Holly's Blog: No such thing as a free lunch as Robinhood chokes


And there was me thinking I’d had a tough week, managing half-term in the rain, as we get progressively fed up with arts & crafts (please no more!!), baking and wet walks. But as always things are relative. Yesterday was a very uncomfortable day for founder and CEO of US fintech Robinhood, Vlad Tenev. He was grilled by US senators about his trading platform’s decision to halt trades in Gamestop on 28th January.


To rewind for a second, Gamestop was the share which was used as the vehicle for a war between the ‘little guys’ who organised themselves on Reddit. And the big bad hedge funds who had spotted a wounded share and gone in for the kill by short-selling (banking on it going down). Not so fast shouted the Reddit brigade, piling in, and all this momentum and hoopla temporarily sent the Gamestop share price jumping, sticking it to the hedge funds. Yay!!


Things started to go wrong when the platform (which built a brand off championing the little guys) temporarily put a stop to trading. Clients went loudly nuts. There’s a lesson in how it takes years to build a brand. And just hours to inflict serious wounds.


Why did they turn off trading?


Some have written that various platforms closed trading to protect retail investors from the massive volatility and accompanying mega-high risk. Hhhmm. But there are also views that Robinhood was sucking up to the Big Boys by shutting down the party.


Robinhood has championed sometimes free, always low-cost trading. This has been welcome disruption and I think the going rate of £10 to trade a share in the UK will come under increasing pressure too.


But it’s not a charity. History has multiple instances of investors who let greed triumph over fear and forget that there is no such thing as a free lunch. Robinhood generates revenue from interest and premium accounts, yes, but behind the scenes it also makes money from various institutions by routing orders their way, rather than using public exchanges to buy and sell things. And one of the main firms they make money from this way is owned by the same bloke as a very big hedge fund. Which is good mates with the hedge fund which had short-sold Gamestop. It’s been disclosed that Robinhood earns more than 50% of revenues from a few Sherriffs of Nottingham.


If “the package is in the post”, you gotta pay a deposit.


Things got even more stressful for the firm. It has also emerged that Robinhood got a 3.30am call from its clearing house amidst the chaos, asking for a deposit of a massive $3 billion it simply didn’t have. That’s some middle of the night phone call.


Many financial institutions have strict rules about how much cash they need to meet potential demands. It’s the ‘just in case’ buffer. And when investors buy shares, trading platforms have to make a deposit at a clearing house. If the platforms can’t make these payments then they can ultimately be forced to sell client holdings. Mega nightmare. So if the clearing house says jump, you jump. Even if the bar is set at $billions.


Some readers will know from experience that there is a delay or a day or two between selling a share and actually being able to get your hands on the cash. These delays are because your broker and the clearing house will ‘tally’ up at the end of a day. Add up all the buys and sells into one single trade to minimise faff. There is trust here and the clearing house holds the risk at this time – it’s a bit like being told that your package is in the post – and so they ask for a refundable deposit as collateral.


For mainstream stuff bought with investor’s cash, the deposit might be about 10%. Start to add in spicy stuff and then spicy stuff which is being bought with borrowed money and then the clearing house shouts "I DON’T LIKE IT" and asks for more to cover the risks.  


Clumsy? Arrogant? Or negligent?


Robinhood was temporarily stuffed. They managed to barter this amount down but still had to scrabble around and raise $1 billion pretty damn quick from existing investors at a time when its valuation was looking arguably wobbly. That is one hell of a lot of operational mud and we could argue management carelessness and arrogance OR bad luck. You will decide. As will the Senators.


It’s all a bit murky. But with the benefit of hindsight and time, it’s clear that Robinhood could have managed this better. And they are having a painful coming of age ceremony at the very public and unfriendly hands of the Senators.


Is it bad to make investing more fun?


Operational requirements aside, when I hear Senators further blast the platform for gamification elements and making it fun, I think that’s a dangerous path to go down.


We know that people find investing boring, dull, scary, baffling. Many fintechs have done a great deal to make it more appealing and more accessible. We know that 1 in 10 investors today have been investors for less than a year – that’s a very different investor audience to just 5 years ago.


These robo advisers and trading apps have lowered costs for us all. Improved access. Made it possible for first-time investors to get going. There is a lot of good in this. If we respond to market volatility or public fiascos by making things harder, increasing the barriers to entry, frowning on emojis, confetti or gimmicks to engage - what will we achieve?


Well. Maybe as a head of compliance no-one will get burned on your watch. Maybe as a regulator no-one will lose money in a high-profile fund which goes down in value. And maybe as a Senator no voter will feel angry that they were locked out of the markets for a day. But guess what? When you are retired, we will still have a world where 7 in 10 people have no investments. They will sit in cash for fear of making a mistake. And when they come to retire and look at that still small cash pile that languished in the era of historically low interest rates – who will take the responsibility for that?


The biggest question as always is this. Would we rather most people were approximately right? Or keep most people being perfectly wrong?


Over and out for this week. Next week #drumroll tune in for our 2021 Best Buy Awards to help those ISA or pension decisions before the end of the tax year on 5th April…



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