The regulatory impact of the GameStop saga for the hedge fund industry
For anyone who was asleep in early 2021, this is what happened with the sleepy video-game US retailer GameStop...
No one could have guessed that a floundering mall-strip video game retailer would be in the midst of a stock market frenzy that captivated the world.
GameStop was a new retail-trading phenomenon that brought hedge funds to their knees and overturned many former conventions about the power of small investors and the non-bank financial sector.
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Surprise onslaught by retain investors
By acting in unison, pandemic-bored amateur investors – mainly in the Reddit community – pushed up GameStop’s share price to astronomical levels causing massive losses for short-sellers.
Tesla chief executive Elon Musk was part of the picture. A surge in the stock price in extended-hours trading occurred after he made a post on Twitter to his 44 million followers that included "Gamestonk!"
The result was a short meme stock squeeze that meant short sellers were forced to repurchase stock as prices rose, pushing the price higher. It sparked market-wide volatility as hedge funds jostled to meet their obligations and wrap up bad bets.
The news story is done and dusted now. But its impact is certainly not.
Unexpected hazards for hedge fund managers
The mix of characters and technology and novel trading platforms involved in the phenomenon are now forcing Wall Street and international regulators to take a hard look at the power of retail investors.
Because while hedge funds can’t intervene on forums anonymously and pump up stocks, regular punters certainly can.
GameStop regulatory fallout
Now underway is a regulatory review of the ever-larger role non-bank firms are playing in the financial markets.
The FSB now states: “Non-banks play an increasingly important role in the global financial system. It is important therefore that risks from non-bank financial intermediation (NBFI) are effectively managed and that authorities have the tools they need to effectively supervise and regulate NBFI.”
The GameStop saga has not yet prompted regulatory action in the UK. But it did spur the European Securities and Markets Authority (ESMA) chair Steven Maijoor to announce an investigation into “the role of online brokers’ business models.”
In a statement, the ESMA added: “ESMA and the National Competent Authorities will continue analysing market events and consider adopting further initiatives aimed at preserving investor protection and market integrity as appropriate.”
If nothing else, hedge funds are likely to be revising the way they monitor risk and manage exposure on the short side to both crowding and retail interest.
This might involve scrutiny of forums such as WallStreetBets and natural language processing of message boards.
And while it may have been unprecedented, it’s unlikely GameStop will be the only short squeeze of its kind.
It’s a sign of an inflection point for financial markets — where the power of retail investors now needs to be taken a whole lot more seriously by regulators and hedge fund managers alike …