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Rehypothecation

Rehypothecation

What Is Rehypothecation?

Rehypothecation is a practice by which banks and brokers use, for their own motivations, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral might be compensated either through a lower cost of borrowing or a rebate on fees. In a normal illustration of rehypothecation, securities that have been posted with a prime brokerage as collateral by a hedge fund are utilized by the brokerage to back its own transactions and trades.

Grasping Rehypothecation

Rehypothecation was a common practice until 2007, yet hedge funds turned out to be significantly more careful about it in the wake of the Lehman Brothers collapse and subsequent credit crunch in 2008-09. In the United States, rehypothecation of collateral by broker-vendors is limited to 140% of the loan amount to a client, under Rule 15c3-3 of the SEC.

Rehypothecation happens when a lender utilizes an asset, supplied as collateral on a debt by a borrower, and applies its value to cover its own obligations. To do as such, the lender might approach different assets guaranteed as collateral including unmistakable assets and different securities.

Components of Rehypothecation and Hypothecation

Rehypothecation occurs in the event that a customer leaves a number of securities with a broker as a deposit, most frequently in a margin account, and the broker then involves the securities as a pledge for the margin on his own margin account or as backing for a loan.

Hypothecation happens when a borrower guarantees the right to an asset as a form of collateral in exchange for funds. One common model happens in the primary housing market, where a borrower utilizes the home he is purchasing as collateral for a mortgage loan.

Even however the borrower states a level of ownership over the property, the lender can hold onto the asset on the off chance that payments are not made as required. Comparative circumstances happen in other collateralized loans, for example, a vehicle loan, as well similarly as with the setup of margin accounts to support other trading activities.

With rehypothecation, the asset being referred to has been guaranteed to an institution outside of the borrower's original intent.

For instance, on the off chance that a piece of real estate capabilities as collateral on a mortgage loan and the lender pledges the asset to one more financial institution in exchange for a loan, assuming the mortgage lender fizzles, the second financial institution might make a claim on the real estate.

Features

  • Rehypothecation was a common practice until 2007, however hedge funds turned out to be considerably more watchful about it in the wake of the Lehman Brothers collapse and subsequent credit crunch in 2008-09.
  • Hypothecation happens when a borrower guarantees the right to an asset as a form of collateral in exchange for funds.
  • Rehypothecation happens when the lender utilizes its rights to the collateral to take part in its own transactions, frequently with the expectations of financial gain.