Template:Voting rehypothecated securities
The question will arise from time to time,[1] “if we have rehypothecated an asset a client pledged to us and there is a corporate action or a shareholder vote on it, then who gets to exercise it?”
To answer this question there are two distinct relationships to consider:
- Issuer and shareholder: Between the security issuer and the holder for the time being of its securities;
- Pledgor and rehypothecator: between you and the counterparty who pledged the security to you, which you then rehypothecated.
They play out quite differently.
As far as the issuer is concerned, whoever is the beneficial owner of the security from time to time has the right to vote. It cares not one whit for private dealings between prime brokers and their clients, nor why their securities have changed hands, much less how; only that they have. Rehypothecation is of no concern to the issuer: it must listen to the beneficial holder’s vote, be that the original pledgor (if not rehypothecated at all) us (if rehypothecated but not kicked into the market) or whoever winds up with the security on the record date (once kicked into the market).
Pledgor and rehypothecator
As between the pledgor and you: as long as you hold the share in custody, you vote it for the client as beneficial owner. If you rehypothecate, the client loses the absolute right to vote the share, because it doesn’t own it any more, but nor do you gain the right to vote the share, because everyone’s expectation is that you’ll deliver the share outright into the market as soon as you have rehypothecated it.[2] Once it is in the market, the security is beyond your, or the pledgor’s control, and the holder for the time being can vote with it as it wishes (though in many common practical uses for reciprocated shares, by convention will not).[3]
Now just let’s say the pledgee has rehypothecated the asset out of custody but for some reason hasn’t yet got round to kicking it out into the market. Here it holds the share in its open depot, beneficially for itself. From the issuer’s perspective, it has the right to vote. But from its contractual perspective, it shouldn’t vote, except as directed by the pledgor. It should treat this as if it were still in custody, because it can. This is a stroke of fortune for the pledgor, but from the pledgee’s perspective remembver the right odf ryhpothecation is a funding optimisation tool, not some residual optionality on the shares themselves. If it can effect a vote on its client’s behalf, it should. If its client is disinclined to vote, nor should the pledgor (though that is possible a rather holier-than-thou attitude, it just aligns you in the right place. Bonum ovum esse; don’t take advantage of situations like this; it will only lead to trouble in the end.
- ↑ Usually it will arise because the same person, who has been working in the client services team processing corporate actions for twenty years, keeps asking it)
- ↑ There’s no point rehypothecating a security if you don’t want to transfer it into the market. You may hold a quantity in inventory as a buffer, but this should really be a transient state of affairs: the expectation is that everything you rehypothecate goes out the door. If you don’t need to send it out the door, leave it in custody.
- ↑ For example, a, agent lender will not typically vote shares it holds as collateral for stock loans. A lot of these shares are rehypothecated.