Robinhood liquidity - any potential risks for customers over SIPC limits?

[aws]

This has probably been discussed elsewhere, but with all the news this week about trade restrictions, liquidity issues and bridge loans needed at Robinhood this week, I felt like a new topic might be in order.

 

How worried does someone realistically need to be if they have over $250k in their Robinhood account?  I guess I always assumed, perhaps naively, that SIPC limits only really became an issue when you held cash in excess of that amount in your brokerage account.  So like any amount of stock or other securities is fine, but over 250k in cash could leave you exposed.  I thought all securities were held separately from the broker's assets and would never be touched even if the broker went bankrupt, and then since the broker knows the beneficial owner of every security they would just be returned directly to the owners right away.

 

From some quick Google searches, that appears not to be the case, but I haven't really found a situation where they said customers took a loss because of a broker bankruptcy either.  Right now Robinhood's issue just seems to be SEC capital requirements blowing out because of the increased volatility, and there is no indication that has led to any losses yet.  But then again the bubble hasn't really burst on any of the WSB stocks yet.  If many of them are loaded up using margin or instant deposits, and there is a crash that actually bankrupts Robinhood, and for whatever reason no one stepped in to make everyone whole, could customers lose their stock portfolio's (the amounts in excess of the insured limits)?

 

 

 

[KCLarkin]

Between the capital requirements, SIPF, segregation, etc, investors very likely to be made whole even if they exceed SIPF limits.

 

But you are trusting Robinhood to properly segregate assets. Given their history, I don't think that's a wise idea.

 

Disclosure: Long IBKR. Hate Robinhood.

[thepupil]

Who would have real money at robinhood?*

 

 

*Watch IBKR go bust now as punishment for my snobbery

[rb]

Who would have real money at robinhood?

+1. Yeah why would anyone have over 250k in a robin hood account.

 

And if one does then one should be very worried. More about their decision making abilities though.

[aws]

Personally I have cashed down to under 250k, but I have seen many 7 figure screenshots and I'm sure some are for good reasons.  I use Robinhood for all my long options and spreads trades, as being free is nothing to sneeze at.  IBKR charges me up to $2 per contract when I take liquidity on options.  I'm pretty sure Robinhood has saved me five figures in commissions at this point.

[rb]

If one has 7 figures why risk it for 5 figures? That's dumb! Also are you sure that you really saved that money? I wonder why PIMCO or Bridgewater doesn't trade with RH? They would save a lot more than 5 figures. You pay zero commission, you get what you pay for.

[LongHaul]

Above the protected limited there is always risk with any brokers.  Historically, prior to 2008 it was the smaller brokers that would go under.

 

There is credit risk if the brokers fails for large accounts and I think it is prudent to:

1.  Be with a broker that is honest.  Qualitative signs that they are sleazy are a big risk factor and they are more likely to

delude themselves and take a lot of risk and go under.  Might even dip into customer assets if times get tough. 

 

2.  Does the broker have financial strength? Are they profitable?

 

Here is IB's founder talking.  I like him and I detect minimal BS from IB over the years. 

He was specifically worried about credit risk from certain brokers. 

 

IB has $9b in Book value and makes ~$1 billion pretax.

 

I personally would not have a big account with Robinhood.  The PFOF seems like legal theft to me.

 

 

Free commissions sound great but how much cost is the Payment for Order Flow?

 

 

 

[aws]

If one has 7 figures why risk it for 5 figures? That's dumb! Also are you sure that you really saved that money? I wonder why PIMCO or Bridgewater doesn't trade with RH? They would save a lot more than 5 figures. You pay zero commission, you get what you pay for.

 

Well they only allow personal, and non-professional, accounts, so that obviously excludes anything you named.  But yes, I am certain I am saving money with the trades I do at Robinhood.  I have accounts at IBKR and a couple of other brokers and I execute only certain orders there, after using my other accounts to get market data.

 

But getting back to the question... Is it really a risk if you kept 7 figures worth of long stock positions there?  It sounds like it's not a risk if they are doing everything they are supposed to be doing with asset segregation, but it could be a risk if there were fraud and somebody were dipping into client assets.

