New NSCC Rule Change Poised to End the Short Squeeze Saga
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New NSCC Rule Change Poised to End the Short Squeeze Saga

Despite having ties to regulatory bodies, it seems that some market makers have become too much of a headache.
Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.

On Wednesday, market makers, which are also DTCC clearing members, will have to tighten up their short-selling belts. Because their available capital will be contrasted more frequently with member deposits, their ability to maintain massive short positions is slated to be crippled.

Current State of the AMC/GME Saga

In case you haven’t yet grasped the basics of short selling, here is a brief recap of basic indicators (we’ll get to the breaking news afterward). The foremost among them is the short interest percentage, referring to the number of shorted shares divided by outstanding shares.

According to Ortex data, as of today, both AMC and GME stocks have relatively high estimated short interests, AMC at 13.64% and GME at 14.54% (17% on May 28) of free float.

Above 10% is considered high, while above 20% is extremely high, which translates to more investors thinking the stock price will fall. Of course, bullish short squeezers tend to use this metric as an opportunity to buy the dip, counting on the stock to rebound.

AMC stock price compared to GME
AMC and GME price moves in 2021, source: TradingView

Regarding the free float, also called public float, it refers to the number of shares available for public trading by using the following formula:

Free float = outstanding shares – restricted shares – closely-held shares

With these two metrics in mind, we arrive at the short-interest ratio, as the number of shorted shares divided by average daily trading volume. This is one of the key factors that enter the consideration when to take short positions. The higher it is, the longer it would take to repurchase the borrowed shares, which is why it is commonly known as the days-to-cover ratio.

A ratio above 10 would indicate a negative outlook on the stock. As of May 28 report, AMC’s short ratio was 0.7 with 20.3 million shares sold short, while GME’s short ratio was at 1, with 11.97 million shares sold short. Meaning, they were both bullish indicators.  

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NSCC Clamps Down on Market Makers’ Power to Short Sell

The last time the Tokenist covered the AMC saga, short sellers lost nearly $1 billion in a week. In the meantime, regulatory bodies have been preparing for the AMC/GME short squeeze fallout, bringing in new rules that would soften the blow to Options Clearing Corporation (OCC) clearing members. This time, a new important rule put forward by NSCC, one of DTCC’s five clearing corporations, may be the one to mark the wind-down of the short squeeze saga.

The proposal, identified as SR-NSCC-2021-002, was submitted by the National Securities Clearing Corp (NSCC) on March 5, but it will take immediate effect tomorrow, on Wednesday, June 23, 2021. The rule tweaks Supplemental Liquidity Deposit (SLD) requirements. As you may recall from previous coverage, the mission of clearing members, numbering at 4,000, is to provide liquidity into the stock market so that trades can be settled in due time and without market disruptions.

SLD changes are devised to tighten loose ends significantly:

  1. Drastic time-frame reduction for calculating and collecting deposits – from one month to daily or even hourly requirement verification.
  2. Each member will be scrutinized based on daily activity, instead of historic settlement activity.
  3. Granular, intraday scrutiny of SLD calculation and collection.

These calculations are conducted automatically by powerful computers and algorithms. After all, the Paperwork Crisis in the 1960s clearly demonstrated what happens when trading volume outpaces human capacity. Therefore, the new SLD rule shores up the ability for DTCC/NSCC to complete settlements on time and prevent liquidity crisis surprises.

In other words, heavily exposed market makers like Citadel Securities would have to cover their short-selling bets within a day, less they risk defaulting and have their assets frozen as outlined in the NSCC framework.

“If, after closing out and liquidating a defaulting Member’s positions, NSCC were to suffer a loss, that loss would first be satisfied by the amounts on deposit to the Clearing Fund and Eligible Clearing Fund Securities pledged from the defaulting Member”

Of course, the NSCC also has the authority to close any open positions of a defaulting member. Rule #2 stands out in particular as it invokes Citadel’s impressive list of FINRA violations. The Tokenist covered Citadel Securities extensively, both in terms of its history of market manipulation and its acutely conflicted ties to Robinhood brokerage, providing it with 43% of revenue for Q1 2021 via controversial payment for order flow (PFOF) business model.

With the new rule about to go live, the ability of market makers like Citadel to exert such market force will be greatly reduced due to their liquidity reduction – daily down payment collection will tie up their available capital. In turn, this translates to the reduction of open positions they can take, given all their other exposed short positions.

How long do you think it’ll take before we see the impact from this new rule? Let us know in the comments below.

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