Daily Client Note
Global Futures Review
Hypothecate: To Make Use Of Property Not Belonging To You
This week’s news-headline buzzword: 'Hypothecate'- To pledge property as security or collateral for a debt without transfer of title or possession. (Full detail below). Traders may want to get used to the H-word, as it is likely to be covered thoroughly during the course of the coming week.
A quiet open to global trade held most asset classes in near-term ranges, after the ramp higher in the final session of last week. Mid-term charts are very mixed and trading on low volume. Moves lower in Gold and Silver bullion have drawn in 1650 and 31.00 as major support swing points; Buying-the-Dip momentum will be tested.
Gold: Sup 1694 Res 1734 Neutral 1714. Silver: Sup 31.10 Res 32.85 Neutral 32.00. Oil: Sup 96.60 Res 101.00 Neutral 98.80.
S&P500: Sup 1218 Res 1276 Neutral 1248. Dax: Sup 5685 Res 6165 Neutral 5925. DXY: Sup 78.10 Res 79.50. Neutral 78.75.
EUR: Sup 1.3210 Res 1.3515 Neutral 1.3360. GBP: Sup 1.5510 Res 1.5810 Neutral 1.5660. JPY: Sup 77.30 Res 77.90 Neutral 77.60.
Recent Market Updates:
- With the SP500 up 0.05% for the year and 15 2001 trading sessions left attention turns to risk tolerance and the impact on bullion and the USD.
-The response to last weeks Eur-zone bailout summit will be seen in full force this week. Signals will follow when moves happen on decent volume.
- Trade books will have light traffic until Monday, as the global market unwinds another schizophrenic week, leaving asset classes looking directionless.
- With fifteen trading sessions to go, which are historically on light volume, SP500 values are at break-even for the year and looking weak.
- Signs that momentum, participation, and sentiment levels are increasing and leading to sustainable global price action are not being seen.
- Finally, the EU has decided on (another) a plan to address fiscal union deficits (again). Global asset classes have not reacted, and retain a weak outlook.
- 10-year Treasuries (ZNZ1) breaking above 131.50 and closing the week higher would signal the next leg lower for SP500 trade to test 1175.
Hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults. A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default. In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).
Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by companies on the basis that it is a capital efficient way of financing their operations. Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker.
For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.
Companies can also channel money into an off-balance-sheet maneuver known as a repo, or sale and repurchase agreement. A repo involves a firm borrowing money and putting up assets as collateral, assets it promises to repurchase later. Repos are a common way for firms to generate money but are not normally off-balance sheet and are instead treated as “financing” under accountancy rules. The repo-to-maturity hybrid involves borrowing cash which is backed by huge sums of sovereign debt, all of which was due to expire at the same time as the loan itself. With the collateral and the loans becoming due simultaneously businesses are entitled to treat the transaction as a “sale” under U.S. GAAP. This allows the firm to move cash off its balance sheet.