Special Purpose Vehicle (SPV)

What is the Special Purpose Vehicle?

Special Purpose Vehicle (SPV) is a separate legal entity which is mostly created by the company for a single, well-defined and specific lawful purpose and also acts as the bankruptcy-remote for the main parent company. In case of bankruptcy of the company, the SPV can carry its obligations as the operations are restricted to the buying and financing of specific assets and projects.

The terminology or importance of a special purpose vehicle came into much usage and popularity after the Enron debacle.

Examples of Special Purpose Vehicle (SPV)

Examples of Special Purpose Vehicle

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#1 – Enron

By 2000, ENRON was known to create hundreds of SPVs and would transfer the quickly-earned money in the form of profit by the rising stock to them and receive cash in return. It had created these SPV’s mostly to hide these billions of dollars in debt, which resulted from failed projects and deals.

In 2001, When the reality came into light and the debts were uncovered, the share price tumbled from $90 to lesser than $1 in just a few weeks; shareholders had to bear a loss of approximately $11 billion.

On Dec 2, 2011, Enron had to shut its SPV’s and filed for Chapter 11 bankruptcy.

#2 – Bear Sterns

Bear Sterns had created multiple SPV’s intending to raise securitized loan using the assets helped by the SPV’s. It continued to take significant exposure and eventually collapsed when it could not revive the company even after closing all the SPV’s. After this failed emergency rescue, Bear Sterns was finally sold to JP Morgan Chase in the year 2008.

#3 – Lehman Brothers

The story of Lehman Brothers and its failure is not hidden. The insolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more of the pillar in 2008 was proof of the weaknesses in maintaining the SPV’s created and their documentation where the Lehman Brothers acted as the SWAP Counterparty. Most of the SPVs were either not registered, or no proper documentation process was done. It resulted in piling unforeseen liabilities, which could never be resolved, and the Lehman Brothers had to announce bankruptcy in the year 2008.

Purpose of Special Purpose Vehicle (SPV)

Special Purpose Vehicle (SPV)

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#1 – Risk Mitigation

Any company entails a significant amount of risk in its regular operations. The SPVs established helps the parent companyParent CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more to legally isolate the risks involved in projects or operations.

#2 – Securitization of Loans/Receivables

Securitization of loans and other receivables is one of the most common reasons to create an SPV. In the case of mortgage-backed securities, the bank can separate the loans from the other obligations it has by just creating an SPV. This special purpose vehicle, therefore, allows its investors to receive any monetary benefits before any other debtors or stakeholders of the company.

#3 – Easily Transfer Non Transferable Assets

Transferring a company’s assets are either non-transferable or very difficult, and for the same reason, an SPV is created to own such assets. If the parent company wants to transfer the assets, they simply sell off the SPV as a self-contained package rather than splitting any asset or having various permits to do the same. Such cases occur in the case of mergers and acquisitions processes.

#4 – Hold Company’s Key Properties

An SPV is created sometimes to make it hold a company’s property. In cases when the property sales are much higher than the capital gains for the company, it will choose to sell the SPV rather than the properties. It will help the parent company to pay the tax on its capital gains rather than on the proceeds of the sale of the property.

Benefits

Limitations

Conclusion

Poor risk management and no clear understanding of the implied risks have led to the downfall of some high profile companies and businesses.

Several regulatory and transaction methods have been changed for the special purpose vehicles after the collapse of Lehman Brothers in 2008. The documentation process should now be compliant with the Basel III norms, earlier Basel IIBasel IIBasel II is the second set of regulations concerning Minimum Capital Requirement, Supervisory Review, Role and Market Discipline, and Disclosure. The Basel Committee on Bank Supervision developed the regulations for international banks in order to ensure a transparent and risk-free banking environment.read more. It is now particularly going through the below checkpoints :

The risks can be further handled better with four essential practices:

  1. Governance
  2. Oversight
  3. Motivation
  4. Assessment

Thus, we see SPV’s creation by any company as the two sides of the same coin. Given the failures, policies have been made tighter to see that the pros of an SPV can be increased effectively.

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