Why did brokers really block GameStop (GME) and AMC trading?

Posted: 8 February 2021 12:22 pm
News
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Traders are outraged but brokers say they had little choice after GameStop shares soared. We look at why.

Investors were left fuming after share trading platforms restricted or blocked trades on GameStop (GME) and other shorted stocks in late January to early February.

Some apps including Stake, eToro and IG were forced to halt trades altogether, while others such as Saxo Capital Markets and Interactive Brokers restricted the ability to short stocks. Some platforms, like SelfWealth, maintained access to GME throughout.

Trading has since resumed on most platforms, but it's left investors with questions. Why did trading need to stop in the first place and why were some brokers impacted and others not?

One now popular theory is that the decision stemmed from broker associations with hedge funds that had been shorting the stocks. Regardless, the reality is that brokers have little choice but to suspend orders when risk levels are too high.

It's a complicated topic, so we spoke to two industry stakeholders, CEO John Miles of Phillip Capital Australia and Marketech Stockbroking managing director Travis Clark, to get an inside view of how it all works.

Higher risk, higher capital

The short of it is, all brokers and clearing houses are required by regulators to maintain a minimum level of liquid capital called the cash market margin. This capital requirement increases as trading risks increase, and if they don't have enough, they must suspend orders.

To clear up any confusion, clearing houses handle cash transactions while brokerages execute trades. The trading platform is what you interact with on the front end. Sometimes these organisations are one and the same, sometimes they're separate entities.

"There's a mechanism in all this where parties including trading members, broker dealers, clearing agents etc., need to maintain a minimum level of capital." Miles told Finder.

We saw this play out when US broker Robinhood said it was forced to raise $3 billion in collateral before it could remove trade restrictions on GameStop last week.

Risk ratings

The tricky part is that minimum capital requirement can change quickly depending on how much risk a broker is taking on.

“In Australia the central clearing house (ASX Clear) calculates a risk rating for all stocks," says Miles.

This risk rating comes from an algorithm that takes into account trade volume, company size and volatility among other factors.

"As you get more volatile stocks, the cost of settling those stocks gets higher and higher," explains Miles.

"This can change every day. The clearing house could put out notice and you've got to meet obligations within hours."

He explains that smaller clearing houses are likely the first to come under pressure followed by bigger firms if the situation exacerbates, which could explain why some brokers could maintain trades throughout and others could not.

So when a large volume of people began buying Gamestop, AMC and others all at once from late January, brokers weren't prepared for the rapid increase in capital they were suddenly expected to have.

"This is a situation that has been created by a combination of new technology, share trading being the latest fad and regulation that is struggling to keep up," Marketech managing director Travis Clark told Finder.

"The regulators are struggling to balance a fair and stable market with the desires for new investors to invest in something they think is the ticket to riches," said Clark.

Australian brokers

Australian platforms were impacted in the same way because they're reliant on US broker partnerships to manage clearance, settlement and trade executions on US stocks.

"Very few US brokers will open a brokerage account for an Australian investor, especially if they are a small retail investor," Clark explains.

"From Commsec all the way down to Stake... It is almost guaranteed that an Australian broker will be using a custodial model for international shares. Each custodian will have their own response to this matter, and there is no black or white to the response," he says.

When US partner brokers, such as DriveWealth, as used by Stake and Goodment, closed trading on GameStop and others, some local platforms were forced to notify users with little to no notice.

Can brokers refuse trades without reason?

Yes, so long as it's stated in the terms and conditions, according to the Australian Securities Investment Commission (ASIC).

"When a client signs up to a broker they typically enter into a set of terms and conditions with that broker. Whether an online broker can close or restrict trades on certain stocks will depend in the first instance on those terms and conditions," ASIC told Finder.

ASIC told Finder most arrangements allow brokers to close or restrict access, although how much depends on the terms and conditions.

"As long as their Terms and Conditions explained that they are not obliged to take any order from a client to buy shares. In the same way, I can’t force a real estate agent to sell me a house," says Clark.

However, if you disagree with such a decision or it has resulted in losses, ASIC advises to lodge a complaint first directly with the broker and then with the Australian Financial Complaints Authority (AFCA).

Looking for a low-cost online broker to buy stocks? Compare share trading platforms to start investing in stocks and ETFs.

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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