[Pool] Untangled Digital Credit Fund

Hello Centrifuge Community,

We are pleased to announce UP Series 1 (“[UP1”) of Untangle Digital Credit Fund (“UDCF” “the Fund”), which represents our first offering to gain exposure to diversified Trade Finance Assets (“TFA”). UP Series LLC (“UP Series”) has launched UP Series 1 (the “Issuer”), a Delaware LLC, which will offer for sale to investors tokens, as described below, corresponding to participation interest in TFAs owed to the Issuer. Untangled Finance Limited has structured this offering.

The Issuer will issue two tranches of ERC-20 tokens: DROP Tokens and TIN Tokens. The DROP Tokens will make up 90% of the total asset pool, and will be offered for sale to investors on the terms described herein and in the Subscription Agreement provided to prospective investors. The TIN Tokens will make up the remaining 10% of the total asset pool, and will be subject to first losses up to the full amount of their value. The TIN Tokens will be purchased by Asset Originators, Untangled Finance and Centrifuge to demonstrate their confidence in the asset pool and to act as a buffer against losses to investors in the DROP Tokens.

About TFA Asset Class

TFA are short term, often self-liquidating financing in both domestic and cross border trade. TFA traditionally has a very low default rate. TFA Series will invest in TFA from multiple asset originators. 2 originators have signed up to supply assets to the Fund. They have good underwriting records with zero default rate to date. All asset originators are subject to due diligence by Untangled Finance.

  • Trade finance assets secured by accepted invoices or inventory
  • Asset term: Self-liquidating in 30 to 180 days
  • Legal form: Accepted invoices, Promissory notes
  • Security: Credit insured where possible
  • Default history: less than 0.5%

Trade finance gives investors access to a USD 15 trillion marketplace. This market has until recently been dominated by commercial banks. New regulations, however, have reduced their ability to meet demand. This has opened a window of opportunity to non-banking investors who want to enter a stable, well-established market that shows limited correlation to traditional credit classes.

With a current financing gap of USD 3.4 trillion, the opportunities are abundant. In the current low-interest rate environment, there is growing demand for trade finance loans amongst institutional investors. This is also due to its efficient return on capital and low default history. When accessed in a robust and diversified way, and where care is taken to limit possible idiosyncratic or volatile risk factors such as commodity price risk, we believe it can be a powerful diversifier as part of a traditional credit allocation.

As an investment, trade finance loans exhibit a number of attractive characteristics. They offer a yield pick-up over other liquid credits and are very efficient from a solvency capital perspective. With most of such loans being self-liquidating, short-dated, and often secured, the asset class also offers protection against default risk and market risk should the cycle turn. Trade finance can also provide an effective platform to realize responsible investment objectives.

Asset selection: Only assets that fit certain criteria e.g. amount, duration, borrower type, credit rating etc will be selected to the pool. This is to further ensure no over concentration of borrower exposures, making the pool more diversified.

About the Issuer

Untangled Finance, through UP Series LLC, is a digital credit fund focusing on bridging real-world assets to DeFi and doing so at scale.

Our objective is to source a diversified asset portfolio that offers, at scale:

  • Strong returns
  • Low risk
  • Broaden access to asset classes that are traditionally reserved to institutional investors

We are specifically focusing on the following asset classes:

  • Supply chain trade finance (TFA)
  • SME Financing
  • Green asset securitisation and green bonds issuance.

TFA opportunities differ widely in terms of complexity, and investors need to understand the true risk drivers behind the attractive returns. Untangled has spent a considerable amount of time assessing the market and possible entry points. We are confident that the strategy we offer benefits from the attractive aspects of the asset class, whilst limiting much of the downside.

Trade finance differs from traditional corporate loan funds because they focus on specific sales, whereas normal corporate credit tends to be non-specific in terms of the use of funds. The financing of a specific sales contract rather than lending to a corporate is really the key to why trade finance consistently outperforms credit.

Our strategy differs from other trade finance funds in the market both in its underlying philosophy and in its investment process. Portfolio construction is aimed at properly diversifying risk whilst still allowing for a robust analysis of each transaction on responsible investing and compliance due diligence criteria.

We aim for a highly diversified portfolio in terms of geography, industry, and counterparties, which we regard as defensive in times of geopolitical uncertainty. We use an integrated approach to rating and risk analysis that builds off Untangled Finance’s significant expertise in credit, supplemented by advanced credit analytic models.

