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Glossary

Special Purpose Vehicle (SPV) / Special Purpose Entity (SPE)

Category — Market Participants
This is a special purpose vehicle (SPV) or special purpose entity (SPE), which is created for specific purposes. SPVs are quite actively used due to the fact that they are free from previous debt and obligations and are separated from their founding companies, which create them, among other things, to facilitate accounting and in order to reduce taxes, issue debt obligations, and securitization.

One type of SPV is the Structured Investment Vehicle (SIV). It is an SPV which is set up to buy high-risk bonds (such as mortgage securitization). Modern software allows you to create models that forecasts the cash flow on such bonds in different market conditions, as well as control the risks associated with SIV activities. SIVs are usually funded by primary investors (also called capital bondholders) and through short-term bond issues (commercial issues). The profit is derived from the difference between the coupon paid on short-term borrowings and the coupon received on long-term investments. The profit is split between the holders of the capital bonds and the investment manager (the company that runs the SIV, in most cases is represented by a bank).

Reasons to use
a. Usually they are created for a specific goal, project, implementation of a financial transaction, the purchase of assets, joint ventures or to isolate the assets or operations of the parent company. An SPV can be either on a balance sheet or off the balance sheet of the parent company.
b. Protection of funds and assets. Allowing the parent company to maintain a higher level of asset and liability management. It also reduces the risks of the parent company; thus it allows to obtain a higher credit rating. It reduces financing costs and provides more financial flexibility with lower capital requirements.
c. Protection against bankruptcy and creditors. It allows the parent company to carry out high-risk financial transactions or investments without jeopardizing the solvency of the entire company. If the SPV’s investment turns out to be unprofitable or the SPV goes bankrupt, these processes will not affect the parent company.
d. Easy financing conditions. It provides a possibility for the company to obtain financing and make transfers of debt with a higher level of risk.
e. Lighter legal requirements. These companies are not subject to the same requirements as the parent companies, which gives SPVs more leeway.
f. Investment strategy. It allows the parent company to check the investment opportunity before getting involved in the process itself.
g. Confidentiality. It may help in maintaining commercial secrets from competitors or investors in the parent company who may not approve a particular transaction or asset allocation.

The benefits and risks associated with the SPV
Benefits:
a. Isolated financial risk.
b. Direct ownership of a specific asset.
c. Tax incentives if the company is incorporated in a tax offshore.
d. Ease of creation.

Risks:
a. More difficult access to the capital at the SPV level (since this company does not have the same capabilities as the parent company).
b. If an asset is sold, it may be revalued at the market value, which could seriously affect the parent company’s balance sheet.
c. Changes in the legislation can cause problems in the use of SPV.
d. Sometimes there is a negative information background around SPV.

Ireland, the Caribbean Islands (British Virgin Islands, Bermuda, Cayman Islands) and the Channel Islands (Jersey, Guernsey) are the most common places of registration for SPVs.
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