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Rehypothecation: Difference between revisions
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{{subtable|{{rehypothecation capsule}}}}}}{{pbprov|Reuse}} — often labeled {{pbprov|rehypothecation}}<ref>Normal [[hypothecation]], by the way, is a term you don’t often see (and which means simply to [[pledge]] assets by way of [[security]] for a [[debt]]).</ref> (the two are ''legally'' very different but ''economically'' very the same things) — is the right a [[prime broker]] has over its client’s {{pbprov|custody assets}} to raise money with them in the market — by ''selling'' them, in a nutshell — to offset its lending costs, against an promise to return [[equivalent]] assets (which it must go and get, by buying them in the market) when the client wants them back. | |||
'' | ===Anorak’s corner: The difference between “reuse” and “rehypothecation”=== | ||
The English law “[[right of use]]” is quite straightforward. Under it, contractually, a custodian may transfer a custody asset into its own name absolutely, against an obligation to “return” an “[[equivalent]]” asset into custody when the client needs it, so sell it. This converts the “custody” relationship over the assets — one of trustee and beneficiary — into one of indebtedness. Once the reuse transfer has happened, the custodian — now ''not'' a custodian, of course — may deal with the asset as it wishes, and ''whether or not it sells it into the market'', but has a liability to return an equivalent asset, and when it does, the custody and security relationship resume over that asset. | |||
So far so good. But now we board our liner at Southampton and head for the New World. Here things are never easy. There is a [[nonsense on stilts|strain of American jurisprudence]] that we might mischievously call “[[Nonsense on stilts|Benthamite]]” in that it admits of [[paradox]] — that ''revels'' in it — and rehypothecation is one of its higher tide marks. To “[[rehypothecate]]” an asset is to take it and sell it outright ''without depriving its owner of legal title to the asset''. Now of course, to someone brought up munching pithy [[Latin]] aphorisms like ''[[nemo dat quod non habet]]'' for breakfast, as all English lawyers were, that doesn’t make literal sense. U.S. attorneys, I fancy, know it. They will regard you beadily should you ask them to explain it, and will decline to do so. It just is. The best I can do is point to a section on the ICMA website which itself sounds rather baffled: | |||
{{quote| | |||
''... the collateral-giver remains the owner but only until the collateral-taker exercises his right of rehypothecation. When this right is exercised, there is a material change in the legal relationship between the parties. The pledge is extinguished and the collateral-giver loses his title to the collateral, which is transferred to the third party to whom the collateral has been rehypothecated. In exchange, the collateral-giver is given a contractual right to the return of the same or similar collateral but this claim is intrinsically unsecured.}} | |||
That sounds to me, readers, like [[title transfer|title-transfer]] [[reuse]] — perhaps only at the point it leaves the custodian’s hands and not before, granting a scintilla of additional protection, but really not much. | |||
=== Reuse generally=== | |||
It is a fundamental part of a [[prime brokerage]] business. This is how a [[prime broker]] funds its costs of lending to its Hedge Fund clients, which allows them to gain [[leverage]], buy the assets and conflate [[alpha]] with [[vega]]: it is ''not'' a [[credit risk mitigation technique]] (for that see {{pbprov|security}} and {{pbprov|margin}}. | |||
It seems a rather drastic right until you put it in context: | |||
*Usually, the client will only own the custody assets in the first place because its [[prime broker]] has lent it the money to buy them. [[Hedge fund]]s like to buy on [[margin]] so they they can (ahem) [[leverage]] their [[Leveraged alpha|alpha]]. | |||
* | *Running a [[prime brokerage]] business — lending to clients and then holding assets they buy with their loans in [[custody]] for them, is an expensive business. If the [[prime broker]] can raise finance against those (for example by using them as [[collateral]] under a [[securities financing]] programme) it can improve its [[balance sheet]] position, repay its internal treasury department the funds they made available at eye-watering rates, therefore markedly cheapening their own cost of lending and avoiding [[custody]] charges. Both of these mean it can price its loans more attractively to its clients. | ||
* | |||
There is a world of difference between [[rehypothecation]] and [[agent lending]], even though {{tag|UCITS V}} threatens (vaguely) to regard them as [[22(7) - UCITS V Provision|different varieties of the same thing]]. | |||
===Where you DO see a right of [[rehypothecation]]=== | |||
====Prime brokerage arrangements==== | |||
A [[prime broker]] lends its client money to buy assets, and holds those assets in [[custody]], taking security over them as [[surety]] for repayment of its loan — a “[[margin loan]]”. As [[custodian]], the [[prime broker]] has legal title but not [[beneficial interest]] in the asset. Therefore the term [[rehypothecation]], to describe the process whereby the [[prime broker]] takes that asset and sells it to defray the cost of financing it, with a [[contingent obligation]] to redeliver something identical back on request, is not an outrageous distortion of the facts of what is happening. | |||
====[[New York law]]-style [[credit support]] arrangements==== | |||
''For the specific provision in the {{nyvmcsa}}, and tart commentary thereon, see: {{nyvmcsaprov|Use of Posted Collateral (VM)}}'' | |||
''Re''hypothecation achieves the chimaerical effect of allowing the recipient of ''[[pledge|pledged]]'' [[collateral]] — i.e., [[collateral]] the holder doesn’t ''own'', but simply possesses with a [[security interest]] — to sell that [[collateral]] outright to a third party, on condition that it remains liable the original pledgor to return an identical (“[[fungible]]”) asset at the conclusion of the [[pledge]]. | |||
Challenging, you would think, because “''[[nemo dat quod non habet]]''” — you can’t give someone else title to something you don’t yourself own. But somehow, under {{tag|New York law}}, one manages it. It is part of the [[Uniform Commercial Code]]. Once pledged [[collateral]] has been rehypothecated, to [[Jolly Contrarian|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 an [[equivalent]] collateral asset. | |||
The [[English law]] equivalent in a [[prime brokerage]] arrangement is to interpose an intermediate step, in which the [[pledgee]] may take title outright title to the [[pledged asset]] itself, whence ''habet'', and accordingly ''aliquis dat'' it ''outright'' to a third person. | |||
====US market-standard {{msla}}==== | |||
The collateral leg of a {{msla}} is a pledge which generally has a right of rehypothecation, allowing the collateral holder to reuse the collateral in the market. Like the {{nyvmcsa}} this entirely defeats the point of creating a pledge structure, but who are we, with our decidedly movable force of namby-pamby ''logic'', to quibble with the quite irresistible force of the US market practice? | |||
===Where you ''don’t'' see it=== | |||
===={{pgmsla}}==== | |||
Under a [[pledge GMSLA]] used for [[agent lending]]. Because, like, why ''would'' you? The whole point is to immobilise collateral and keep it out of the lender’s [[bankruptcy estate]] | |||
====[[UCITS]] funds==== | |||
{{ucits and reuse}} | |||
====[[Title transfer collateral arrangement]]s generally==== | |||
Under a [[title transfer collateral arrangement]] (as opposed to a [[pledge]]) the [[collateral]] a {{sex|lady}} receives is hers to do with as she pleases, as long as she returns something “[[equivalent]]” when the time it right.<ref>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.</ref>If she receives a [[security interest]] over collateral then, unless she has a separate [[right of use]] over the asset, she cannot sell it — it not being hers to sell — but must return the self-same thing. | |||
{{voting rehypothecated securities}} | |||
{{sa}} | |||
*{{nyvmcsaprov|Use of Posted Collateral (VM)}} | |||
*[[Rehypothecation]] | |||
*Art {{ucits5prov|22(7)}} {{t|UCITS V}} | |||
{{ref}} | {{ref}} | ||