The Securities and Exchange Commission may consider a wide range of new regulations to prevent future volatility and conspicuous short pressures such as those in GameStop and AMC Entertainment that plagued Wall Street last week.
The Bank of America, Merrill Lynch, says the agency that oversees U.S. markets can follow a number of rules, ranging from a limit on the level of short-term interest rates on a particular security to aggressive taxes on short-term trading.
“Brokerage platforms are already creating constraints on margins, options and trading in certain securities with unusual activities,” writes Michael Carrier, an analyst at BofA, in a note to clients.
Carrier has ticked off a list of rules the SEC is likely to follow if it is serious about preventing the dramatic swing that was the last week of January.
In addition to the short-term interest rate ceiling and the tax on short-term bets, Carrier said the commission would be able to review payment for order flows, as well as oversee social media to prevent market manipulation.
It remains unclear when Gary Gensler, President Joe Biden’s president of the SEC, will be confirmed in his post, given the Senate’s focus on confirming candidates at the cabinet level and former President Donald Trump’s impending prosecution.
A SEC representative declined to comment on the story, but referred to CNBC in a statement issued Friday. Although the regulator did not name any parties by name, it promised to protect individual traders and look into allegations of unfair trade restrictions that brokers may have imposed.
However, Bank of America was not the only Wall Street research firm wondering whether the SEC could finally take decisive action in a handful of heavily shorted stocks after a chaotic few days.
The wildlife poster child last week, GameStop, rose 399.9% from the closing price on January 22 to the end on January 29. Its share grew unexpectedly, given a bleak fundamental outlook for the brick-and-mortar video games, surprised most of Wall Street.
As the week progressed, it became clear that the rally was largely the result of a coordinated group of retailers benefiting from an extraordinary level of short selling in GameStop shares. The group, which apparently originated on Reddit, also targeted AMC and headphone maker Koss.
Short selling is a strategy in which investors borrow shares of a stock at a certain price in the expectation that the market value will fall below the level when it is time to pay off the borrowed shares.
When the price of those shares rises instead of falls, short sellers are often forced to buy back the shares they borrowed to avoid further losses. If this happens en masse, it could lead to a so-called short-term pressure and even a further rise in the share price.
But the explosive movements, and the subsequent action by brokers to restrict trading, have upset both sides of the political path. Senator Elizabeth Warren, an outspoken campaigner for financial oversight, lamented the SEC on Thursday for the regulator’s failure to act.
“We need an SEC that has clear rules about market manipulation and then has the backbone to go in and apply those rules,” Warren said at the time. “To have a healthy stock market, you have to have a policeman tailored.”
According to Echoing Bank of America, Jefferies shared his own thoughts on how the SEC could try to stop future short pressures of the same magnitude.
“With the confirmation of Gary Gensler as the new SEC chairman, the issue of market structure and small investment participation has come to the fore,” analyst Daniel Fannon wrote in a note published Friday.
The analyst said he believes the regulator could weigh greater investor training on derivatives and risk management and increase costs for certain products or services such as leveraged financing and derivatives. He agrees with Carrier’s thoughts that the SEC could eventually better monitor the short positions of hedge funds and a stricter oversight of payment for order flows.
“Restricting access, increasing margin requirements, and restricting stocks creates a temporary stop-gap that gives the incoming SEC chairman a long-term problem to solve,” Fannon wrote. “Historically, changes in the market structure, even in small dimensions, take time and usually involve hearings, pilot programs and comments / feedback from market participants.”
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