Derivatives and Rehypothecation Failure: It's 3:00 P.M., Do You Know Where Your Collateral is?

Abstract

This article begins with a discussion of over-the-counter derivative transactions and the over-the-counter derivatives industry in general, focusing in particular on transactions involving interest rate swaps. Part II discusses the practice of rehypothecation and describes why secured parties are so insistent on the right to rehypothecate collateral. Part III focuses primarily on the risks assumed by a pledgor with respect to its posted collateral if the secured party becomes insolvent or bankrupt after it has rehypothecated the posted collateral. Part IV argues that a participant should resist consenting to rehypothecation, or should at a minimum, be compensated by its counter party for assuming the risk of rehypothecation failure.

Keywords: Derivative, rehypothecation, repledge, uniform commercial code, damages, interest rate swaps, collateral, insolvent, bankrupt, bankruptcy, insolvency, ISDA, international swaps and derivatives association

JEL Classification: G2, G21, G28, G29