As I recently watched friends, neighbors and co-workers dig out from the biggest winter weather event of our lifetimes as Texans, I realized that deferred investment in core infrastructure and maintenance isn’t just an isolated problem with the Texas power grid.
Last month’s Reddit-driven "memestock" rally, which led to e-brokerages like Robinhood restricting trading and even forcing the liquidation of Gamestop and other equities held by retail investors, has exposed cracks in the financial plumbing responsible for moving money between banks.
The prevailing narrative is that Robinhood restricted trading in volatile shares hyped by the self-proclaimed "degenerates" of the "wallstreetbets" forum, after the National Securities Clearing Corp. demanded it post $3 billion in cash as collateral to cover the risk of a potential memestock "dump."
Instead, Robinhood posted $1.4 billion in collateral and halted trading in shares presumed to be at heightened risk for volatile price swings. Collectively, Reddit traders lost millions, according to media reports. The public outcry against Robinhood’s decision has prompted regulatory probes and dramatic House Financial Services Committee hearings.
But the real issue, and one that has been largely ignored by the press, cuts straight through the heart of legacy financial market infrastructures. Like the recent ice-storm disaster that froze gas pipelines in Texas, cutting off electricity to much of the state last month, it’s clear that investment in deferred maintenance to the core infrastructure of inter-bank payments and money movement is long overdue.
In Robinhood’s case, the problem is its reliance on the automated clearing house network for funding stock purchases from their customer’s bank accounts. The ACH network is a digital, interbank payment system that financial institutions use to settle money transfers between different banks. ACH transactions can take up to five days to settle.
As we’ve seen, a lot can happen in five days.
Robinhood uses aggregation platforms that enable data extraction from customer’s linked bank accounts. These platforms extract the account number and routing information necessary to set up an ACH withdrawal (or "pull") from a consumer’s bank and confirm that there is enough money in the account to cover the transfer.
With this "pull" information, Robinhood initiates a withdrawal of the funds from the bank via ACH, and issues an “instant” credit on those transfers up to $1,000 to allow customers to immediately make trades in the Robinhood app.
However, as the memestock rally revealed — the time gap that separates an investor’s purchase of a stock and the settlement of the actual ACH transfer of cash to cover the trade exposes e-brokerages to unsustainable levels of risk.
During the height of the memestock rally, Robinhood saw massive spikes in new-user signups and trading activity by new accounts in an overwhelmingly volatile environment. Given ACH settlement delays, the NSCC’s heightened trade collateral demands were inevitable in hindsight.
But if there was a better mechanism to fund bank transfers into Robinhood accounts, could retail investors have been spared millions in losses caused by the trade stoppage? The answer to this question may lie in emerging real-time account-to-account (A2A) payment options that would enable Robinhood’s user’s to "push" funds to the company directly from their bank, without leaving the mobile app.
Today, many banks offer real-time A2A payments in the form of Zelle or the Clearinghouse’s RTP service. However, these platforms aren’t designed for the type of user-funding experience that Robinhood and other businesses demand.
To use these real-time A2A rails, users have to opt in to rules that are designed to make these A2A systems "no recourse" or cash-like. This means that there are no automatic claw-back rules in the event that a payment is made by mistake. As implemented, users must also initiate these payments from their online banking portal or mobile app, which compounds friction.
Could Robinhood have kept memestock trading active and mitigated its liquidity and counterparty risk exposures by accepting customer “deposits” over debit card, or through A2A transfers?
Not really. Unlike ACH, these options are expensive and would have cost Robinhood 1.5% or more of every deposit. Implementing these payment methods would drive up costs that would inevitably be passed on to investors in the form of trading, account maintenance or other hidden fees.
Moreover, both debit and Guaranteed ACH rails both would settle into Robinhood’s account next-day, and (in the case of debit) carry the risk of fraud or chargebacks that would expose customer banks and Robinhood to additional risks.
Had Robinhood adopted instant-settlement technology, they could have mitigated NSF risks, fraud exposures, settlement times, and NSCC collateral requirements spawned by the Reddit rally.
With regulatory fallout from Robinhood’s trading stoppage continuing to unfold, all e-brokerages catering to today’s emerging class of web-savvy retail investors should prioritize upgrading their payment infrastructure to avoid being frozen out by the next liquidity fiasco triggered by reliance on aging infrastructure.
