Robinhood Says Stock Settlement Times Are a Wall Street Risk

(Bloomberg) -- Robinhood Markets is calling for change in the under-the-radar business that underpins vast parts of Wall Street, after the crisis that engulfed the brokerage in the past week.

The industry should cut the two-day stock settlement period to a real-time process, Robinhood said in a blog post Tuesday, arguing that the lag time was part of the problem in last week's wild trading environment.

The statement coincides with a renewed, though less ambitious, push by the Depository Trust & Clearing Corp., which wants to move toward settling trades in one day instead of two, according to a person familiar with the matter.

“There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time,” Robinhood's blog post said.

A move to one-day settlement -- let alone the real-time scenario advocated by Menlo Park, California-based Robinhood -- wouldn't be cheap, however. When the industry previously cut the settlement time by one day it cost more than $500 million, by one estimate.

DTCC, a co-operative owned by trading firms that clears about $600 billion in transactions every day, pushed the settlement issue in March when stocks plunged -- but little came of its efforts. The latest episode involving Robinhood provided another reminder that faster clearing could be one way to help limit risk in the overall system.

The time it takes to settle a stock trade is usually a forgettable detail on Wall Street. In normal times, two days is good enough for brokers and the clearinghouses that oversee the process.

But at extreme moments -- like March's Covid-19 crash and last week's Reddit-fueled frenzy -- the current duration, known as T+2, can seem like an eternity to market participants. For DTCC, charged with overseeing the plumbing of American finance, moving to T+1 is an obvious way to remove a potential vulnerability in an otherwise fast-moving electronically linked market.

“Everything is happening at lightning speeds and it seems like this is an antiquated process,” said Jim Toes, head of the Security Traders Association. “The world of finance and the world of social media have managed to peacefully coexist for the past 10 or 20 years,” but the past week shattered that balance, he said.

Nevertheless, some brokers are reluctant to undertake the expense and effort to change their systems to comply with a T+1 regime, said the person familiar with the matter.

A DTCC spokesman declined to comment.

The industry has brought down settlement times in recent decades. The U.S. Securities and Exchange Commission adopted the T+2 settlement cycle in 2017, shortening the timespan by a day from T+3, which had been the norm for most transactions since 1993.

The recent move cost the industry about $550 million, according to an analysis by the Boston Consulting Group. The research also found the shift resulted in savings of about $195 million a year thanks to better efficiency and lower costs related to clearinghouse requirements.

Larry Tabb, an analyst for Bloomberg Intelligence, said that moving to real-time settlement would be a laborious overhaul that could introduce its own problems. One potential issue could be information on trading behavior leaking out among market players, he said.

“Unless the government forces them, I can't see every buyside broker, clearinghouse and custodian re-engineering their back-end infrastructure just to make sure Robinhood doesn't have to put up a couple billion dollars in extra capital,” said Tabb.

Cutting settlement times even by a day would help a firm in Robinhood's predicament. In recent days the brokerage curbed trading and sought billions from its backers after DTCC dramatically raised capital requirements. Last week its obligations for stock trades at the clearinghouse increased 10-fold, Robinhood said in a statement. Chief Executive Vlad Tenev said the DTCC asked for $3 billion in collateral, an amount larger than the firm had raised from its venture backers in its entire existence.

Read more: How a Collateral Call Put a Pause in GameStop Mania: QuickTake

The demands forced Robinhood to seek a $3.4 billion cash infusion from its venture capital investors.

Most retail traders place stock orders with little thought to how they're completed. DTCC's role in the process rose to popular awareness after Tenev explained the settlement system -- and how it influenced Robinhood's decisions -- to users angry that the company had capped purchases of popular stocks including GameStop Corp. and AMC Entertainment Holdings Inc.

Extreme volatility in such stocks “generated substantial risk” for brokerages, DTCC said Thursday. By the end of that day, the clearing firm raised its industrywide collateral requirements to $33.5 billion, up from $26 billion.

“The clearing and settlement system is the plumbing,” said Charles Cascarilla, CEO of Paxos Trust Company. “It looks fine when systems are normal, but the minute any storm hits, the streets flood. You have to take advantage of the impetus when the streets are flooded.”

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