Case Studies covered:- 1) Vishal Acquisition 2) PPP Projects 3) SBI Capital raising 4) Enron Accounting Scandal

1. Sahil Goel
November 28, 2015
Email: sahil_goel_student@yahoo.co.in
Concept of Special Purpose Vehicle
AND RELATED CASE STUDIES

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Contents
Meaning of Special Purpose Vehicle (SPV):- _______________________________________ 2
Types of SPVs __________________________________________________________________ 3
Feature and Uses of SPV ________________________________________________________ 3
Securitization _______________________________________________________________________ 3
Asset transfer _______________________________________________________________________ 4
Financing ___________________________________________________________________________ 4
Risk sharing ________________________________________________________________________ 4
Financial engineering________________________________________________________________ 4
Raising capital ______________________________________________________________________ 4
Competitive Purpose: ________________________________________________________________ 4
PPP Model of SPV: ___________________________________________________________________ 4
Key benefits to sponsoring firms ________________________________________________ 5
 Hives off the risks_______________________________________________________________________ 5
 Minimal red tape _______________________________________________________________________ 5
 Clarity of documentation ________________________________________________________________ 5
 Regulatory Compliance __________________________________________________________________ 5
 Freedom of jurisdiction __________________________________________________________________ 5
 Tax benefits____________________________________________________________________________ 5
 Legal Protection ________________________________________________________________________ 6
 Meeting regulatory requirements__________________________________________________________ 6
Key risks to sponsoring firms____________________________________________________ 6
 Lack of transparency ____________________________________________________________________ 6
 Reputational risk _______________________________________________________________________ 6
 Signaling effect _________________________________________________________________________ 6
 Franchise risk __________________________________________________________________________ 6
 Liquidity and funding risk________________________________________________________________ 6
 Equity risk _____________________________________________________________________________ 6
 Mark-to-market risk ____________________________________________________________________ 6
 Regulation_____________________________________________________________________________ 6
Enron Case Study_______________________________________________________________ 7
ONE OF THE biggest accounting frauds of US history___________________________________ 7
Public-Private Partnership Case Studies:-_________________________________________ 8
SBI to Raise Capital through SPVs - Case Study: ___________________________________ 9
Conclusion:- ___________________________________________________________________ 9
Sources: _______________________________________________________________________ 9

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Meaning of Special Purpose Vehicle (SPV):-
A Special Purpose Vehicle (SPV) sometimes referred to as a Special Purpose Entity (SPE) is a legal
entity created by the sponsor or originator, to fulfil a temporary objective of the sponsoring firm.
Its powers are very restricted and limited and its life is destined to end when the purpose is attained.
SPVs can be viewed as a method of disaggregating the risks of an underlying pool of exposures held by the
SPV and reallocating them to investors willing to take on those risks. This allows investors access to investment
opportunities which would not otherwise exist, and provides a new source of revenue generation for the
sponsoring firm.
A SPV may be incorporated as a corporation, a trust, or a partnership firm. Consequently, the
provisions of the parent law for incorporation of such entity, i.e., the Companies Act, Trust Act, the
Partnership Act, etc. will apply to the formation of such SPVs.
“SPV is a legal entity created by the sponsor or
originator, to fulfil a temporary objective of the
sponsoring firm”
SPV
Risk
Balance Sheet
Disaggregating the risk

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Types of SPVs
The type of SPV floated depends upon the purpose to be fulfilled by such a SPV. But just for
classification we can categories SPVs as:-
1. On- Balance sheet SPV; and
2. Off- Balance sheet SPV.
On- Balance sheet SPV Off- Balance sheet SPV
An ‘on-balance sheet SPV’ is that entity whose
financial results are consolidated with the
results of its sponsor.
An ‘off-balance sheet SPV’ is that entity whose
financial results are not to be consolidated with
the results of its sponsor.
In the case of on-balance sheet SPV the income
or receivables are by some way or other
transferred to the sponsor company.
In the case of off-balance sheet SPV the income
or receivables are not transferred to the sponsor
company.
Feature and Uses of SPV
Some common uses of SPVs are as follows:-
SECURITIZATION – SPVs are the key characteristic of a securitization and are commonly used to
securitize loans and other receivables. This was the case with the US subprime housing market crisis
whereby banks converted pools of risky mortgages into marketable securities and sold them to
investors through the use of SPVs. The SPV finances the purchase of the assets by issuing bonds
secured by the underlying mortgages.
SPONSOR
SPV SPV
Public

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ASSET TRANSFER – Many assets are either non-transferable or difficult to transfer. By having a SPV
own a single asset, the SPV can be sold as a self-contained package, rather than attempting to split
the asset or assign numerous permits to various parties.
FINANCING – A SPV can be used to finance a new venture without increasing the debt burden of the
sponsoring firm and without diluting existing shareholders. The sponsor may contribute some of the
equity with outside investors providing the remainder. This allows investors to invest in specific
projects or ventures without investing in the parent company directly. Such structures are frequently
used to finance large infrastructure projects.
RISK SHARING – SPVs can be used to relocate the risk of a venture from the parent company to a
separate orphan company (the SPV) and in particular to isolate the financial risk in the event of
bankruptcy or a default. This relies of the principle of ‘bankruptcy remoteness’ whereby the SPV
operates as a distinct legal entity with no connection to the sponsor firm. This has been challenged
recently, post financial crisis with several court rulings that SPV assets and funds should be
consolidated with the originating firm.
“A bankruptcy remote company is a company within a corporate group whose bankruptcy has as
little economic impact as possible on other entities within the group. A bankruptcy
remote company is often a single-purpose entity.”
FINANCIAL ENGINEERING – The SPV structure can be abused to achieve off-balance-sheet
accounting treatment in order to manipulate more desirable financial and capital ratios or to manage
regulatory requirements (for example to meet Basel II Tier 1 capital ratio requirement) or as a method
for CFOs to hide losses and debts of the firm (as was the case with Enron, see case study below)
RAISING CAPITAL – Such vehicles can be used by financial institutions to raise additional capital at
more favorable borrowing rates. Since the underlying assets are owned by the SPV, credit quality is
based on the collateral and not on the credit quality of the sponsoring corporation. This is an
advantage for non-investment grade companies which can achieve lower funding costs by isolating
the assets in a SPV.
COMPETITIVE PURPOSE: For example, when Intel and HP started developing Itanium processor
architecture, they created a special purpose entity which owned the intellectual technology behind
the processor. This was done to prevent competitors like AMD accessing the technology through pre-
existing licensing deals.
PPP MODEL OF SPV: Due to the policy of liberalization and encouragement to private sector
participation in the areas reserved for public sector, a trend has been started by government sector
entities by forming SPVs for specific projects. The PSUs operating in infrastructure industry usually
float entities with investment firm’s government, both central and States and a portion by the private
sector participant (which is usually selected by a Bidding procedure). It is convenient in many ways.
Such a set up provides convenience in obtaining approvals from the State at various levels. Once the
project is completed the government may easily exit. For Example: Maharashtra government and the
Ministry of Railways will be setting up Maharashtra Railway Infrastructure Development Corporation
(MRIDC), a special purpose vehicle, to provide a boost to the railway infrastructure projects in the
state.

