Rehypothecation: How Institutions Have Become More Opaque.
Rehypothecation is the process where a financial institution reuses collateral posted by its clients to secure borrowing or investment activities. Typically involving the legal transfer of title of the asset, allowing them to reuse it. For example, a broker may post UK gilts as collateral to another brokerage in a margin agreement, in which the other brokerage firm may use them to fund its own activities by putting them up as collateral itself. This has the benefit of increasing liquidity within the market, but leads to counterparty risk Rehypothecation chains can be complicated as they lead to opacity of who owns the underlying asset and can lead to situations where multiple parties can lay claim to an asset. Imagine a situation where Banker A sets up collateral for Banker B, and Banker B sets this as collateral for Banker C. If Banker B were to default, it complicates the line of ownership, as they should give the asset to Banker C, but Banker A still lays claim to it. Banker A ...