The FAQ Corner column intends to offer basic descriptions and explorations of various mechanisms and terminology within the rapidly growing alternative finance industry. The purpose is to guide novice investors through the nooks and crannies of investing via P2P lending, equity crowdfunding and online invoice finance platforms.
A provision/contingency/safeguard fund (the terminology differs platform-to-platform…) is a pool of money that partially covers private investors against the risk of bad debt.
The peer-to-peer lenders in the UK that currently feature such funds are RateSetter, Zopa, Wellesley & Co., Lending Works, Assetz Capital and SavingStream. The concept was coined by RateSetter upon launch back in 2010. The idea is that a very small portion of every transaction that takes place on a platform is sliced out of the total amount lent (typically from the fee paid by the borrower) and pooled on behalf of the investors.
That pool of capital is on hold in case of an instance of default. Should a default occur, the contingency fund may be drawn upon by the platform in order to make the affected lenders whole. Some platforms are selective as to whether they will draw from the provision fund in the instance of a default. Others have up to now adopted a policy of always deploying the provision fund in order to cover losses.
But irrespective of the historical performance of a given contingency fund, such mechanisms must not be treated as all enduring, nor must they be equated with the state-backed Financial Services Compensation Scheme (FSCS). The FSCS provides full coverage of traditional investment and deposit account structures (such as banks and building societies) for losses of up to £85,000. That’s a cast-iron guarantee. The contingency funds of peer-to-peer platforms are not.
The depth of coverage offered by a provision fund varies platform to platform (we’ll come onto these differences soon), but “coverage” is measured against various metrics: claims made by private lenders on the contingency fund, anticipated default rate, cumulative lending volume and so on. RateSetter, for example, currently boasts a “Provision Fund” balance of £13,782,947 – set against a backdrop of a 172% figure for “Level of cover against claims”.
As mentioned, contingency funds vary in terms of shape, size and mechanism, depending on the platform that you’re investing in. To conclude, I’ve provided a brief summary of the characteristics of each Fund below:
- Pioneered the concept in 2010.
- Fund amassed through borrower-fee contributions.
- The current balance of the fund is £13,769,991. RateSetter claims that this offers a 172% level of cover against claims.
- The fund has a 100% track record to date. None of RateSetter’s 21,872 lenders have “lost a penny” – the platform’s oft-repeated strapline.
- The “Safeguard” fund steps in if a borrower lags 4 months behind their loan repayment schedule.
- The fund aims to return both principal and interest owed to lenders.
- The fund is accumulated with a portion of every borrower’s fee.
- As of writing this, the fund was worth £8,142,334.65. The estimated total that the fund would have to cover was £6,842,298.02, giving the fund a £1,300,036.62 buffer.
- The Safeguard fund has covered all losses since its launch (a 100% track record to date). The fund launched midway through 2013, and all lenders were brought under its protection in 2014.
- The fund is held in trust by a not-for-profit company called P2PS.
Wellesley & Co.:
- Wellesley launched with a provision fund in tow from the outset – initially made up of £5m contributed by the platform’s Directors.
- As of 23/04/15, the balance of the platform’s Provision Fund and “Wellesley Group Capital” stood at “in excess of” £9,628,997.
- The size of the actual provision fund itself at that date appeared to be £1,628,997. The headline figure above of nearly £10m is made up of the provision pool, Wellesley’s “skin-in-the-game” capital and the capital held by Wellesley on its own balance sheet. Each of the latter capital sources is worth in excess of £4m.
- These various resources are available to be used to compensate Wellesley lenders in the event that they suffer a loss due to a borrower default.
- But it is important to note that these resources are available for distribution “at the discretion of the directors of Wellesley Group”. Payout is not automatic.
- Wellesley’s directors always retain a portion of every loan and their own claim to repayment is subordinate to that of any private P2P lender – in the event of a default.
- The “Reserve” Fund is held within a ring-fenced Trust and is used to compensate lenders in the instance of a default.
- It is maintained by taking a portion of the fees paid by borrowers.
- It is part of a broader device – the Lending Works Shield – that also provides a level of insurance and cyber-crime coverage.
- The platform has lent £7,707,936 to date, and the Reserve Fund stands at £162,250.
- Launched relatively recently, this particular contingency applies only to those investors that lend via the Assetz “Green Energy Investor Account”.
- To quote the site: “Set up to provide a discretionary Provision Fund linked to identified Assetz Investment Accounts or loans”.
- Made up of cash provided by Assetz Capital, a part of the interest rate coupon paid by the borrower, a part of other loan arrangement fees charged by the platform, and cash or other asset security that has been contractually pledged by third parties.
- The fund will not pay out automatically. If funds are available, the fund intends to pay “under all reasonable circumstances where there is a genuine credit loss or missed / delayed payment towards any Green Energy Income Account investor”.
- This Provision Fund was created to recompense private lenders if the security held by Saving Stream proves insufficient to cover a default.
- The discretionary fund is run as a separate company to Lendy Ltd. (the firm behind Saving Stream), but by the same Directors.
- Those Directors will consider defaults on a case-by-case basis in terms of whether to engage the Provision Fund.
- The company stresses that the fund is not a guarantee – indeed, none of these contingency options are!
- The current balance of the fund is £413,785, against a live loan book of £20,689,250 and £39,290,000 of security held.