Rehypothecation

Hypothecation is a mechanism in the securities market that is possible when collateral is easy to transfer, it does not use the concept of a lien. While this is possible with other collateral in theory, rehypothecation in practice is most prevalent in the professional securities market where a financial market participant reuses the collateral pledged by the counterparty for its own use (such as borrowing or short selling). It is possible because in financial markets the practical implementation of hypothecation is a simple title transfer of the security against cash - together with the promise of opposite transaction in the future (a repo transaction). This ability is an important feature of fungible securities when used as collateral. A central registry, when there is one for the security type in question, further facilitates the process. Securities when pledged simply change hands when pledged, since it is so easy to do so. Few collateral are as suited as those of the securities market. In the absence of such fungibility and ease of transfer of the collateral the more cumbersome lien mechanism is used. If a creditor can only take possession of the asset in a bankruptcy, such asset cannot be rehypothecated. Rehypothecation enables fluid transactions required for proper financial market operations, as only the possession of the title needs to be verified to conclude the transaction. This mechanism also enables leverage in the securities market.^[1][2]

References