Last week a question was posed to on the forum RateSetter as to where the £17.2m in the platform’s provision fund sat. RateSetter duly responded a few days ago with a blog post. In that blog post, we learned that the fund invests in ‘assets which are considered to be low risk’. It goes onto list those assets
UK bank accounts
fixed term deposits with a maturity of less than six months,
money market funds with a rating of AAA or above;
12% with an established fund manager with a low risk remit;
The blog then explains: “The Provision Fund cannot invest in the equity of RateSetter (i.e. buy shares in it). However, a small proportion of the money in the Provision Fund can be used to provide temporary liquidity to the RateSetter market in order to bridge gaps between supply and demand for money, particularly in the case where a larger loan is approved. Less than 10% of the Provision Fund is currently used for this purpose. This liquidity is temporary – the cash must be returned to the Provision Fund within six months.”
This would seem to suggest that the provision fund is investing in loans on the platform?! The key description here is to “provide liquidity to the RateSetter market in order to bridge gaps between supply and demand for money”. Critics might wonder what happened to the idea of the market setting its own rate? No surprise then, that there has been much heated debate on the forum. Obviously there was a wide range of views expressed but some common themes included questions about whether this was equivalent to a bank using its capital reserves to further lending; would an insurance business use its fall back reserves; and whether there was the fiduciary need to completely separate out the back stop money via a trustee structure that stayed well away from the operating business.
It appears, however, that investors are not unanimous in their concerns about RateSetter investing provision fund money on the platform. Some have come out in support of RateSetter, pointing out that the provision fund has excess liquidity in the short term and therefore what’s the harm in using some of that to facilitate the smooth flow of bigger loans on the platform. Others argue that in a resolution event, (the provision fund becoming depleted), lenders would be no worse off as in that case, all money on the RateSetter platform is pooled.
I have to say though that the ‘borrowing’ of money from the provision fund to underwrite new loans still doesn’t sit entirely comfortably with me. Surely a provision fund should only be used for that singular purpose, namely to act as a back stop for wider investments on the platform?
We talked to RateSetter about the arrangement and they reiterated that they feel that this is a sensible use of the provision fund. They explained that the underwriting of larger loans to SMEs and property developers enables diversification for lenders and, if capital from the provision fund were not used, other sources of capital would be required at a cost to lenders. RateSetter also pointed out, in another recent blog post, that the majority of these loans are secured. The platform confirmed that the practice of underwriting funds using provision fund capital had started in ‘late autumn’ of last year and that the current usage was 0.6% of the fund, although this ebbs and flows, hence RateSetter’s reference to ‘less than 10%’ in its blog post. All money used to underwrite a loan must be returned to the provision fund within 6 months, in practice it takes less time.
Rhydian Lewis, CEO and co-founder, explained further: “We believe in disclosure because all markets grow with transparency, hence why we set out our approach to managing the money in the Provision Fund.
The basic approach is to keep the money safe and liquid – using UK bank accounts and fixed term deposits, for example – to ensure the Provision Fund is very well placed to meet its forecast liabilities. We have also, in the last three months, started using a very small amount (currently only 0.6% of the balance) to enable our market to absorb larger loans (such as loans to businesses or for property development), where being able to deliver a large amount of money at a specific point in time is essential. This is temporary funding and we do not intend for it to become permanent because we don’t want a circular reference appearing.
This is very important for our market – the ability to approve a loan with confidence is key to its ongoing development – and benefits not only borrowers, but also investors as it helps to deepen and diversify our market.”
For comparison, the ever-conservative Zopa keeps its Safeguard fund in a trust that is administered by a separate company, P2PS. All the fund is held in cash with RBS - probably the safest bank in the UK right now. But perhaps Zopa should be putting a portion of the fund into UK government bonds? 3 month Gilts yield almost 0.5% at the moment, likely more than the interest that RBS are paying, and the UK government guarantee is explicit rather than implicit.
This debate comes at an interesting time for Ratesetter. It recently updated the structure of its provision fund, changing from a discretionary trust to a legal company. It also announced its intention to find a third, independent, director to join the two current directors, RateSetter’s co-founders Rhydian Lewis and Peter Behrens.