Special Purpose Vehicle (SPV)

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is The Special Purpose Vehicle?

Special Purpose Vehicle (SPV) is a separate legal entity mostly created for a single, well-defined and specific lawful purpose. It acts as the bankruptcy remote for the main parent company.

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Special Purpose Vehicle (SPV) (wallstreetmojo.com)

In case of the company’s bankruptcy, the SPV can carry out 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.

Special Purpose Vehicle Explained

A Special Purpose Vehicle, also known as Special Purpose Entity (SPE), is set up to mitigate financial risks to the utmost possible extent. Poor risk management and no clear understanding of the implied risks lead to the downfall of some high-profile companies and businesses. In such a scenario, SPV becomes an entity that helps companies assess risks and deal with them.

Several regulatory and transaction methods have been changed for special purpose vehicles after the collapse of Lehman Brothers in 2008. The documentation process should now be compliant with the Basel IIIBasel IIIBasel III is a regulatory framework designed to strengthen bank capital requirements while also mitigating risk. It is an extension in the Basel Accords, designed and agreed upon by members of the Basel Committee on Banking Supervision.read more 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 – governance, oversight, motivation, and assessment. Thus, SPV’s creation by any company can be seen 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.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Purpose

The SPV is established by a company with the specific objective of keeping it protected from financial risks in the event of bankruptcy. However, there are multiple other reasons why an entity must have a special purpose vehicle. Some of them have been listed below:

Special Purpose Vehicle (SPV)

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Special Purpose Vehicle (SPV) (wallstreetmojo.com)

#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 isolate the risks involved in projects or operations legally.

#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 securitiesMortgage-backed SecuritiesA mortgage-backed security (MBS) is a financial instrument backed by collateral in the form of a bundle of mortgage loans. The investors are benefitted from periodic payment encompassing a specific percentage of interest and principle. However, they also face several risks like default and prepayment risks.read more, the bank can separate the loans from the other obligations it has by just creating an SPV. Therefore, this special purpose vehicle allows its investors to receive any monetary benefits before any other debtors or stakeholders of the company.

#3 – Easily Transfer Non Transferable Assets

reason, an SPV is created to own such assets. If the parent company wants to transfer the assets, they 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 processesMergers And Acquisitions ProcessesMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more.

#4 – Hold Company’s Key Properties

An SPV is sometimes created 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 pay the tax on its capital gains rather than on the proceeds of the sale of the property.

Examples

Let us consider the following examples to understand how SPVs work and isolate financial risks:

Examples of Special Purpose Vehicle

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Special Purpose Vehicle (SPV) (wallstreetmojo.com)

#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. However, it had created these SPVs mostly to hide these billions of dollars in debt, which resulted from failed projects and deals.

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

On Dec 2, 2011, Enron shut its SPVs and filed for Chapter 11 bankruptcy.

#2 – Bear Sterns

Bear Stearns had created multiple SPVs intending to raise securitized loans using the assets helped by the SPVs. However, it continued to take significant exposure and eventually collapsed when it could not revive the company even after closing all the SPVs. After this failed emergency rescue, Bear Stearns was finally sold to JP Morgan Chase in 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 did not have a proper documentation process. It resulted in piling unforeseen liabilities, which could never be resolved, and the Lehman Brothers had to announce bankruptcy in the year 2008

Benefits

When a company sets up an SPV, it is likely to enjoy many benefits out of it. A few of them are as follows:

Limitations

Though the advantages of a special purpose vehicle are many, it doesn’t make it flawless. There are a few disadvantages of having an SPV too, which companies setting them up must know of. Here is a list of some of them:

Special Purpose Vehicle (SPV) Vs Joint Venture (JV)

SPV and JV are the two terms that play a major role in the corporate sector when it comes to risk management. However, these two differ widely in multiple aspects. Let us a have look at the differences between them:

  • JV is a setup where two or more parties come together for a business and share rewards and risks equally. On the other hand, SPV is an arrangement of a parent company to look after the financial risks associated in the event of financial crisis or bankruptcy.
  • While JV is a long-term arrangement that blossoms as a partnership between the parties involved, SPV is a short-term setup established to serve a specific purpose.

Recommended Articles

This article has been a guide to what is Special Purpose Vehicle (SPV). Here, we explain the concept with examples, vs joint venture, benefits, and purpose. You can learn more about accounting from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *