A provision fund is a pool of money that is kept aside incase of a borrower default. If a default occurs, the pool of money may help pay back any money that has been lost.
It is not just platforms that offer these types of contingency funds. There is also a state-led compensation structure called the Financial Services Compensation Scheme (FSCS), which offers some coverage for traditional investment products.
In this article we are going to look into the FSCS and then explore some of the different compensation funds that the platforms have available to investors. As you read more into the article you will see that each of the funds differ slightly from one another.
The FSCS became operational in 2001 and the scheme was set up to protect money that is put into traditional investment structures such as banks, building societies and credit unions in the event of their insolvency.
The FSCS is funded by levies on firms authorized by the Prudential Regulation Authority and the Financial Conduct Authority. Some examples of the maximum levels of compensation are:
Deposits: £85,000 per person per firms
100% of £85,000
Investments: £50,000 per person per firm
100% of the first £50,000
As of, next year, January 1st 2016, the fee of £85,000 is to be dropped to £75,000. This is due to the FSCS being designed to stand in line with a European scheme, which offers up to €100,000 of coverage to savers.
As you can see from the above, investors/savers are guaranteed to recoup up to £85k and £75k from next year of their losses and in most cases this will take less than seven days.
The first platform to bring in such a fund was RateSetter back in 2010 and they quite proudly state that since that day not one investor has lost a penny of their money.
The provision fund currently stands at £16,301,827, and offers a 154% level of cover against claims. But how does the RateSetter provision fund actually work?
When individuals or businesses borrow money from RateSetter’s investors they have to pay a small fee – this small fee then goes into the provision pool, which may then pay out to the investor if there is a borrower default.
RateSetter has gained confidence from its investors by putting the company’s own money into the provision fund and put in £150,000 when it was first launched. Earlier this year the peer-to-peer lender added more capital to it.
“Putting our own money down, aligning our interests with our lenders and binding our success to our credit performance shows our commitment.”
Another peer-to-peer lending platform that works on a similar format is LendingWorks, which has a Reserve Fund, which is held within a ring-fenced Trust.
The LendingWorks compensation scheme works in a similar fashion to the RateSetter provision fund, where borrowers will pay into it as part of the lending fees. The Reserve Fund currently stands at £249,943 and is ‘maintained at a level sufficient to cover the expected rate of missed payments.’
Of the £16,562,627 that was lent via the platform in 2014, Lending Works expects 1.54% to default. The defaults currently stand at 0%. With the Reserve Fund being held in a trust any default should be instantly compensated.
The Reserve Fund is part of a wider safeguard - the Lending Works Shield – that provides a level of insurance and cyber-crime coverage.
The provision fund is a separate UK Limited Company and can be found as Assetz Provision Funding Limited (APFL). As quoted from the website the fund ‘has been set up to provide a discretionary Provision Fund linked to specific identified Investment Accounts or loans.’
The fund only applies to investors who put their money through the following accounts:
Quick Access Account
Great British Business Account
Green Energy Income Account
The money will not be paid out automatically to investors. Instead the APFL, as long as funds are available, pays out under all reasonable circumstances where there is a genuine credit loss or missed/delayed payment towards any Assetz Investment Account covered by the provision fund.
The provision fund money is principally made up from Assetz Capital, part of the interest rate coupon paid by the borrower and part of any loan arrangement fees charge by the platform. There are two other permitted sources of income for the fund:
Cash or other asset security that has been contractually pledged by third parties
The benefit of credit insurance.
Saving Stream was launched in 2013 by Lendy Ltd. The platform has a provision fund run from a separate company (Lendy Provision Reserve Ltd). However, both companies have the same directors, who are in charge of deciding whether a shortfall can be refunded.
The fund was created to reimburse investors if the security held by Saving Stream proves insufficient to cover a default. Investors can apply for compensation if their investment cannot be fully repaid due to a shortfall in the sale of the security. Directors will consider each application on a case-by-case basis.
The fund has a minimum balance of 2% of the total live loan amount at any time. Every time a new loan is made a portion of the fee charged to the borrower is paid into the provision fund (the amount is dependent on the loan size).
The provision balance currently stands at £1,037,610 against a live loan book of £51,880,500 and £120,372,500 of security held.
Zopa calls its provision fund as a ‘Safeguard Trust’ and makes it clear to investors that they needn’t be concerned if they do not receive a payment from a borrower when due:
“You don’t need to take any action if a borrower misses a payment. We chase them for you and if they get 4 months in arrears loan contracts are assigned to Safeguard to claim for the outstanding loan amount”
According to the website, since the launch of the Safeguard Trust, in 2013, all claims on loans have been paid to investors.
The money in the fund is made up of a contribution from the fee a borrower pays when their loan is approved. The amount of money in the Safeguard Trust is based on the estimated default rate for each borrower, and an assessment of whether there is enough money in the fund to make estimated payouts.
The current balance of the fund stands at £10,950,994.47 with the estimated amount that the fund may have to cover at £9,280,503.79. The fund also has buffer on top of what it expects to pay out - £1,670,490.68.
The fund is held in trust by a not-for-profit company called P2PS Limited.
Each of the platforms above offer something slightly different to one another.
Some platforms deploy the cash so that they can cover all loses and show that not one of their investors have lost any money, whereas others will look at each loss on a case by case basis. It is important to remember that none of the platforms guarantee that the provision/contingency/reserve funds will 100% pay out.
The FSCS covers traditional financing institutions such as banks and building societies. The state-led scheme only protects up to £85,000, soon to be £75k. Any losses beyond that will not be covered. The RateSetter website states:
“FSCS cover is pricey, and large institutions pass on the cost to their customers. So while they have £85k "protected" against disaster, these customers aren't protected from the disastrously low rates partly caused by the cost of that cover.”
RateSetter conducted a survey last year looking into the FSCS and found some rather staggering stats on the scheme:
Only 47% of respondents had heard of the FSCS.
17% believed a low rate of interest on their savings was a fair price to pay for the protection afforded by the FSCS. Over 52% of people disagreed.
Only 39% were aware of the £85,000 (soon to be less!) protection buffer.
71% thought that the scheme should cover unlimited amounts of money. On average, respondents believe that the FSCS should cover up to £115,137 – 35% higher than the current level of protection.