Even stock trading has tested resilience and capacity of markets, SEC report concludes


On January 27, 2021, a battle between David and Goliath unfolded on Wall Street that captured the attention of markets and regulators.

A group of day traders on Reddit and other social media networks threw the gauntlet at the hedge funds that had short-sold the shares of the game company GameStop, buying the “same stock” in numbers so large that the price of its share swelled by 12,500%. , which has led some retail brokerage firms to temporarily ban certain trading activities. Some funds also suffered significant losses as they were forced to liquidate their short positions in the same stocks.

Today, 10 months after the momentous event, a 45-page Securities and Exchange Commission (SEC) report concluded that the extreme volatility of stocks even like GameStop has tested the capacity and resilience of markets. While a short squeeze or “buy-to-cover” transactions were not the main driver behind the sharp increase in GameStop’s stock prices, the report raises questions about the market’s effectiveness in terms of short selling.

The services report on the conditions of the stock and options market structure in early 2021, which was released by the SEC on October 18, identified a number of areas requiring further study and examination:

  1. Forces which can cause a brokerage to restrict trade;
  2. Digital engagement practices and order flow payment;
  3. Trading in dark pools and wholesalers;
  4. The dynamics of the short selling market.

“The events of January gave us the opportunity to consider how we can continue our efforts to make the stock markets as fair, orderly and efficient as possible,” said SEC Chairman Gary Gensler. “Making the markets work for everyday investors is at the heart of the SEC’s mission. I would like to thank the staff for bringing their expertise to this important report and for their continued work to resolve the issues raised by the events of January.

The report found that in January 2021, more than 100 stocks, mostly aimed at consumers and familiar to the public, experienced significant price movements or an increase in trading volume, which “significantly exceeded more market movements. wide “. The amount of “short interest”, in some stocks based on the number of stocks sold short as part of the total shares outstanding, has exceeded the market average.

The SEC staff report concludes that buy-to-cover or short-squeeze volumes may have put additional upward pressure on the GameStop share price, forcing other short sellers to exit their positions. adding even more upward pressure on prices.

As short sellers are out of the market, at least temporarily, the report indicates that the price of a stock may continue to rise unchecked. “Also, since short sellers could lose more than the capital they put in, tail risk could deter further short sales of the stock. While GameStop’s price eventually fell, we one wonders to what extent is a short squeeze behind its price increase momentum? ”

However, the GameStop share price remained elevated even after the direct effects of hedging short positions abated, according to the SEC report. “The underlying motivation for such buying volume cannot be determined; perhaps it was motivated by the desire to maintain a short squeeze. Whether motivated by a desire to squeeze short sellers and thus profit from the resulting price increase, or by belief in GameStop fundamentals, it is the positive sentiment, not the buying for. cover, which has supported the price for weeks. appreciation of the GameStop action.

GameStop’s price spike also raises questions about the market’s effectiveness with respect to short selling, the report said, with SEC staff observing that it was “exceptionally expensive” to borrow GameStop stock. “Since GameStop was expensive and risky to sell short, the reluctance to sell short could have contributed to the price increase and the steep decline that followed,” the report said. Improved Short Selling Reporting, SEC Says, Would Allow Regulators To Better Track Price Dynamics In The Market

The SEC highlights the important role that clearing agencies such as the National Securities Clearing Corporation (NSCC) played during the events of January 2021. dealers – to pause and manage the risk exposure that arose as the rate of transactions were accelerating, ”the report says.

He says some of the trading restrictions placed by brokers during the highly volatile January trading conditions were a reaction to margin calls and capital charges imposed by NSCC in response to the extraordinary volatility. Other brokers have restricted trading due to capacity issues.

“This raises questions,” the SEC said, “about the possible effects of sharp margin calls on smaller-cap broker-dealers. One method to mitigate these risks, the report adds, would be to shorten the settlement cycle. .

The SEC also said it should be examined whether dark pools and wholesalers, where much of the retail flow of GameStop stocks occurred in January, should be subject to the same levels of transparency and resilience as the exchanges. and ATS (automated trading systems).


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