[rb]

If one has 7 figures why risk it for 5 figures? That's dumb! Also are you sure that you really saved that money? I wonder why PIMCO or Bridgewater doesn't trade with RH? They would save a lot more than 5 figures. You pay zero commission, you get what you pay for.

 

Well they only allow personal, and non-professional, accounts, so that obviously excludes anything you named.  But yes, I am certain I am saving money with the trades I do at Robinhood.  I have accounts at IBKR and a couple of other brokers and I execute only certain orders there, after using my other accounts to get market data.

 

But getting back to the question... Is it really a risk if you kept 7 figures worth of long stock positions there?  It sounds like it's not a risk if they are doing everything they are supposed to be doing with asset segregation, but it could be a risk if there were fraud and somebody were dipping into client assets.

Yes it is! That's why custody accounts exist. Big boys (even medium and smaller boys) don't keep their assets with their brokers. For sure some do stupid shit because of greed. Ask Fortress about their experience with holding their assets at Lehman and whether it was worth the savings. There are tons of people with 7 figure accounts that have custody accounts and don't keep assets at brokers. They pay more than zero though.

[TwoCitiesCapital]

Personally I have cashed down to under 250k, but I have seen many 7 figure screenshots and I'm sure some are for good reasons.  I use Robinhood for all my long options and spreads trades, as being free is nothing to sneeze at.  IBKR charges me up to $2 per contract when I take liquidity on options.  I'm pretty sure Robinhood has saved me five figures in commissions at this point.

 

I'd echo the same concerns others have expressed - I don't trust RH's risk management to want to be with the crowd who bids Hertz up to $5 in bankruptcy, pays 50% premiums to NAV oil ETFs because they believe they're buying at negative prices, or yolo on margin on OTM options on GameStop.

 

Plenty of brokers offer free commissions now - I occasionally use Schwab. But ultimately am happy paying IB the occasional small commission for better fills, international access, and greater certainty of execution. Enjoy no commissions at Schwab, but also note the limit orders there don't always fill even if prices are below my limit.

[fareastwarriors]

 

Online brokerage Robinhood said it raised another $2.4 billion from investors.

 

That brought to $3.4 billion the firm has raised amid the recent market volatility.

 

 

https://www.cnbc.com/2021/02/01/robinhood-raises-another-2point4-billion-as-broker-app-deals-with-retail-trading-frenzy.html

[Santayana]

What exactly are they doing that puts them in a position of needing to raise money?  Seems to me that if you're a trading platform, and losing money in a time of high volume, something smells fishy.

[fareastwarriors]

(Reuters) - Robinhood, the U.S. online broker that has emerged as a gateway for amateur traders challenging Wall Street hedge funds, has held talks with banks about raising $1 billion in debt so it can continue to fulfill orders for heavily shorted stocks

 

https://www.reuters.com/article/businessNews/idUSKBN2A13HG

[Spekulatius]

What exactly are they doing that puts them in a position of needing to raise money?  Seems to me that if you're a trading platform, and losing money in a time of high volume, something smells fishy.

 

They settle trades themselves. Others use a clearinghouse which reduces capital requirements. The explosion in trading, higher stock prices for certain securities  and account influx has made the capital raise necessary, at least that’s my take, based on limited info.

[Guest cherzeca]

WSJ had a good op ed article by former GC at IBKR. RH uses clearinghouses, and they wanted increasing deposits from RH so that they wouldn't get stuck holding GME, and then asking RH to make good, and then hearing that RH couldn't make good

[wabuffo]

Think of it as RH must maintain a checking account at the clearinghouse.  Because trades take two days to settle, RH has to have its own money (not its customers' money) in a clearing account (as do other brokers who clear for themselves as well as clearing agents) to cover a calculated percentage of the expected cash its customers must deliver two days out to settle and pay for the net buys that were placed at RH with non-RH brokers.  This system of settlement balances ensures no settlement fails due to a lack of payment by one of RH's customers (or anyone else's customers).  If there is a failure, the cash gets taken first from RH's account (if its one of their customers), second from the clearinghouse itself and 3) from passing the hat to other brokers.  That's why other brokers like IB also pumped the brakes on buys - all to reduce settlement balances overall and reduce risk.  Peterffy (Chairman of IB) said as much on Thursday night in various business TV interviews.

