Alternative finance: how safe is your money?
Sam Hodges compares the protection available to investors from P2P investment platforms' contingency funds with that provided by the Financial Services Compensation Scheme (FSCS) for more conventional investments.
As somebody who is investing their money into another person or another person's business it is no surprise that you will want some assurances when it comes to protecting your money. This is something the platforms know is important and is why many have provision/protection/reserve funds set up.
A provision fund is a pool of money that is kept aside in case of a borrower default. If a default occurs, the pool of money may help pay back 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 was set up to protect money in 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 authorised by the Prudential Regulation Authority and the Financial Conduct Authority. The maximum levels of compensation are:
Deposits: £85,000 per person per firm
Investments: £50,000 per person per firm
As of 1 January 2016, the maximum of £85,000 will fall 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 £85,000 (£75,000 from next year) of their losses. In most cases this will take less than seven days.
The first platform to bring in a reserve fund was RateSetter back in 2010 and it quite proudly states 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, saying that "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 coverage against cyber-crime.
Assetz Capital's provision fund is a separate UK limited company, Assetz Provision Funding Limited (APFL). According to Assetz, 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 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 launched in 2013 by Lendy Ltd. It 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.
Each of the platforms above all offers something slightly different to each other.
Some platforms deploy the cash so that they can cover all losses and show that not one of their investors has lost any money. Others will look at each loss on a case by case basis. It is important to remember that all of the platforms do not guarantee that the funds will 100% pay out.
The FSCS is different. It covers traditional financing institutions, such as banks and building societies, whereas the platform's contingency funds the money of individual investors.
The state-led scheme also only protects up to £85,000, soon to be £75k, and anything above that will not be secured.
RateSetter conducted a survey last year looking into the FSCS and found some rather staggering stats:
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.
This article was first published on AltFi.com