New Union recently announced that it has appointed Vistra Trust as an escrow agent to hold crowdfunded funds. Vistra is an international trust company and is licensed and regulated by MAS. This news is positive development for p2p lenders because it reduces the counterparty risk of the lending platform. Besides New Union, Funding Societies also uses an escrow agent to hold crowdfunded loans.
What is an Escrow Agent and what benefits does it bring?
Without an Escrow Agent, the cash from borrowers and lenders are held at the platform company. Although this could be on separate bank accounts, there is still the possibility of the platform company using lender’s cash for its own operations. Also, if the platform company goes bankrupt, the lenders’ cash may be subject to claims by all creditors of the platform company. See here and here on platform risk and cash management.
An Escrow Agent holds the cash from borrowers and manages cash-flows between the different parties. The cash from lenders are legally segregated from the accounts of the platform company. In other words, lenders’ money is lenders’ money; the platform company is not supposed to touch it to support its own operations. The escrow agent also help to protect lenders’ cash if the platform company goes bankrupt.
To summarize, an escrow agent system gives lenders additional protection against platform risk. Personally, I use platforms both with and without escrow agents. For those platforms without an escrow agent, I typically spend more time assessing the platform company’s credit and management integrity. Finally, it is important not to confuse borrower risk with platform risk. Having an escrow agent will not protect against weak underwriting.