I’m not very familiar with stock settlement, but I’m quite familiar with the settlement of some other, less regulated instruments. These often also have two-day settlement but seem less dysfunctional. So I’m not convinced that the T+2 settlement is the problem per se. To the contrary, T+2 settlement gives people a chance to correct errors, if any, before anyone takes the money and runs.
I can imagine a two-day settlement system that works better. Specifically, all parties would need to post cash with the clearinghouse before buying and to post stock before selling. Customer funds would be expected to be used for this purpose — no broker should ever go bust because their customers bought stock too fast. And, critically, unsettled receipts would be valid collateral, possibly with a small haircut. So, if you sell one stock, you can immediate use (most of) the proceeds to buy something else without needing to come up with additional collateral.
In effect, this would be immediate settlement plus two-day escrow.
That's literally exactly what currently happens. Every stock has a margin requirement, you post cash with the clearing house as a percentage of order flow. When a particular equity becomes highly volatile, the amount of margin you need to post goes up. In GME's case, to 100 percent. So when somebody on Robinhood uses instant deposit, Robinhood has no access to your funds for a couple days, but when you buy GME, they need to put up 100 percent collateral on your behalf when they submit your order request. They simply didn't have the liquidity to cover all of that.
As I understand it, Robinhood cannot use customer funds to satisfy their collateral requirement, nor can they use the proceeds from sales that have not settled. And somehow naked shorts exist, which means that it’s possible to sell stocks without first posting 100% of that stock as collateral.
The fact that Robinhood needs to come up with external funding to secure a customer cash stock purchase (if I’ve understood the current rules correctly) is, IMO, bizarre at best.
So no, I don’t think the market already works the way I proposed.
>Robinhood cannot use customer funds to satisfy their collateral requirement
Of course they can. That's literally what they're for. When I buy 100 shares of SPY, the brokerage requires that Robinhood attaches a percent of required margin to submit the order to the settlement clearing house. Ideally, that's a percentage of my money, or their money, or whatever.
>And somehow naked shorts exist, which means that it’s possible to sell stocks without first posting 100% of that stock as collateral.
Naked shorting is illegal. You cannot sell shares you aren't able to locate and purchase. The GME clusterfuck happened because people bought GME and sold them short to somebody who turned around and sold those same shares short again.
>The fact that Robinhood needs to come up with external funding to secure a customer cash stock purchase (if I’ve understood the current rules correctly) is, IMO, bizarre at best.
They need to come up with cash due to the fact that they don't require your funds to settle before you trade with them. Basically they're fronting the settlement fee for you assuming that your money will clear before the settlement clears. ACH takes 24 hours, trades settle in T+2, there's some time for it all to happen. When the clearinghouse required 100 percent margin, it meant that Robinhood needed to put up 100 percent of the cost of the share you purchased before they had a single penny of your money. It's not that they won't settle at some point, but RH has to float large sums of money for a few days in the interim.
I can imagine a two-day settlement system that works better. Specifically, all parties would need to post cash with the clearinghouse before buying and to post stock before selling. Customer funds would be expected to be used for this purpose — no broker should ever go bust because their customers bought stock too fast. And, critically, unsettled receipts would be valid collateral, possibly with a small haircut. So, if you sell one stock, you can immediate use (most of) the proceeds to buy something else without needing to come up with additional collateral.
In effect, this would be immediate settlement plus two-day escrow.