Special Purpose Vehicle

The word "special purpose vehicle" or "special purpose entity" is a

buzzword in structured finance and can be potentially confusing.
Especially 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 corporation, a Special
propose 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-sustained 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 management decision: they are almost "brain
dead".
Apart from securitizations, 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. 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 SPEs
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
SPEthus, if the SPEs 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 owners 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.