An Update on Sellout
The new RateSetter Sellout feature launched three weeks ago today and we wanted to update you on how it has gone.
The feedback from Lenders has been encouraging, with many telling us that is has rounded out the RateSetter proposition for them – if you can get out, you are happier to get in.
Some Lenders have been wanting to exit for one reason or another and have welcomed the new functionality. Others have used it, only to reinvest in longer term markets – it’s gratifying to see that people are using Sellout to increase rather than reduce their commitment to RateSetter!
Over the past two weeks we have seen £174,868.54 of loans sold out across all the four markets.
Our objective was to create a simple system that lets Lenders access their funds quickly and easily and design a secondary market that allows reliable access without encouraging speculation – we want to create a situation where the rate matches your commitment, even if you exit early.
Like many things that appear simple, there is a much complexity under the bonnet and it has taken a surprising amount of time and resource to build. Firstly, we applied that the principle that you can always withdraw your funds from RateSetter – provided there is another lender(s) to take your place. There were then three key things to consider: how contracts would be refinanced, which individual contracts would be sold and the cost to the Lender for being able to access their funds early:
- Contracts are refinanced in their original market. This means that there will regularly be situations where assigned contracts are shorter than the full market term. This happens quite a lot in peer-to-peer lending anyway because the Borrower has the right to repay at any time which means contracts are frequently not of the originally intended duration.
- As for which contracts are sold, it starts with the most recent. In one sense, it’s arbitrary as to which order we choose contracts to sell on Lenders’ behalf – our rationale was that younger contracts should be more reflective of current rates and less likely to incur assignment fees (even though the duration on those contracts would be higher). So, it is a real-time calculation based on live rates and specific to you on any given day that you look to Sellout.
- Balancing a decent rate of return without creating perverse incentives guided how we approached the question of cost. We feel the principle of our offering – that Lenders receive the rate of return they would have achieved had they chosen to lend for the same length of time they end up lending for – is simple and fair. Yes, you give up some of the interest you have earnt but you are fully rewarded for your time in the market.
- So, a 5 Year Income contract sold out after 1 month receives the Monthly Access rate, after 12 months the 1 Year Bond rate, and after 36 months the 3 Year Income rate. These rates are based on a snapshot of the rates and markets that were available the day the contract was formed. As we add terms on RateSetter, the rates can become even more granular.
- We initially intended an additional 0.25% fee to discourage “abuse”. We have amended this fee to apply as a 0.25% minimum to your entire Sellout order.
- To smooth the sharpest drops, we have retrospectively applied the 1 Year Bond since its inception (Feb 2012) back to day zero. This has the effect of decreasing a sharp drop in return facing those Lenders who matched 3 Year Income rates before the 1 Year Bond existed.
- There is another potential cost as well. If rates rise, the contract must be refinanced at a higher rate. In this situation, the Lender will also incur an “Assignment Fee”. The assignment fee is used to compensate the new Lender (“the assignee”) for being matched with contracts with an interest rate that is less than his request. This ensures contracts can always be sold, though at potentially a higher cost if rates have moved against you – it also ensures there is no benefit to Sellout only to re-lend at better rates. If rates have fallen, the excess interest – rather than going to you or the new lender – goes to the Provision Fund.
- So, the overall cost of exit (the exit fee plus any assignment fee) can therefore vary depending on when the contract was originated and what the refinancing rate is. It is lower in the early stage of the contract (because the amount of interest foregone is so little) but can also be expensive because the assignment fee is most sensitive to interest rate increases when the remaining duration is highest.
- In total, the £174,868.54 that has been refinanced has cost 1.12%: 0.95% in exit fees and 0.16% of assignment fees.
Below we have set out a worked example, showing what happens when someone exits the 3 Year Income market at various stages during the 3 years and what the net return is.
Sellout is our latest step in creating a richer and more rounded offering that reflects how Lenders want to use RateSetter. It requires a lot of calculations (and processing power!) but we think it follows fair and simple principles and adds reliable liquidity to the list of advantages of lending on RateSetter. Thank you for all your comments so far, and please keep them coming – we will keep looking to innovate and respond.
Kind regards
The RateSetter Team
Sellout: A Worked Example.
£1,000 lent and reinvested for 3 Years at 7.8% (1st January 2011)
Sellout ensures your rate matches your commitment
Why this is so different to the way normal fixed income products work?
If I buy a £100 worth of a 7% corporate bond with a 10 year maturity @ par and then decide to sell two years later when market rates for that bond are 5%, through bond math I will get £112.93 from another buyer (less the spread and commission) and keep my £14 interest.
With Ratesetter though, not only do you ask me to give up some of the interest I have earned through taking extra duration risk, I also lose any capital gains I may have made to the provision fund. If I made a capital loss, I have to pay up via an “assignment fee”. Heads you win, tails I lose!
I respect that regulation likely makes it impossible for you to run a proper secondary marketplace and that this is the best you could achieve within current constraints. Maybe I’m missing something, but I don’t believe this should be described as “simple and fair” when it doesn’t seem to be either!
