Back in my fight with Wall Street 15 years ago, I argued for reducing or eliminating the “option market maker exception” to the rules on short selling, that exception being known colloquially as “the Madoff Rule“ or “the Madoff exception“ (because, no kidding, when Bernie was chairman of the NASD, he had argued for it). Finally, it just happened. It just got throttled.

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Subject: NSCC Clamps Down on Market Makers’ Power to Short Sell

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:

Drastic time-frame reduction for calculating and collecting deposits – from one month to daily or even hourly requirement verification.
Each member will be scrutinized based on daily activity, instead of historic settlement activity.
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.