Reverse pledge

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Pledge GMSLA Anatomy™
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No, your legal eagles haven’t been in to the cooking sherry again, though at first blush it may certainly sound like it. A reverse pledge is a mightily counter-intuitive idea but it arises in the context of agent lending arrangement with certain counterparty types — for example, UCITS funds — for whom the standard 2018 Pledge GMSLA doesn’t work.

Under the normal 2018 Pledge GMSLA structure, as we all by now know, the Borrower pledges Collateral to the Lender as security for its obligation to return Equivalent Loaned Securities at the end of the Loan. This means the Lender is a secured creditor of the Borrower: it has credit exposure to the tune of the Loaned Securities, but secured on the collateral.

Contrast this with the normal 2010 GMSLA, where the Lender holds Collateral outright by title transfer, and therefore (courtesy of close-out netting) has no credit exposure at all to the Borrower — except where there is a Collateral shortfall — and indeed, where there is a Collateral excess, as usually there is, the Borrower has credit exposure to the Lender, to the tune of that excess amount.

The RWA and LRD consequences of that exposure to Collateral excess is what prompted the 2018 Pledge GMSLA project in the first place.

Poor old UCITS funds have exposure concentration limits of all kinds and, for them, we hear, security interests promised by a 2018 Pledge GMSLA aren’t good enough risk mitigant. They need to eradicate their exposure altogether, as they do under a 2010 GMSLA.

So Banks can’t do title transfer, UCITS can’t do pledge. What to do?

You’re going to love this.

We are going to do both. The Borrower title-transfers Collateral to the UCITS Lender under a standard title transfer 2010 GMSLA. The the UCITS Lender pledges the collateral back to the Borrower under a separate security arrangement, as security for its obligation to return Equivalent Collateral under the 2010 GMSLA. Now the UCITS fund has no risk to the Borrower, and the Borrower has secured, RWA and LRD-friendly risk to the UCITS Lender. And everyone is happy. Especially the legal eagles who dreamt up this absurd Heath Robinson machine.

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