I've been reading this page on the recent GameStop short squeeeze.

It mentions that at one point Robinhood and other brokers prevented their clients from purchasing shares of GameStop (GME):

On January 28, some brokerages, including Robinhood, halted the buying of GameStop and other securities, later citing their inability to post sufficient collateral at clearing houses to execute their clients' orders.

I don't understand why a purchase would require collateral. I understand why short-selling requires collateral, and I understand why options require collateral - in either case you could end up with obligations exceeding your initial investment.

However, if I give a broker cash money and ask for a share of a stock in return, why would this need anyone to have collateral?

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    Most day-traders buy with margin, not with cash. Probably their App/backend didn't support to block only margin-buying (while allowing cash-buying), so they blocked all buying. – Aganju Feb 9 at 9:35
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    @Aganju Moreover: Robinhood accounts are margin by default: "When you sign up for a new account, you’ll automatically start with a Robinhood Instant account, which is a margin account." – JimmyJames Feb 11 at 16:47


The seller's broker needs to get paid by the buyer's broker. Because this is a legal obligation of the buyer's broker, the buyer's broker must use their own funds to settle this obligation. A broker cannot commingle their own funds with their customer's funds or use customer's funds to settle their own obligations.

So the buyer's broker must have collateral somewhere to ensure that there is money to pay the seller's broker for the stock. This is a legal obligation of the buyer's broker and is not the buyer's responsibility.

If you give your broker $10,000, the broker must store that in an account that only holds customer's funds. Then if you buy $5,000 worth of stock, your broker immediately incurs a legal obligation to deliver $5,000 to the seller's broker. To protect the seller's broker against any issues with your broker failing to settle that obligation, your broker has to have sufficient collateral of their own at a clearing house.

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    In short, the answer is "because middle are the ones actually making the trade, not you" – TylerH Feb 10 at 15:24
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    "A broker cannot commingle their own funds with their customer's funds or use customer's funds to settle their own obligations." Is this really true? If you deposit money at a bank, the bank can (and does, because it's the entire point of banking) loan that money to someone else to buy a house, car, etc. Can a brokerage not lend the cash or securities in customer's accounts at all? – Phil Frost Feb 10 at 20:39
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    @PhilFrost A broker can indirectly lend customer funds so long as they can do it without commingling customer assets with broker assets and without using customer assets to settle their obligations. For example, they can hold customer funds in an interest-bearing account at a bank if that account only holds customer funds. Obviously, they have to store the customer funds somewhere. A broker can lend customer securities. – David Schwartz Feb 10 at 21:00
  • Hm, so are you saying if I buy shares, the money I agreed to pay for that doesn't become the broker's money until after settlement? That's certainly interesting, I had no idea. – Phil Frost Feb 10 at 22:57
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    By "when the transaction is made" do you mean when the trade executes or when it settles? I had figured when the trade executes the funds come out of my account, and then (at end of day perhaps, aggregated with all other customer activity) the brokerage sends those funds to the clearinghouse. Your first paragraph makes me wonder if this is actually how it works, but if it is, I'm not sure I follow your explanation. If the brokerage can't "mingle" my funds then they should certainly be available, so why could they not be deliverable to the clearinghouse before settlement? – Phil Frost Feb 10 at 23:10

This was explained on a very recent NPR Planet Money podcast: https://www.npr.org/transcripts/963466346

Here's a brief summary:

There is a two day window between when a stock transaction executed and it is actually settled. So if we were to agree this instant that I will sell you x shares of y stock for z price the transaction would be executed. However the settlement, where the shares and money actually change hands, takes a couple more days to complete. The collateral is meant to make sure that the money is there when the settlement occurs.

Note: the two day window is an remnant of a time where physical shares were actually changing hands. It could be remade to be nearly instantaneous which should eliminate the need for such a window. Many exchanges already do this -- the transaction occurs, your account is immediately debited and the other account instantly credited.

On a final note, there's definitely a lot of controversy around this and I'm sure many would call the podcast overly sympathetic towards Robinhood's position. Robinhood makes money by working with the same hedge funds that were getting squeezed and in general the motto of "if it's free you aren't the customer, you are the product" very much applies. In particular, the CEO claiming that he only found out at 3 AM that they needed billions of dollars by 7 AM raises my skeptical eyebrow.

