Rehypothecation
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.
The equivalent concept doesn’t exist under common law: under English law collateral arrangements the 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.[1]
Once pledged collateral has been rehypothecated, to this correspondent’s best guess it is exactly as it would be had the pledgor transferred by outright title transfer in the first place: The pledgor has full credit risk to the pledgee for the return of the collateral asset.
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).
References
- ↑ If someone tells you they wish to rehypothecate collateral they’ve taken under a title transfer collateral arrangement, quickly find a sleeve you can laugh up.