Cadence | The Logistics of Protecting Your Investments

The Logistics of Protecting Your Investments

The #1 priority at Cadence is protecting investors’ capital. The investment platform we’ve built allows you to easily sign-up for an account, explore curated opportunities, transfer funds and ultimately put your hard earned capital to work. But what’s going on behind the scenes to ensure your money is safeguarded? How are we making sure your investment performs inline with objectives? If all investments carry risk, what exactly are we protecting you against?

In order to answer these questions, let’s first dive into my favorite topic (risk!) and explore two types of risk that are specific to all available offerings on Cadence.

There are Many Types of Investment Risk, We Actively Manage Two

Investments of any kind carry many different risks. Just as we make risk-adjusted decisions in day to day life, investors must also contend with a myriad of variables that may impede their ability to earn a positive return. Inflation risk, interest rate risk, reinvestment risk, market risk, liquidity risk and concentration risk are just a handful of considerations. While most of these risks are common to all investments, the two defined below directly impact our offerings. And since these two are the most prevalent, Cadence actively manages them for your benefit.

Asset-Level Performance Risk

When most people hear the word risk in the context of making an investment, they are typically thinking about performance risk. Buying stock in a public corporation captures a piece of that company’s cash flows, growth and profitability. Performance is reflected in share price. Buying a mutual fund subjects an investor to that fund manager’s ability to track or outperform a benchmark index. Performance is visible in historical returns.

Similarly, investing in Cadence offerings grants an investor unique exposure to the performance of underlying assets. While these assets can take many forms, like receivables, loans and cash advances, they all inherently carry asset-level performance risks. When a retailer doesn’t pay an invoice on time or when a consumer fails to make a credit card payment, these actions directly impact the expected cash flows of these underlying contracts. Performance here is reflected in your return of capital plus some positive value, as marketed.

We at Cadence are acutely aware of these asset-level performance risks. While the typical high yield ascribed to our offerings compensates investors primarily for this particular risk, we painstakingly structure every offering to mitigate as much uncertainty as possible. Internal and external credit enhancements such as overequatization, cross-collateralization and/or credit insurance are embedded into every offering and are a key part of our risk management strategy. You can think of these credit enhancements as built-in “buffers” or “cushion” in the event that all the underlying assets don’t perform to expectations. Basically, a little “wiggle-room” so that the underlying asset portfolio as a whole has a higher chance of delivering what investors expect from their investment.

Counterparty Risk

A less considered risk among public market investors, although quite obvious in the private markets, is counterparty risk. Counterparty risk is defined as the risk of an entity involved in a financial contract defaulting and therefore not honoring its obligations. Most public market activity such as stock transactions are executed through well-known, highly regulated third party exchanges and clearinghouses like the NYSE or NASDAQ. Therefore, in these instances investors have virtually no counterparty risk.

Investor <-----> Borrower

However, most private market activity as well as over-the-counter derivatives are executed directly between two or more parties. Therefore, the risk that the parties may not know each others’ financial health and subsequently may not honor their obligations is much higher. With Cadence and our originator partners serving as counterparties to investors and the underlying assets, we inherently expose our investors to counterparty risk. To be explicit, this is the risk that Cadence or an originator partner becomes incapable of fulfilling its obligations for any reason including bankruptcy, insolvency or default.

Investor <--- Cadence <---> Originator <--- Borrower

Akin to our awareness and management of asset-level performance risk, we are hyper-focused on our need to mitigate counterparty risk to the utmost extent. While the former is commensurate with the rate of return investors can expect from their investment, the latter is intolerable in our view. It is for this reason that we’ve created a robust internal diligence process and legal apparatus to drive the logistics behind every dollar you bring to the Cadence platform.

How Cadence Combats Counterparty Risk

Virtually all online investment platforms carry some degree of counterparty risk. This exposure could come from the platform itself or trusted third parties involved in any given investment. At Cadence, we directly address both.

