Everybody knows (should know) it takes a few days before a stock settles. When trading goes crazy in several of the "hot" names, you realize there is a lot of money that needs to change hands, and given the settlement procedures there are some risks out there most never think of. Only the risk managers that have been in the game for long will have these procedures in place.

So say you work as a trader at a smaller investment bank, trading the prop book. Say you for some reason use two different online brokers to execute an equal amount of buys and sells in the same stock during one day. As an example you buy one million GME shares with one broker and you sell one million GME shares with another broker. We can assume you are just day trading, but use two different online brokers.

So the risk manager gets the risk report every day, or a few times a day. He sees the total exposure for GME as zero, you have bought and sold one million GME shares during the day. These net out each other and voila the risk manager is happy.

That goes for the risk managers that have never seen real risks blow up. In an ideal world these two opposing trades net each other out, what you need to pay and receive matches and everything is great.

So, imagine one of the brokers you traded with "glitches" for some reason on the settlement day. Suddenly the risk free netted out positions become liquidity issues. They are still showing zero exposure in your trading book, but the trades are not matching. When the numbers are small, these things do not matter, but imagine if size is big. Most of these issues get resolved quickly, but let's take the above logic one step further.

You as head of prop trading at the investment bank have bought and sold the same amount of shares all day long and at the end of the day you are flat. Imagine then if the broker you have bought one million GME shares with goes into trouble suddenly and can't deliver the shares to you. Imagine then GME goes to the moon again and you have to deliver the shares you bought with broker 1 to broker 2, but you simply have not received any shares. Imagine then if broker 1 suddenly finds out they have other issues, not even related to this trade. You get the point, suddenly both brokers will be in trouble as well as the investment bank you are working at. When this happens, it usually does not stop affecting these players only...

We are not suggesting there are urgent problems, but there are definitely risks involved that not all risk managers are familiar with, especially in a world that has seen easy money and little focus on possible risks "outside" the normal day to day business.

Going back to GME, below is another angle worth considering by our friends at Spotgamma;

"The GME float is ~46 million shares, much of which is not available due to investors holding shares. We estimated that the options net delta exposure was around $5bn Wednesday, which is hedges of roughly 15mm shares of stock @ $300/share. Based on yesterdays data we saw about 50k in the money call options set to expire on Fridays close (1/29). 50k calls is potentially 5 million shares of stock that has to be delivered. Now its likely most of these calls would be closed before being exercised, but its still easy to see the issue here. There simply may be not enough shares to meet hedging requirements and settlement needs. “Failure to deliver” is the term when there isn’t stock available to send, and that can create a murky, unpleasant blend of issues. To be clear the above is a theory and we have no primary knowledge of issues with market makers or clearing firms. Its likely these issues remain for the next several days and warrants a great deal of caution in markets."

When it comes to people furious about what RH decided doing yesterday, it is just managing risk according to law. RH's actions were most probably a must due to regulatory risk and not necessarily liquidity risk, but people never care to read the details, and we know the devil is in the details. In short, the exposure for RH probably got too concentrated in one/few names, hence the action. Given the growth of RH, we would not be surprised if risk management was given too little focus as growth has been top focus.

As we are publishing this, news of RH restricting crypto trading due to extraordinary market conditions are hitting the screens (CNBC). 

Trading is easy, pushing buttons back and forth. Managing your risk is the complex part, especially if you need to consider "operational" risks...