 

The balance that must be in there varies with numerous factors but clearly one of those factors is exponential growth in order flow at RH.  The issue for RH is that they must find their own source of cash to deposit into that account. 

 

That's oversimplifying it - but another big factor is a surge in orders limited to a few names whose price, in turn, is very volatile.  This is what happened to RH last week.  By Thursday RH was being asked by the clearinghouse (NSCC) to add more money in RH's clearing account.  Since they didn't have the cash immediately to put in, RH had to stop the buys and only allow sells (since sells reduce the amount RH has to have in its net settlement balance).  As RH's settlement balance shifted due to the stop-buy and the capital raise Thursday night, they now had the cash and added it to their clearing account. 

 

wabuffo

[wabuffo]

BTW - this is similar to the Federal Reserve system.  Banks have reserve account balances at the Fed to ensure that all US payments transactions between banks settle without failure.

 

Of course, the Fed ensures no payment will fail because it backstops the whole thing with unlimited funds.

 

But the DTCC/NSCC is a private clearinghouse set up by the financial institutions who run the markets in order to clear stock transactions and does not have an unlimited source of funds like the Fed.

 

In the end its all plumbing... in one form or another.

 

wabuffo

[Santayana]

Thanks, Wabuffo.  That's a great explanation.

[Spekulatius]

Think of it as RH must maintain a checking account at the clearinghouse.  Because trades take two days to settle, RH has to have its own money (not its customers' money) in a clearing account (as do other brokers who clear for themselves as well as clearing agents) to cover the expected cash its customers must deliver two days out to settle and pay for the net buys that were placed at RH with non-RH brokers.  This system of settlement balances ensures no settlement fails due to a lack of payment by one of RH's customers (or anyone else's customers).  If there is a failure, the cash gets taken first from RH's account (if its one of their customers), second from the clearinghouse itself and 3) from passing the hat to other brokers.  That's why other brokers like IB also pumped the brakes on buys - all to reduce settlement balances overall and reduce risk.  Peterffy (Chairman of IB) said as much on Thursday night in various business TV interviews.

 

The balance that must be in there varies with numerous factors but clearly one of those factors is exponential growth in order flow at RH.  The issue for RH is that they must find their own source of cash to deposit into that account. 

 

That's oversimplifying it - but another big factor is a surge in orders limited to a few names whose price, in turn, is very volatile.  This is what happened to RH last week.  By Thursday RH was being asked by the clearinghouse (NSCC) to add more money in RH's clearing account.  Since they didn't have the cash immediately to put in, RH had to stop the buys and only allow sells (since sells reduce the amount RH has to have in its net settlement balance).  As RH's settlement balance shifted due to the stop-buy and the capital raise Thursday night, they now had the cash and added it to their clearing account. 

 

wabuffo

 

Thanks for the explanation. obviously, my info was incorrect as far as stock clearing is concerned - yours makes a lot of sense.

[aws]

Well it's good they were able to raise additional capital and then felt safe enough to remove most of the limits on stocks.  If only their communication at the start hadn't been disastrous, then they might have been able to get through this without much loss is customer confidence. 

[wabuffo]

Just one clarification in my original post.  RH's account at the clearinghouse is a collateral account -- there as insurance to backstop/cover customer payment failures.  Co-mingling customer and broker assets is a no-no.  It is not a payment account like my Fed example. 

 

wabuffo

[Guest cherzeca]

Well it's good they were able to raise additional capital and then felt safe enough to remove most of the limits on stocks.  If only their communication at the start hadn't been disastrous, then they might have been able to get through this without much loss is customer confidence.

 

I suppose RH's margin was pretty nice at the original capital amount

[shamelesscloner]

Well it's good they were able to raise additional capital and then felt safe enough to remove most of the limits on stocks.  If only their communication at the start hadn't been disastrous, then they might have been able to get through this without much loss is customer confidence.

 

As of this morning they were only allowing users to buy 1 share of GME and 5 options contracts for GME.