The investment activity by retail investors buying stocks such as GameStop and AMC on Robinhood could have regulatory consequences as they consider how to deal with the extreme volatility it caused.
According to ClearBridge Investments, the activity drove up volatility and meant margin brokerages were required to be increased which left brokerages imposing trading restrictions and raising margins for those stocks for their clients.
While this was not an unusual move for brokerages, the issue this time around was that the volatility occurred in a very narrow range of stocks.
Implied volatility has Skyrocketed for GameStop, AMC over the year to 2 February 2021
Data as of Feb. 2, 2021. Volatility is measured for a composite of near-dated, at the money options with expirations in 30 days over the past year for GME and AMC. Source: FactSet.
“As greater numbers of investors and others outside of the trading business learn more about what is going on behind the scenes, it will likely lead to greater regulatory and legislative scrutiny of trading activity and market structure,” the firm said.
“Newer entrants like Robinhood do not charge commissions, have minimal spread income due to small account balances and earn no asset management fees. Instead, they rely on payment for order flow as the primary driver of revenue, whereas it is only a small portion of the more diversified revenue streams seen at larger brokers.”
According to ClearBridge, the three areas where regulatory change could occur would be payment for order flow, increased capital requirements and financial transaction tax.
“We view the latter two items as highly unlikely, but believe that developments on payment for order flow bear watching. Whether or not it played a role in the events that transpired over the last two weeks, it is now in the spotlight and the SEC may take a fresh look at the controversial practice. More stringent stock lending and borrowing rules to limit naked shorting is also a possibility.”