Re-hypothecation and collateral re-use: Potential financial stability issues, market evolution and regulatory approaches
This report describes potential financial stability issues and explains the evolution of market practices and current regulatory approaches to the re-hypothecation of client assets and collateral re-use. It examines the possible harmonisation of regulatory approaches to the re-hypothecation of client assets and any residual financial stability risks associated with collateral re-use.
For the purposes of this report, re-hypothecation is defined narrowly as “any use of client assets by a financial intermediary” (e.g. broker-dealers). In contrast, collateral re-use is not limited to client assets and broadly includes “any use of assets delivered as collateral in a transaction by an intermediary or collateral taker”.
Both re-hypothecation and collateral re-use increase the availably of collateral, reduce the cost of using collateral, and consequently reduce transaction and liquidity costs. At the same time, however, as highlighted during the 2007-09 global financial crisis, re-hypothecation and collateral re-use may pose potential risks to the financial system. For example, they may create operational impediments that hinder clients from promptly accessing their securities in the event that a financial intermediary faces insolvency. They may also contribute to a build-up of leverage, and increase interconnectedness among market participants.
The FSB has concluded that there is no immediate case for harmonising regulatory approaches to re-hypothecation. At the same time, the FSB encourages its member jurisdictions to implement Recommendation 7 in its Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos published in August 2013, which provides a common basis for authorities to design their regulations with respect to re-hypothecation of client assets. With respect to collateral re-use, the FSB considers that appropriately monitoring collateral re-use at the global level will be an important step towards obtaining a clearer understanding of global collateral re-use activities in the securities financing markets, and thus, reaffirms the importance of implementing its Standards and Processes for Global Securities Financing Data Collection and Aggregation published in November 2015. The FSB furthermore encourages authorities to consider monitoring collateral re-use activities beyond securities financing transactions as appropriate.
This report is part of the FSB’s work to transform shadow banking into resilient market-based finance, in particular its work to dampen procyclicality and other financial stability risks in securities financing transactions such as repos and securities lending. The FSB developed policy recommendations to address financial stability risks in securities lending and repos in August 2013 which include recommendations for enhanced transparency, regulation of securities financing, and improvement of market structure.