Protective options for P2P investments
We continue our series of articles on financial literacy. Today we are devoting material to mechanisms for minimizing P2P investor risks in today's market.
Structural notes. Notes, which appeared in the US in 1969, are securities consisting of a traceable underlying asset, the yield on which is paid at the time of expiration.
How does it work in P2P? The mechanism is approximately the following. Several loans that are as similar as possible in terms of a number of parameters are selected. The platform splits each loan into parts (notes) with a nominal value. Further, notes from different loans are combined into a single pool, and the investor is offered to purchase this pool.
Since the notes actually consist of loans, the yield here is paid from the cash flows that are generated by the borrowers. Each package provides the investor with a share in all its constituent loans (in proportion to their amounts). Therefore, in the event of a default on some loans, the overall yield suffers minimally.This, of course, is beneficial to the investor in the absence of other protective mechanisms.
ISIN. Since notes in P2P are usually issued through a pool of loans, registration is required in order for them to be traded (including on the secondary market). To do this, the national depository assigns an international ISIN identifier to the pool, which confirms the legality of the security, the reliability and status of the issuer itself. The assignment of international codes improves the efficiency, reliability, quality and transparency of financial transactions with issuers' securities, as well as the consistency of data about them in various aggregators. ISIN does not directly protect the investor, but indirectly reduces the risk of fraud by the platform.
Loan originator default protection. A P2P lending scheme may include a credit institution providing its loans on a P2P aggregator platform. If the creditor declares himself bankrupt, then the platform can assume debt collection obligations in favor of its investors.
Another option is a group guarantee. If the platform works for the interests of the financial group, then the default of one of the credit units is compensated at the level of the entire holding (this is how Robo.cash works).
Buyback guarantee is one of the most popular ways to protect investors in P2P lending. The bottom line is that the investor has the right to return their investment in the event of a default of the borrower, even with interest (each platform has its own conditions). Responsibility for the return of the money of the default borrower can be assumed by both the entire group to which the P2P platform belongs, or the platform itself. Such a guarantee can also be maintained for structural notes.
RingFence. This feature was developed after a series of high-profile bankruptcies (Lendy, Funding Secure and Wellesley), when investors were unable to get their funds back and were left with nothing. RingFence allows you to separate platform assets from investor funds and store them in different bank accounts. In other words, in case of possible problems with financial and other legislation, investors' funds will not participate in their solution.
Please note that only statements about the presence of the RingFence platform or similar mechanisms are not enough. The obligation must be clearly stated in legal documents. Therefore, interested investors should inquire about this in more detail.
Possibility of mortgage loans. In the Real Estate sector, an investor can be additionally protected by investing in mortgage loans. In case of non-payment from the borrower within a certain time, the right to the property pledged by them or part of it passes to the investor. This will allow them to cover the losses and reduce risks in the long run.
Secondary market. If an investor predicts that the platform (or the world as a whole) may have financial and economic problems in the future, they can sell their loan (or notes) to another investor at the market price without losing the received coupon yield. The possibility of selling on the secondary market is a good insurance against risks from the outside.
The proposed options are not the only ones, especially if we talk about different combinations of their use. In the final selection of suitable investment instruments, as well as risk minimization mechanisms, you need to take into account individual needs and your investment objectives.