We set out the vision of tokenizing supply chain trade finance in this whitepaper.

Pool Description

Untangled Finance has structured the pool to initially reflect a 90% vs 10% allocation to Drop & Tin, respectively. We structured the pool to ensure that there is sufficient coverage from Tin for the Drop tranche based on the characteristics of the underlying asset pool e.g. historical loss, average asset size, initial pool size for each asset originator selected to the pool.

(1) Asset originator makes an advance to a borrower.

(2)The asset originator accumulates a pool of assets then sells it to an SPV in Originator’s jurisdiction (Originator SPV). Originator SPV enters into a Master Participation Agreement with UP Series LLC (Issuer SPV).

(3) UP Series LLC issues DROP to investors according to the proposed parameters*.

(4) The proceeds from investment will then be used to pay the asset originator.

(5) At the end of the asset term, the obligor/borrower repays the asset plus interest into a bank account of Originator SPV. The Originator SPV remit the repayment to UP Series LLC’s bank account.

(6) The UP Series LLC converts the money in its bank account to Dai to pay investors back principal plus interest.

Credit Underwriting

UP Series LLC has a rigorous risk management framework:

  • Asset originator’s participation in Junior token is determined by institutional-grade reserve methodology developed by rating agencies. Initially these will be set at a conservative level.
  • Reserve is dynamic based on the deemed default and actual collection record. Positive collection results will lead to lower reserves for incoming assets and vice versa. The reserve will be calculated daily together with NAV
  • Credit insurance will be applied where possible. The credit insurers will take the first loss in case of default

INVESTMENT RISK FACTORS

Asset-Level Risk

  • Underlying Asset Payment Risk
    • Originator has experienced a 0% default rate in the last twelve months
  • Effects of the COVID-19 pandemic prove to be severe
    • Economic downturns may negatively affect the trade finance industry, which in turn may have a material adverse impact on the Issuer’s business operations and financial condition, including the Originator’s ability to generate or acquire Underlying Assets, or to collect payments on the Underlying Assets.
    • The COVID-19 pandemic has contributed to a significant decline in consumer demand in many industries. This decline in demand may negatively affect the trade finance industry, and in turn negatively affect the Issuer as described above.
    • In addition, laws, orders, public guidance and other measures taken by governments worldwide in response to the COVID-19 pandemic are unpredictable, and continued developments in response to changing conditions are likely. Laws, regulations and orders which may adversely affect the operations of businesses in general may also adversely affect the businesses of the Originators, the Suppliers and Buyers with which they transact, and the Trade Finance industry generally. At this time, such impacts are difficult to predict in nature, scope and duration, and may continue to change as the COVID- 19 pandemic continues.
    • The business operations of each of the Originators, the Suppliers and Buyers with which they transact, the Trade Finance industry generally, and any third parties that any of the foregoing may rely on in connection with the transactions contemplated in this offering may be adversely impacted by the effects of COVID-19 on their respective directors, officers, employees, agents and representatives.

Security-Level Risk

  • Other DROP’ Default Risk
    • This DROP token is not cross-collateralized with any other DROP and this DROP will be the only outstanding obligation of the SPV Series during the token’s life
  • Breach of Contract Risk
    • Under the terms of the Purchase Agreement entered into between the SPV and the Originator, the latter shall be obligated to repurchase the asset from the SPV in the event there is a breach of representations and warranties
    • The SPV has recourse to the Originator in the event it does not honor the PA
  • Illiquidity Risk
    • DROP token holders are able to redeem at any time by making a redemption request. Underlying assets are also short term (less than 90 days)
  • Regulatory-risk
    • The DROP token is exempt from SEC registration via Regulation D, and all necessary filings have been completed by Untangled Finance or its legal counsel to affect this status

Counterparty Risk

  • Originator Insolvency Risk
    • Investors are purchasing a token issued by an industry-standard bankruptcy-remote SPV that Untangled Finance has established to protect investors

In Summary, we bring

  • Diversification - avoid over concentration in a single originator, geography, borrower segment and collateral type
  • Safety - institutional-grade risk management framework consisting of 3 layers: credit insurer, junior participation, over collateralisation
  • Transparency: daily on-chain portfolio performance tracking
  • Premium returns over equivalent investments

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