The Financial Stability Board has been considering the possible
harmonization of rules relating to rehypothecation of client assets
in securities financing transactions (such as securities loans,
repo and margin loans) for several years. On January 25, 2017, it
released a report entitled Transforming Shadow Banking into Resilient
Market-based Finance, which summarizes the
findings of its Rehypothecation and Re-use Experts Group.
Regulatory Approaches to Shadow Banking
Those of you who want to know more about how this aspect of
so-called "shadow banking" works will find the new report
very informative. Specifically, it explains:
What rehypothecation is;
Why it is important to the efficient functioning of lending
What systemic risks it poses;
How those risks are currently addressed by regulation and
market practice; and
The possibilities for harmonizing regulatory approaches.
Disclosure to clients by financial intermediaries with respect
to rehypothecated assets so clients can assess their risks.
Restricting rehypothecation to the intermediary to
client-related purposes such as financing long positions or
covering short ones, not for the intermediary's own
Only allowing entities subject to adequate regulation of
liquidity risk to rehypothecate client assets.
With respect to these issues, the Rehypothecation and Re-use
Experts Group found that:
Most jurisdictions require client consent before assets can be
All jurisdictions have reporting mechanisms to track the status
of rehypothecation of client assets;
No jurisdiction bans the practice outright;
Many jurisdictions' restrictions vary depending on whether
the assets are cash or non-cash;
Restrictions are laxer for banks/investment firms than for
investment funds; and
All jurisdictions require adequate regulation of liquidity risk
as a condition.
Approaches in the jurisdictions examined diverged on the second
element of Recommendation 7 (not permitting rehypothecation to fund
intermediary's own-account purposes). Even where this element
was not implemented, however, its underlying rationale was often
satisfied by rules preventing intermediaries from funding a
material portion of their own account activities with client
assets. The FSB is monitoring implementation of this element of the
Ultimately, the FSB concluded that there was no immediate case
for harmonizing regulatory approaches. The differences in
approaches are deeply rooted in national/regional securities laws,
bankruptcy laws and other legal regimes that vary significantly
across jurisdictions. Moreover, since the 2007-09 financial crisis,
firms and clients have made notable improvements in risk management
practices associated with rehypothecation, making the entire issue
somewhat less urgent from a regulatory point of view.
The report also addresses collateral re-use.
This is the practice of secured parties using collateral provided
by the debtor party. It overlaps with rehypothecation inasmuch as
the financial intermediary may be a secured party and the debtor
may be a client. This practice raises similar issues. The risks are
addressed in different ways, such as Basel III Leverage Ratio and
liquidity frameworks, and clearing requirements. Successfully
implementing the global securities financing data collection and
aggregation initiative will be an important step in obtaining a
clearer understanding of these activities and allow any residual
risks not addressed by the current initiatives to be identified and
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The case of Harbouredge Mortgage v Powell is a classic example whereby a secured party registered a financing statement which contained an error in the debtor's name, and therefore lost their claim as a secured creditor.
The Supreme Court of Canada has provided guidance to financial institutions holding otherwise "highly sensitive" information to determine when that information is somewhat less sensitive, such that it can be disclosed.
The purpose of the Clearing Rule is to impose central counterparty clearing of certain OTC derivative transactions in order to mitigate counterparty risk in the derivatives market and to increase financial stability.
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