Even that each platform allows exposure to a diversified book of assets, the platform itself is a risk exposure that needs to be managed. The investment manager thoroughly contemplates on a continual basis the following counterparty risks:
-Fraud risk: how likely is it that the platform will commit fraud and embezzlement or is running a pyramid scheme? This concern is significantly ameliorated if the platform is regulated by a reputable authority and if the platform itself produces audited annual reports, which many do.
-Systematically flawed underwriting: it can be that a platform’s underwriting practices are proven to be flawed ex-post in a systematic way, which would undercut the benefit of being diversified over many assets on that platform. All assets on that platform would suffer severe losses at the same time, due to the deficiency in the underwriting or collection processes. This concern is ameliorated by a good track record of the platform.
-Balance Sheet Risk: some platforms lend their own money alongside with crowd-investors. On the one hand this is good because they have skin-in-the-game. On the other hand this is risky because in the case that severe losses are suffered on these assets then the operator itself can go bankrupt, exactly at the time it is needed the most to take care of the intense collection effort. This risk is ameliorate by a platform operator which is well capitalized relative to the riskiness of its own balance sheet.
-A comprehensive enumeration of the counterparty and other risks involved in investing in the Fund is documented in the Fund’s Private Placement Memorandum.
-The platforms via which the Fund invests are chosen in accordance with a holistic evaluation process.
-License to operate: does the operator have a Credit Provider license, a Broker-Dealer license, a Specially Designated License to operate a Peer-to-Peer platform, a simple Real-Estate Broker License, an Explicit Exemption from being regulated, or is the operator Unregulated? Which is the regulatory body and what is its reputation?
-Audited reports: does the platform operator produce audited financial reports of its activities? Which is the accounting firm?
-Track Record: how much loan volume have they brokered to date? how long have they been operating? what was the net return delivered to investors? do they have experience at successfully collecting problematic debts?
-Quality of Data: how transparent and detailed is the data the platform is providing to investors?
-Quality of Management: does management seem to know what they’re doing? The Investment Manager bases his opinion of management on the features of the platform, the frequency of updates to the platform and processes, based on papers published, videos uploaded, and often based also on personal interviews with senior management.
-Counterparty risk cannot be eliminated so therefore the approach is to manage it within risk tolerance limits. The answer is to diversify across counterparties such that if one or even two counterparties default, the loss will be no more than what the Fund’s investors can withstand, and no more than what the Fund can grow itself out of. See the combined and severe stress test.