Re-hypothecation Right of use of a collateral (in US Markets) - PowerPoint PPT Presentation


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Re-hypothecation Right of use of a collateral (in US Markets)


Re-hypothecation Right of use of a collateral (in US Markets) Guru Raghavan What is it? The ability of a prime broker to use client assets posted as collateral to ... – PowerPoint PPT presentation

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Title: Re-hypothecation Right of use of a collateral (in US Markets)

Re-hypothecationRight of use of a collateral (in
US Markets)
Guru Raghavan
What is it?
  • The ability of a prime broker to use client
    assets posted as collateral to that prime broker
    for the prime brokers own purposes

Rehypothecation Business Drivers
  • - Liquidity
  • - Securities lending
  • - Market leveraging
  • - Revenue generator
  • - Tool for risk management
  • - Creating business opportunities

Rehypothecation Business Risks
  • - Regulatory risk
  • - Legal risk
  • - Operational risk
  • - Market risk

What can happen to the rehypothecated assets
  • Pledgor (out of the money party) financially
    strong Secured Party financially weak.
  • If Secured Party becomes bankrupt and pledged
    collateral exceeds termination payment to Secured
    Party, Pledgor becomes unsecured creditor of
    Secured Party for the excess.

Rehypothecation Normally Accepted Securities
  • Equities,
  • Government / Corporate Bonds,
  • Convertible bonds,
  • ADRs,
  • Warrants,
  • ABS / MBS,
  • Mortgage certificates,
  • Letters of credit and Cash

Rehypothecation Classification of Assets
  • Fully-paid securities, which are generally held
    in the cash account into which a customer has
    actually made full payment
  • Excess margin securities, which are that
    portion of a customers margin securities having
    a market value that exceeds 140 percent of the
    customers debit balance to the broker-dealer

Rehypothecation Classification of Assets
  • Margin securities, which are customer
    securities held in a margin, or any other
    Regulation T account for which a customer has not
    made full payment. Margin securities are not
    subject to the possession and control
    requirement, so a broker-dealer can use these
    securities in its own business, subject to
    certain limitations and
  • Non-customer securities (proprietary positions,
    for example).

Rehypothecation Guidelines
  • Fully paid securities and excess margin
    securities cannot be rehypothecated (they have
    to be controlled). A broker-dealer has the
    right to rehypothecate (customer) margin
    securities when the customer pledges those
    securities to the broker-dealer to support a
    margin debit. Under Rule 15c33, the
    broker-dealer may use an amount up to 140 percent
    of the customers debit balance

Rehypothecation Criteria for Asset Acceptance
  • Legal certainty
  • Ability to objectively price or MTM the value
  • Liquidity
  • Marketability
  • Low volatility
  • Low correlation with the underlying exposure
  • Rating of the collateral/ issuer of the

Rehypothecation Issues to consider in Asset
  • Nature and location of counterparty
  • Nature and location of collateral
  • Regulatory issues
  • Perfection issues
  • Tax issues

Rehypothecation - Regulatory Oversight in US and
FED and SEC oversight Five day window to settle trades and negotiate client transfers SIPA trustee and rules SIPC compensation schemes BoE and FSA oversight Administrator with rules Immediate seizure - Failure of trades - Freezing of assets - Suspension of services - Absence of information Uncertain value and timing Diminishing confidence
Rehypothecation in US and UK
  • In the UK re hypothecation can be for a an
    unlimited amount of the customers assets and
    there are no customer protection rules such as
    Rule 15 c 3 3 in the US. Rule 15 c3-3 prevents
    a broker dealer from using its customers
    securities to finance its proprietary activities.
    Under Rule 15 c 3-3 the broker dealer may use /
    re hypothecate an amount upto 140 per cent of the
    customers debit balance (i.e. borrowing from the
    broker dealer)

Rehypothecation and SIPA
  • A defined set of customer protection rules for re
    hypothecated assets exists in the US but not in
    the UK. This difference meant that when Lehman
    Brothers International Europe filed for
    insolvency there was no statutory protection
    available to those customers as the UK
    insolvency regime is not specific to entity type.
    In the US, however, the SPIA of 1970 provides for
    certain procedures that will apply in the event
    of the insolvency of a broker dealer

Rehypothecation and SIPC
  • Created by SIPA, the Securities Investor
    Protection Corporation is an important part of
    the overall system of investor protection in the
    US. SIPCs focus is very specific restoring
    funds to investors with assets in the hands of
    bankrupt and otherwise financially troubled
    brokerage firms. Since 1970 SIPC has accumulated
    almost 2 billion from its members assessment
    that can be used by investor to recover assets
    during insolvency

  • The End