Special Purpose Vehicle
The word "special purpose vehicle" or "special purpose entity" is a buzzword in structured finance and can be potentially confusing. Specially after the Enron collapse, the word SPE has acquired an unpleasant connotation in public mind.
The word "vehicle" is a marketplace equivalent of "entity". Therefore SPV and SPE mean the same thing. As opposed to a general purpose vehicle or a trading corporationg, a Special puropose vehicle, as the name suggests, is formed for a special purpose: therefore its powers are limited to what might be required to attain that purpose and its life is destined to end when the purpose is attained.
When a corporation, call it the sponsor of the SPV, wants to achieve a particular purpose, for example, funding, by isolating an activity, asset or operation from the rest of the sponsor's business, it hives off such asset, activity or operation into the vehicle by forming it as a special purpose vehicle. This isolation is important for external investors whose interest is backed by such hived-off assets,etc., but who are not affected by the generic business risks of the entity of the originating entity. Thus SPVs are housing devices - they house the assets etc transferred by the originating entity in a legal outfit, which is legally distanced from the originator, and yet self-substained as not to be treated as the baby of the originator.
By its very nature, an SPV must be distanced from the sponsor both in terms of management and ownership, because if the SPV were to be owned or controlled by the sponsor, there is no difference between a subsidiary and an SPV.
Being an independent, an SPV is responsible for its own funding, risk capital and management decisions. Most SPVs, for example, securitization SPVs, run on a pre-punched program and do not have to take any managemenet decision: they are almost "brain dead".
Apart from securitisations, SPVs are often used for many purposes. One common purpose is to use them for what is known as "synthetic leases" - a device by which assets are acquired under an off balance sheet lease from the vehicle that funds them with debt. [For more on synthetic leases, see John Murray's article here and generally on leasing, Vinod Kothari's leasing site]. After the Enron collapse, the public has come to know for the first time the all kinds of obscure SPVs floated by US companies.
The key issue in examining an SPV is distancing of the SPV as far as management, control and shareholding is concerned. If the SPV stands on its own feet in terms of ownership, funding and management, it achieves an arms length relation with its sponsor and therefore becomes just like any other relationship.
But the real issue is that most SPEs are figments floated by the originator and are hardly independent in any sense. The mechanical rules that define SPEs are largely responsible because these rules, based on a certain amount of risk capital in the SPE are easy to circumvent.
The present rules (the FASB is setting up new rules for SPEs - see elsewhere on this page) set out in an interpretation called EITF 90-15 are as follows:
1. A third-party owner (or owners) independent of the sponsor has a sufficient equity investment in the SPE;
2. The independent third-party owner (or owners) investment is substantive (generally meaning at least 3 percent of the SPE’s total debt and equity or total assets);
3. The independent third-party owner (or owners) has a controlling financial interest in the SPE (generally meaning that the owner holds more than 50 percent of the voting interest of the SPE—thus, if the SPE’s total equity is only 3 percent of total assets, all of its equity must be held by one or more independent third parties); and
4. The independent third-party owner (or owners) possesses the substantive risks and rewards of its investment in the SPE (generally meaning the owner’s investment and potential return are “at risk” and not guaranteed by another party).
If all the above conditions are satisfied, the SPV will not be consolidated with the parent.
- See FASB Chief's testimony before Subcommittee on Commerce Trade and Consumer Protection (Enron case) on FASB site here.
Other relevant pages on this site:
- Page on accounting issues.
- Also see page on securitsation cases for SEC order in PNC Capital's case for misuse of SPEs.
More on SPEs and QSPEs
- See our news article on 'Yet another shock to bankruptcy remoteness - UK Chancery Court defends attack by Lehman counsels,' the ruling of the Chancery Court dated 7, August, 2009 - Vinod Kothari discusses this significant English ruling and the fragility of the concept of bankruptcy remoteness in the current environment
- [Added 12th Dec 2006] Paper by Gorton and Souleles on special purpose vehicles - examines, among other things, that pricing of securities by SPVs takes into consideration bankruptcy risk of the sponsors; also here
- NBER working paper (march 2005) on Securitization and Special Purpose vehicles
- For detailed compendium on what are SPEs and QSPEs, and how they came about, see Prof R Jensen's page here. This has lots of recent additions over time.
- See our page on FIN 46
- Dr Bala Dharan has written an excellent article on SPEs - tracking their history in the 1970s, various types of SPEs, their misuse, etc. A very readable article - click here. For more by Dr Dharan, see http://www.dharan.com/
- Article by Prof Steven Schwarcz on uses and abuses of SPEs on our premium section - click here to register
- The FASB has come out with an exposure draft of the interpretation on consolidation of SPEs with the books of the primary beneficiary in certain cases. See our page on accounting issues for details
- We have carried brief excerpts from articles by Standard and Poor's and Nomura Securities on our news page here.
- KPMGs' guidance on SPVs - click here
- Jeffrey Taylor's article on off balance sheet financing makes an interesting reading: click here