User:Metroprolix/sandbox
From Wikipedia, the free encyclopedia
Hypothecation is the practice where (usually through a letter of hypothecation) a borrower pledges collateral to secure a debt or a borrower, as a condition precedent to a loan, has a third party (usually an affiliate) pledge collateral for the borrower. The borrower retains ownership of the collateral, but the creditor has the right to seize possession if the borrower defaults. A common example occurs when a consumer enters into a mortgage agreement, in which the consumer's house becomes collateral until the mortgage loan is paid off.
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The detailed practice and rules regulating hypothecation vary depending on context and on the jurisdiction where it takes place. In the US, the legal right for the creditor to take ownership of the collateral if the debtor defaults is classified as a lien.
Hypothecation mechanism in the securities market is based on Rehypothecation and does not use the concept of lien. Rehypothecation is a practice where a financial market participant reuses the collateral pledged by its counterparty for its own use (for example borrowing). It is possible because in financial market 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 (repo transaction). This ability is an important feature of securities and distinguishes their collateral use (where the security change hands) with the other assets (where there is only a lien). This enables fluid transactions proper for financial market as only the possession of the title needs to be verified to conclude the transaction.[1]