.S. Treasury bond repurchase market in 2020, these problems have become more and more obvious. This turmoil is only the exposure and re-release of the problems of the past 20 years.
For example, one of the fuse of GameStop’s short-squeeze war is that according to the market disclosure, GameStop’s short position has reached 139% of available stocks. In other words, nearly 40% of the stocks are non-existent but are “borrowed and sold.” . This practice is called “naked short selling” and is generally prohibited but rarely implemented. This happens because Wall Street’s existing indirect owner model and delayed delivery system cannot coordinate the ledger records that show who owns what and when. In fact, the reason why the market is so angry with GameStop is that the market has understood Wall Street’s operating routines for many years. This is just another of many examples.
The financial policies of the Federal Reserve and the SEC in the past 13 years have created ample currency liquidity environment, which has led to distortions in the entire market and companies overseen by official and industry self-regulatory organizations. Under GameStop’s specific story scenario, currency liquidity through quantitative easing (QE) and near-zero interest rates are conducive to momentum speculation and investors. In other words, once the price of GameStop starts to rise, the stock price can easily skyrocket. The SEC and the Federal Reserve need to conduct a more thorough assessment of the impact of various policies implemented in the past on financial markets.
Investment vs. shopping: With the development of emerging online financial technology companies and the decline in the product competitiveness of the full-service brokerage companies in the original regulatory system, a large number of investors have transferred their investment accounts to financial services that provide lower or even zero transaction costs. Go to a technology company. However, many new investors have limited understanding of regulatory and system risks, and expect online brokers/dealers to operate unregulated, and investment is more like a shopping service.
The business model of fintech companies: Robinhood’s zero transaction cost and payment to order flow (POF) business model has also begun to be examined by a magnifying glass. Legally speaking, broker-dealers are not obliged to accept transaction execution, that is, they must execute the transaction immediately after actually accepting the transaction. Robinhood seemed to immediately reject the transaction it did not want to execute. In the case of non-payment, is the investor only part of the information product? The real customers are actually paying customers—wholesale market makers, similar to Citadel. How do regulators evaluate fair dealing between retail brokers and wholesale market makers, and how to evaluate transaction efficiency? Moreover, the requirements of financial regulators and the central counterparty DTCC on its capital, liquidity and other aspects may prevent these companies from accepting unlimited transactions and even drive these companies to conduct selective transactions.
The role of social media: This GameStop storm is the first time that social media has really penetrated the financial sector. GameStop’s large investment collection comes from forum information (including KOL) obtained from social media. In the fields of information disclosure and risk disclosure, it is not subject to the supervision of traditional financial regulatory entities. Will a group of decentralized online opinion agents become a group that needs supervision to destabilize, collude, and manipulate the market? The previous response to unstable market events has been more regulations. However, with the increase in social media visits, is it necessary to increase financial accountability and responsibility supervision?
Follow-up impact
The smooth operation of the financial system has become a new hot topic in the context of the integration of current policies, technology, and social media.
The first is the modernization of financial infrastructure, especially the feasibility of using blockchain for real-time transaction clearing. The US House of Representatives hearing on Thursday lasted five hours and was the first of three hearings planned by the Financial Services Committee. Robinhood CEO Vlad Tenev once again called for changes in trade settlement procedures across the industry at the hearing on Thursday, “shortening settlement cycles and transparent capital models.” These calls are for existing The opportunity for a thorough reform of the settlement system of the securities industry may also be a new development opportunity for a real-time transaction settlement system based on the blockchain.
Under the current T+2 settlement process, the trading system requires two days to clear transactions. Therefore, DTCC requires companies to increase deposits to make up for this lag. When stock volatility increases, deposit requirements also increase. At the height of the GameStop frenzy, Robinhood’s stock-related DTCC requirements for deposits soared 10 times. Vlad explained that this is what caused the company to impose purchase restrictions on stock trading.
DTCC does not mind shortening the time required to settle transactions. According to Michael McClain, DTCC’s managing director and general manager of stock clearing and DTC settlement services, said in a published Q&A, DTCC “has long advocated settlement cycles to enhance market flexibility, lower margin requirements and reduce investors’ concerns. cost”. But DTCC cannot make the decision alone. Although the existing technology can already support certain T+1 or even same-day settlement, market participants are required to pay for such changes. This also means major changes to the current complex market structure, original business and operational processes.
First, the government must support this move.
Secondly, in addition to the modernization of financial infrastructure, supervision also faces a series of key policy problems.
Level playing field. Regardless of whether regulation should deal with this recent incident or what measures should be taken, it is important to recognize that broader financial stability issues beyond this incident are rooted in inequality in financial transactions. problem.
Need more financial education. Especially the understanding of financial risks and complexity of the new generation of aboriginal people on the Internet.
Examine the rationality and safety of Payment to order flow as a business model, and the audit and supervision of its effectiveness.
The line between blockchain and financial technology is beginning to blur. With the mainstream financial institutions’ efforts to stabilize coins and the speed of real-time payment using blockchain, most fintech companies have begun to accelerate the addition of blockchain to their business models. This also puts forward new requirements for institutional supervision.
Putting GameStop in a larger context, the rise of digital finance is a real trend after the global COVID-19 health crisis in 2020. The epidemic has increased the demand for “digital services” and “alternative” digital assets. Perhaps this is a new opportunity for the development of native digital assets and digital financial infrastructure.
The follow-up is worth continuing research.
