The value of used vehicles can swing wildly depending on factors that include demand, supply and residual values and that fact has long been an issue for both large fleet owners and insurance companies, especially when values tank.
But fintech startup Exponential Exchange has jumped into the market to help mitigate that risk combining what it terms the first tradeable index for the used vehicle market and a slate of derivative products—similar to the way energy or agriculture futures markets operate.
“This way, a fleet owner or insurance company could hedge a portion of their exposure via a derivatives contract – with our index determining the cash price of those assets on the agreed-upon settlement date,” wrote Paul Fortin, Head of Index Products at Exponential Exchange in a recent blog post.
A derivative is a type of financial contract whose value is dependent on an underlying asset, group of assets, or benchmark between two or more parties that can trade on an exchange or over-the-counter (OTC) according to Investopedia.
They’re commonly used to access certain markets and can be traded to hedge against risk.
The risk against used vehicle price fluctuations for insurance companies and large fleet owners is considerable which Exponential Exchange aims to temper through its new offerings.
“There’s about $500 billion dollars in unhedged exposure, and this is an effective hedge for the auto ecosystem,” said Fortin in an interview. “What we’re doing is basically just tweaking what currently exists and what other industries are currently using and have leveraged for decades. What is completely new, is that we’re doing it in the used car space and that we’re creating a tradeable index.”
Indeed, tradeable indexes date back as far as the 1896 establishment of the venerable Dow Jones Industrial Average Index widely depended upon to gauge the health of the U.S. economy by tracking 30 blue chip stocks traded on the New York Stock Exchange and NASDAQ.
Today, there are hundreds of other indicies tracking prices in a wide swath of industries including metals, agriculture, energy, stocks and bonds.
Perhaps the most prominent in the used vehicle segment is the closely-watched Manheim Used Vehicle Value Index, or MUVVI.
There’s a loose relationship with Manheim. The new Exponential Used Vehicle Index, in part, draws from National Auto Auction Association AutoData into which Manheim feeds data.
NAAA AutoData represents about 80% of U.S. wholesale vehicle auction transactions according to Exponential Exchange.
For the consumer, talk of a new, tradeable used car index, derivatives and hedging isn’t all high finance. Exponential’s Paul Fortin explains both insurance premiums and the cost of auto leasing could be affected by mitigating risk in both segments.
Regarding insurance companies, Fortin uses the example of an insurer setting the premium for a used vehicle originally valued at $10,000. If it’s totaled in an accident but the cost of replacement is now $13,000, then the insurance company is taking a hit.
But by lowering its risk,“this should stabilize that because if I’m a large insurance company, ABC, and I know that I have protection, it stabilizes the prices in the market,” Fortin said.
By the same token, Fortin asserts risk mitigation will also be helpful in protecting automakers from price fluctuations, especially with regard to leasing, explaining, “if we can increase the if we can basically take away the pricing uncertainty for auto manufacturers, then yes, then there’s a chance that this could work and it actually that was a chance that basically you could have higher lease penetration.”
In addition,“We’re taking the asset risk off the table for a captive finance company for a rental car company, and then that basically helps them free up different aspects of their business, right from a planning perspective from a weighted average cost of capital perspective, but that has immediate benefits for them,” Fortin said.
The Exponential Used Vehicle Index is available on a Bloomberg terminal, other financial and analytics platforms, on the Exponential Exchange website and on the website of Exponential’s calculation agent, Solactive.
At this point, Exponential is working on derivatives trades via over-the-counter transactions, although no OTC deals have yet to be executed but that’s expected to happen by the end of this year, according to Fortin.
The goal is to move to the major exchange and “we’re in negotiations with a couple of exchanges right now,” Fortin said, although he wasn’t at liberty to reveal specific names.
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