Thank you Greg. Yes, we will continue to review our secondary market and assignment fee in line with what we can do. In the meantime, we felt the Provision Fund (from which all RateSetter lenders benefit) was the right place for the assignment fee – it doesn’t go to RateSetter as a company. Re simple & fair, we designed the exit fee to create a system that gives people “what they would have got” even though they’ve ended up choosing to exit early. I concede it may not be simple – there are a huge amount of calculations for the computer to make with all those amortising payments! – but we feel it is fair for all lenders across the markets and we wanted to peg the exit rates to rates you our lenders have set, i.e. it’s a market-driven exit fee. We need to keep communicating the principle of “getting what you would have got” and perhaps improving the presentation on the exit screens but the idea of our new sell out development is that liquidity is pretty reliable and you will always get an amount of interest that rewards your time in the market.
I cannot but agree with Greg.
Where does the extra interest paid by the borrower go anyway (I understand the fee goes to the Provisional Fund)? I would have liked a proper secondary market, with Ratesetter showing the current “fair” value of the fixed income product you want to sell based on the current interest rates; it would have been then up to the seller to determine a price. I think that if this is implemented the liquidity and appeal of Ratesetter will improve greatly. I’m not opposed on a small fee for this, that should go to Ratesetter, not necesseraly the Provisional Fund (since no new risk was introduced in the market).
I’d just like to know if would be possible in the current regulatory framework. Do you think this would encourage speculation that would harm your borrowers?
Many Thanks,
Giacomo
Thank you Giacomo. To answer your questions, we will definitely look to continue to develop the secondary market within any regulatory guidelines. I don’t think a secondary market like you describe should harm the borrowers (who should be unaffected by any Sellout) and obviously in any development we would always make sure borrowers are protected as well as lenders. I hope this is helpful for now.
There seem to be multiple problems, with the “worked example” itself, and/or in the way that these “exit fees” are calculated if the “example” uses the same calculations as the real implementation…
Rather than a full-on rant pointing out errors one by one and suggesting fixes, I’ll simply point out the overall results:
1. after 36 months the loan is fully repaid anyway, so you’re charging £76.29 to cash out “nothing”.
2. after 34 months, there would be just 2 payments remaining, leaving a capital balance just over £61 (from a starting balance of £1000), yet you propose to charge an exit fee of £72.85 for this – where is the remaining £11 or so to come from, or will fees be capped at 100% of the amount being sold out?
I trust that if the errors are in the implementation rather than the example, that users who have already used this function will be refunded the difference between the fees they were actually charged and the fees they should have been charged under the correct calculation.
Thank you Steve. The example shows £1,000 continually reinvested – sorry that could have been clearer and we have since clarified that as you will see: “£1,000 lent and reinvested for 3 Years at 7.8% (1st January 2011)”. What we are trying to show here is what return you would get if you invested for 3 years and pulled out all your money at various stages – as you can see, while the cost of exit in absolute £ terms rises, so does your return over the period. In answer to your second question, where the sell out cost is higher than the outstanding capital plus accrued interest you cannot exit (there would be no point in exiting because you would get nothing back so it is better if the system just doesn’t allow you to sell out and just lets the contract run to term).
Thanks for your reply, and for the earlier discussion by phone.
Perhaps it would be useful if you could (also) put together an example of what I originally thought I was looking at – the sellout cost of a single £1000 loan without re-investment, where the investor intended to use it to draw an income for 36 months (as would be expected for a “3 year income” product), but later needed to access the capital early. It would also be more transparent in this example to show the fee as a % of sellout value.
As discussed by phone, it is this instance which I believe would currently show unreasonably high fees, due to clawing back interest from capital that has already been repaid, rather than just from the capital that is being sold out.
A calculation along the following lines would seem more in lines with user expectation, as well as being easier to calculate, both for your systems, and for a user who wants to check they’re being charged the right fee (at least approximately) with a standard calculator:
fee = [sellout capital value] * [interest rate MINUS alternate interest rate] * [time since investment]
For a “bond-style” product, where sellout capital value is equal to the original loan amount, this should essentially be the same as your current system.
“We initially intended an additional 0.25% fee to discourage “abuse”. We have amended this fee to apply as a 0.25% minimum to your entire Sellout order”
I’m not sure what ‘entire Sellout’ may mean or if it’s been added to just the amended term, so I may have the wrong end of the stick with my query…
Does this amendment mean that if there’s a sudden demand, then the withdrawal fee, currently set at its ‘minimum’ at 0.25%, is planned to be allowed to increase to dampen demand? Does this go to the Provisional Fund as well?
Also, can I ask if the “Assignment Fee” is the exact difference between old and new interest rates or might it be weighted when it is calculated?
Thanks for adding this facility
0.25% on entire sell out just means that the minimum fee is 0.25% on the entire amount you sell out. No, there are no current plans to increase this minimum above 0.25% and no, it doesn’t go into the Provision Fund (it goes to RateSetter). If there was a sudden demand for early exits you would expect the interest rates to go up which would mean the Assignment Fee would rise which in turn should dampen demand. And yes, the Assignment Fee is based on the exact difference between the old and new interest rates. I hope this is all clear and helpful.