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    If one opens a brokerage account with $1000 and places a market order for 10 shares of AcmeCo at a time when the ask price is $90, but only one share is available at that price and no other shares are available for less than $150, would one risk being stuck having to pay a bill for an extra $440 or $500, or would the order be partially fulfilled, or what? – supercat Feb 9 at 23:40
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    @supercat: that is a different question. It should not be asked in a comment. – Ross Millikan Feb 10 at 5:42
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    @RossMillikan: I'm trying to understand the nature of collateral requirements. If the effect of the scenario I described would be that the order would get cancelled, then the participants would face no risk, but if ten shares would get purchased then the person placing the market order would face a risk beyond the purchase price, and the broker would face a counter-party risk if the purchaser defaults, and collateral would seem necessary to cover those risks. Do the latter risks apply, or would the purchase simply be cancelled so as to nullify them? – supercat Feb 10 at 15:54
  • If you place a limit order it will not be filled above the limit price. You can(could in the past?) also place an all-or-none order which requires you get the entire order filled. I think you can do both, so here you would get no stock at all. – Ross Millikan Feb 10 at 16:24
  • Citadel Securities is a Market Maker and there's a hedge fund named Citadel. I just read that they used to be under the same LLC but had a Chinese Wall between them and now they're (supposedly) completely separate LLCs. It makes me wonder if Robinhood was in any way sympathetic to the hedge fund when they restricted GME trading or if it was completely about their capital requirement and liquidity. – Bob Baerker Feb 10 at 16:30

When you make a trade, you're only entering an agreement to trade. The money and the shares still have to change hands, a process called settlement.

After the trade executes, but before it has settled, the buyer's brokerage is holding money that doesn't technically belong to them, and the seller's brokerage is holding shares that don't technically belong to them. They've agreed to exchange them in a future date at a fixed price, so it's not unlike a futures contract.

If you want to trade futures your broker will require you maintain equity in a margin account. This guarantees you'll be able to meet your contractual obligations. The market wouldn't work if people could just bail on their futures contracts when they felt like it.

Likewise, settlement of trades between brokerages and other institutions are facilitated by clearing houses. Clearing houses require collateral from the institutions for the same reason. For every buy made by a customer there should be some money to pay for it in the customer's account. The brokerage should be able to withdraw money from customer accounts and deliver it to the clearing house before settlement. But should isn't good enough: a guarantee is needed. The collateral provides that guarantee.

  • I would think, based upon your description, that RH would need more collateral to sell stocks on behalf of its customers than to buy them. If RH buys 10 shares of stock for its customers at $120/share from CS, its liability to CS would be limited to $1200 no matter what the stock price does. If CS buys shares from RH, however, RH would have open-ended liability until it actually supplies the shares. – supercat Feb 10 at 19:24
  • @supercat you're right, I rewrote it to address buying stock specifically, and shifted the timeframe the peak and decline, which is the part that's more relevant to the question. – Phil Frost Feb 10 at 20:29

When you open a margin account, you sign a hypothecation agreement which pledges the securities bought on margin to the broker. loan. The broker rehypothecates these securities to a bank to secure a loan. IOW, your broker, who is the lender to you, then uses your assets for a loan to cover its own obligations.

Reg U limits the amount of customer securities that can be pledged to 140% of the customer's debit balance. The remaining non pledged securities are called "excess margin securities" and must be segregated.

Here is A Hypothetical Example of Rehypothecation:



Your brokerage firm had to come up with the $100,000 in case you wanted to borrow in order to settle the trade when you bought P&G. In exchange, you've pledged 100% of the assets in your brokerage account, as well as your entire net worth, to back the loan as you've given a personal guarantee. That is, you and your broker have entered into an arrangement and your shares have been hypothecated. They are the collateral for the debt and you've given an effective lien on the shares.

How Brokers Get Margin Lending Funds



To protect its depositors and shareholders, the bank needs collateral. So the broker takes the Procter and Gamble and Coca-Cola shares you pledged to it and re-pledges it, or rehypothecates them to Bank of New York Mellon as collateral for the loan.

  • For those who haven't grasped it, hypothecation/rehypothecation addresses the OP's question about collateral. When the capital required for operation exceeds the loan amount that rehypothecation provides, the brokerage firm can't continue doing business. – Bob Baerker Feb 10 at 16:34
  • tld;dr "Because short sales are made with borrowed money, and loans require collateral". – RonJohn Feb 10 at 16:42
  • In case you missed it, my answer addressed the OP's question about why the GME short squeeze restrictions were implemented not the Captain Obvious answer that long margin buying and short selling require collateral. – Bob Baerker Feb 10 at 16:53
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    Which is why I upvoted your answer. – RonJohn Feb 10 at 16:58
  • In this case, upvoting my answer makes you a unicorn ;->) – Bob Baerker Feb 10 at 17:26

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