Rising retail investor trading volume is fuelling both the markets and the brokerage sector, but the spike in speculative activity poses risks and will attract increased regulatory scrutiny, says Moody’s Investors Service.
“A rapid increase in a handful of stock prices amid excessive trading […] exposes retail brokers, exchanges and clearing houses to market and operational risks, especially when the orders are single-sided,” a report from the rating agency said.
For instance, while margin trading typically generates interest income for retail brokers, it can also expose firms to greater counterparty risk amid volatile trading.
Brokers are “exposed to potential losses if the clients’ trades lose money faster than the broker’s ability to liquidate the shares on behalf of the client,” the report said.
At the same time, while clearing houses can increase margin requirements to limit counterparty and liquidity risk, this “could strain clearing members’ liquidity,” Moody’s noted.
Moreover, the effects of fast-moving stock prices spills over to the options market, “creating a hedging challenge for market makers,” it said.
While brokers have imposed trading restrictions to curb some of the speculative activity in recent days, they are also likely to face increased attention from regulators.
Moody’s reported that the U.S. Securities and Exchange Commission (SEC) has pledged to review how the industry is handling the current spike in trading.
“Increased regulatory scrutiny of market infrastructure and practices and the application of existing risk controls could curb some of the ongoing rising volume and limit revenue upside for retail brokers, exchange operators and market-makers,” it said.
However, this action could also result in the introduction of new risk parameters that would be credit positive for the industry, it noted.