What Is Rehypothecation?
Power Of Attorney?
Rehypothecation? What is Rehypothecation.
Rehypothecation’ is an alternative name for ‘re-pledging’. In other words, a party who receives a pledge of collateral makes a pledge of the same collateral to a third-party. In the derivatives market, rehypothecation is sometimes also called ‘re-use’. However, the term ‘re-use’ is used in the repo market for the outright sale of collateral by the buyer to a third party. This has caused some confusion (and elsewhere in these FAQs, we therefore employ the term ‘use’ when talking about repo).
Rehypothecation... There is an important legal distinction between rehypothecation on the one hand and use of collateral in the (non-US) repo market on the other. In a pledge, title to collateral remains with the collateral-giver. If the collateral-giver grants a right of rehypothecation to the collateral-taker, the collateral-giver remains the owner but only until the collateral-taker exercises his right. When the right of rehypothecation is exercised, the collateral-giver loses his title to the collateral, which is transferred to the third party to whom the collateral has been rehypothecated. Instead, the collateral-giver is given a contractual right to the return of fungible collateral but this is unsecured (although the collateral-giver is likely to have received funding in return for giving the right of rehypothecation to the collateral-taker and, in the event of the collateral-taker’s insolvency, the collateral-giver typically has a contractual right of set-off of all mutual obligations against the collateral-taker). In a repo, the buyer becomes the owner of the collateral at the start of the transaction and can dispose of the collateral when and as he wishes. His right of use is not a discretionary right granted by the seller. It is an automatic right arising from property ownership.
Rehypothecation is widely used by prime brokers involved in the collateralisation of derivatives transactions with hedge funds. It is a practice introduced into Europe by US firms. The concept was alien to English law but formally introduced in 2003 by the adoption of the EU Financial Collateral Directive. Rehypothecation is regarded by prime brokers as essential to the economics of their business. In return for rights of rehypothecation, they can offer clients cheaper funding.