Originator Counterparty Risk

Beyond our near-obsessive onboarding and ongoing diligence process for all originators we partner with, we take several additional steps to mitigate originator counterparty risk.

On the operational side, we stipulate in our Master Participation Agreements with each originator that all cash flows emanating from underlying assets are paid to our investors first until all obligations have been met. Furthermore, cash coming into an originator is immediately wired to Cadence rather than sitting in the originator’s accounts. This technique is similar to payment-netting, which is widely adopted in the international derivatives markets and is a standard method of reducing potential future counterparty exposure. In the event the originator ceases to operate, all associated cash flows up until that date will have been already received by Cadence to service the underlying investment.

On the legal side, we obtain security interests, when applicable, in the originator’s underlying assets through UCC filings. This helps protect these assets against claims from other creditors if the originator ever went bankrupt. While we never anticipate our originators to cease operations, this is the final recourse our investors have on any remaining obligations due in association with their investment. Cadence would manage the entire recovery process on behalf of investors in this unlikely scenario.

Cadence Counterparty Risk

Just as we thoroughly diligence our partners, we performed a similar exercise on ourselves and developed a robust risk management framework to address potential issues.

Operationally, we ensure every potential offering is properly structured, vetted and reviewed through a formal deal committee. This standardized committee review process ensures Cadence is always acting as a whole to protect investors from poorly structured offerings and abide by all of its legal obligations. These preventive measures strengthen Cadence’s operational success and bolster its likelihood to continuing operating its platform going forward.

If the unlikely scenario of Cadence ceasing its operations becomes a reality, users and investors of our platform are fully protected. All investors’ uninvested funds are deposited in separate FDIC insured bank accounts and are not commingled with Cadence’s operational bank accounts. This means you are legally entitled to your own money placed on the platform and all funds would be automatically returned to the bank account of your choice. All investors’ funds invested in current opportunities, yet to be settled at the time of a hypothetical Cadence insolvency, would also be fully protected. This is done through our use of industry standard special purposes vehicles (SPVs).

What are SPVs and How Do They Protect You?

SPVs are nothing new. These are legal organizational entities, typically formed through limited partnerships (LPs) or limited liability corporations (LLCs) and have been around for decades. As the name implies, these entities are specially created by parent entities (like Cadence) to isolate assets and keep them off the parent company’s balance sheet. While the parent manages the operations of the SPV, it remains a separate legal entity with its own balance sheet and financial health.

Investor <--> SPV<--Originator <---Borrower

This structure effectively creates a bankruptcy-remote entity whereby owners, debt holders or interested parties of this newly created SPV are left completely unaffected by the parent’s financial, operational and/or legal health. If the parent becomes insolvent, SPVs continue operating and its assets are fully protected against any and all creditor claims on the parent. A third party manager would be appointed in this scenario to ensure operations continue under the SPV so that investors are not impacted whatsoever by the parent’s inability to continue operations and manage the SPV.

Ready to Buckle Up in Cadence’s Special Purpose Vehicles?

Every investment offering Cadence makes available to investors is structured through a bankruptcy-remote SPV. All the assets we amass and structure from our originator partners are contained within dedicated SPVs for that particular offering or that particular originator. Investors are therefore purchasing a security issued by the SPV to gain exposure to those underlying assets that are effectively pledged by the originator. We use this structure for several reasons:

  • Bankruptcy-remote to protect investors in the event of Cadence insolvency
  • Afford us the flexibility we need to structure unique investment offerings
  • Cost-efficient method that ultimately translates into higher returns to investors
  • Industry standard technique with plenty of legal precedents

When you deploy capital into an investment on Cadence, our dedicated SPVs handle many of the details. They retain secured claims on assets, issue regulated securities, send and receive cash flows and ultimately return your investment. Cadence manages this process from start to finish, but this SPV structure is the backbone of how we deliver high quality investment offerings to your fingertips and protect your hard earned money.

All investments carry risk, but our commitment to doing the heavy lifting to protect your capital is the heart of our platform.

Author
Prath Reddy
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