Rehypothecation
The practice of a custodian using a client's assets — posted as collateral — for its own borrowing or lending activities, creating multiple claims on the same underlying asset.
When you deposit assets with a financial institution — whether cash, securities, or precious metals — those assets may be used by the institution as collateral for its own transactions. This is rehypothecation: the assets are pledged (hypothecated) multiple times, each pledge creating a new set of counterparty relationships and legal claims on the same underlying asset. In a fully functioning financial system, the process is orderly and each claim can be honored. In a liquidity crisis, the chain of claims can collapse rapidly.
In precious metals, rehypothecation primarily concerns unallocated storage accounts and the gold leasing market. When you hold unallocated gold at a bank, the bank may lend that gold to another institution, which may lend it again. Theoretically, the same ounce of gold can be simultaneously claimed by the depositor who "owns" it, the bank that lent it, and the institution that borrowed it. As long as all parties behave normally and no one demands simultaneous physical delivery, the system functions. The stress test comes during a financial crisis — precisely when precious metals holders are most likely to want their metal.
The significance for investors is straightforward: allocated physical holdings are immune to rehypothecation. Unallocated holdings, ETF shares held in street name, and futures contracts are all, to varying degrees, exposed to counterparty chains that rehypothecation creates. Physical gold in your possession or in segregated allocated storage cannot be rehypothecated. A claim on gold in an unallocated bank account can be — and often is.
This definition is for informational and educational purposes only. Nothing on Finance Compass constitutes financial, investment, or trading advice. Always conduct your own research and consult a qualified professional before making financial decisions.