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Senators ponder faster trade settlement after GameStop frenzy

Former regulator calls real-time settlement ‘a bridge too far’

Senate Banking Chairman Brown said “everyone would benefit” by shortening the time needed to complete stock transactions.
Senate Banking Chairman Brown said “everyone would benefit” by shortening the time needed to complete stock transactions. (Tom Williams/CQ Roll Call)

Senators on both sides of the aisle at a Banking Committee hearing Tuesday on the GameStop trading frenzy pondered the efficacy of shortening the interval between trades and the exchange of payment and securities, or settlement.

Senate Banking Chairman Sherrod Brown, D-Ohio, and ranking member Patrick J. Toomey, R-Pa., directed questions to former Securities and Exchange Commission member Michael S. Piwowar, who led the agency’s previous efforts to shorten settlement from three days to two. 

“The SEC and others should examine and consider how to reduce risk in the financial system,” said Brown. “By cutting the time it takes to complete stock purchases, everyone would benefit from that.”

Retail investors using the Robinhood Markets Inc. trading app temporarily lost the ability to buy GameStop stock on Jan. 28, which Robinhood said could have been avoided if trades were settled instantly. GameStop’s share price soared from under $20 at the beginning of January to a high of $483 at one point, as ordinary investors piled into the stock. 

Robinhood cited instruction from a clearinghouse to greatly increase its margin payments, collateral to ensure against default before a trade settles, as the reason for the trading pause. Instant settlement would’ve allowed trading to proceed more smoothly during heightened volatility of GameStop shares, Robinhood CEO Vlad Tenev said in a blog post and at a House Financial Services Committee hearing last month.

In response to Brown’s questions, Piwowar said moving to instant settlement of securities trades would be “a bridge too far.” Halving settlement times to one day would be the better solution, he said. 

“As we shorten the trade settlement cycle, we reduce risks, like market risk, liquidity risk, and systemic risk, but we also … have the challenge of increasing operational risk,” he said. “In order for real-time settlement to work, everything has to work perfectly all the time.”

That includes ensuring that cash is instantly available, which would involve updates to banking and payment systems. Foreign exchange settlements would also have to work perfectly in the case of cross-border transactions. Right now, that’s too heavy a lift, Piwowar said. 

Piwowar, in response to questions from Toomey, said blockchain technology, which some have put forward as a possible solution for real-time settlement, isn’t a viable option yet. 

“We may get to a point where blockchain technology or digital ledger technology gets us to a point where we can achieve real-time settlement, but I don’t think we’re there just yet,” he said. 

Transaction tax

Lawmakers also asked witnesses about implementing a financial transaction tax, which has been proposed by Democrats to deter excessive trading and volatility in markets. 

Sen. Chris Van Hollen, D-Md., said he planned to reintroduce legislation that would impose a 0.1 percent tax on Wall Street transactions. 

Rachel Robasciotti, founder of the socially conscious investment advisory firm Adasina Social Capital, said a tax of that size would be a reasonable price to ensure an “orderly, fair and efficient market.” 

A tax would slow “the non-human algorithmic, high-frequency trading that’s caused so much damage,” Robasciotti said in response to Van Hollen’s questions. “What we’ve seen time and time again, whether it’s the Great Recession or the flash crash, is that high-frequency trading simply exacerbates that.”

Teresa Ghilarducci, a behavioral economics professor at the New School, said a tax of 0.1 percent would hit a sweet spot by discouraging high-frequency trading without hurting retail investors. 

“It changes behavior toward more long-term holdings, exactly where all of us want people to be with their stocks,” she said during the hearing.

Sen. Thom Tillis, R-N.C., criticized the tax, citing a Modern Markets Initiative study that said it would hurt retirement savers, who would have to save for an additional two and a half years to make up the difference.

Order flow

Witnesses also faced questions from lawmakers about whether the payment-for-order-flow arrangements Robinhood has with Wall Street firms present a conflict of interest or should be banned. 

The practice, which Robinhood relies on for more than half its revenue, allows the app to offer zero-commission trading. Under the arrangements, Wall Street firms receive Robinhood’s orders placed on the app in exchange for a fee. The firms make money on the spread between the sale and purchase prices, a portion of which goes back to Robinhood. 

Gina-Gail S. Fletcher, a law professor at Duke University, said payment for order flow “undermines the relationship between a broker and their client” and leaves retail investors worse off, despite the appearance of savings at the front end of the trade.

“It pits the brokers’ primary revenue source directly against the clients, to whom they owe a duty of best execution,” she said in response to questions from Brown. “Under the payment-for-order-flow model, brokers are incentivized to put their own profit-seeking interests above their clients in deciding where to route orders.”

Andrew Vollmer, a scholar affiliated with the Mercatus Center at George Mason University, said he dislikes payment for order flow, which is “disruptive and not obvious to investors.” However, the SEC should proceed cautiously in restricting or banning the practice, which could spell the return of commissions at retail brokers, he said in response to questions from Sen. Catherine Cortez Masto, D-Nev.

“Start from the proposition that every participant that provides services in the market deserves some reasonable fair compensation,” he said. “Payment for order flow is a method of compensation. If you remove it, you need to find another mechanism.”

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