Rehypothecation

Revision as of 10:09, 16 September 2016 by Amwelladmin (talk | contribs)

Rehypothecation is an important concept in collateral management: more important than ordinary hypothecation, a term you don't often see (and which as far as I know simply means to pledge assets by way of security for a debt).

Rehypothecation achieves the chimaerical effect of allowing a recipient of pledged collateral — i.e., collateral the recipient doesn't actually own, but simply possesses with a security interest — to sell that collateral outright in the market to a third party, on condition that it remains liable to return an indentical ("fungible") asset at the conclusion of the pledge. Challenging, you would think, because "nemo dat quod non habet" - you can't give title to something you don't yourself own. But somehow, under US law, one manages it. It is part of the Uniform Commercial Code. (Note that the equivalent concept doesn't exist under common law - English law collateral arrangements are typically done under title transfer (for example the ISDA 1995 CSA, in which case a right of rehypothecation isn't required, since it is an inplication of owning legal title that you may deal with an asset absolutely, or by pledge (for example the ISDA English law CSD, in which case you can only give as good as you get).

Once pledged collateral has been rehypothecated, to this correspondent's best guess it is exactly as it would be had the pledgor title transferred it in the first place: The pledgor has full credit risk to the pledgee on its insolvency.

To be contrasted, vehemently, with a title transfer collateral arrangement, under which collateral a lady receives is her keep and do with as she pleases, as long as she returns something equivalent when the time it right. If someone tells you they wish to rehypothecate collateral they've taken under a title transfer collateral arrangement, find a sleeve you can quickly laugh up.

Where you see a right of rehypothecation

  • Under an 1994 NY CSA it may be switched on or off.
  • Prime brokerage documentation may allow it (but only where the collateral is only pledged in the first place).