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Key benefits to sponsoring firms
 Hives off the risks - By removing assets or liabilities from
balance sheets of the sponsor, the SPVs act as a
“bankruptcy remote”. If the sponsoring firm has financial
problems, it can safely escape its creditors because in any
way creditors cannot seize the assets of the SPV. By
isolating high risk projects from the parent organization
and by giving to new investors the opportunity to take a
share of a very specific risk in a firm with a simple and
clear balance sheet (as it is created for a single purpose
only, and there are no debt obligations), SPVs definitely
can help both, firms and investors.
 Minimal red tape – Depending on the choice of jurisdiction, it is relatively cheap and easy to
set up an SPV. The process may take as little as 24 hours, often with no governmental
authorization required.
 Clarity of documentation – It is easy to limit certain activities or to prohibit unauthorized
transactions within the SPV documentation.
 Regulatory Compliance - A special purpose entity can sometimes be set up to overcome regulatory
restrictions, such as regulations relating to nationality of ownership of specific assets.
Case: As we see in case of Vishal Retail Limited which will transfer all its fixed assets to a
special purpose vehicle (SPV) that will be predominantly owned by the foreign private equity
firm – Texas Pacific Group (TPG). Once the assets are parked in the SPV, TPG will run the
entity because present regulations do not allow foreign direct investment in multi-brand retail
companies.
 Freedom of jurisdiction – The firm originating the SPV is free to incorporate the vehicle in the
most attractive jurisdiction from a regulatory perspective whilst continuing to operate from
outside this jurisdiction. For example: Companies prefer having SPVs in countries like
Singapore, which are top rated in ease of doing business.
 Tax benefits – There are definite tax benefits of SPVs where assets are exempt from certain
direct taxes. For example, in the Cayman Islands, incorporated SPVs benefit from a complete
tax holiday for the first 20 years. Further, SPVs are often used to make a transaction tax
efficient by choosing the most favorable tax residence for the vehicle. SPVs are often used in
financial engineering schemes which have, as their main goal, the avoidance of tax or the
manipulation of financial statements. Some countries have different tax rates for capital gains
and gains from property sales. For tax reasons, letting each property be owned by a separate
company can be a good thing. These companies can then be sold and bought instead of the
actual properties, effectively converting property sale gains into capital gains for tax purposes.

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 Legal Protection – By structuring the SPV appropriately, the sponsor may limit legal liability
in the event that the underlying project fail
 Meeting regulatory requirements – By transferring assets off-balance sheet to an SPV, banks
are able to meet regulatory requirements by freeing up their balance sheets.
Key risks to sponsoring firms
 Lack of transparency - The complexity of SPVs
- often in the form of layers upon layers of
securitized assets - can make it near impossible
to monitor and track the level of risk involved
and who it lies with.
 Reputational risk - The firm’s own perceived
credit quality may be blemished by the
underperformance or default of an affiliated or
sponsored SPV. For this reason it is not a
credible risk that the firm will abandon the
SPV in times of difficulty.
 Signaling effect - The poor performance of collateral in an SPV attracts a high degree of
attention and assumptions are made that the quality of the firm’s own balance sheet can be
judged on a similar basis.
 Franchise risk - There is a risk that investors in an affiliated SPV are upset and this affects
other relationships between the sponsor and these investors, for instance as holders of
unsecured debt.
 Liquidity and funding risk - The poor performance of an affiliated SPV may affect the firm’s
access to the capital markets.
 Equity risk - The firm might hold a large equity tranche in a vehicle (e.g. an SIV). If the firm
does not step in and support or save the vehicle from collapse in difficult situations, the
resulting wind-down of the SPV and sale of the assets at depressed valuations is likely to erode
the firm’s equity in the SPV, to a greater extent than the firm stepping in and either affecting
an orderly wind-down of the vehicle or bringing its assets back onto its balance sheet.
 Mark-to-market risk - The forced sale of assets from an affiliated SPV could depress the value
of related assets that the firm holds on the balance sheet. The firm will want to prevent a large
negative mark-to-market impact on its own balance sheet.
 Regulation - The same regulatory standards do not apply to assets contained within an SPV as
to the firm’s assets on balance sheet. This is a reason that many firms opt for these vehicles in
the first place. However, this lax regulation poses an indirect risk to the originating firm.

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Enron Case Study
ONE OF THE BIGGEST ACCOUNTING FRAUDS OF US HISTORY
The first case that comes in mind, when we discuss about off balance sheet SPVs is of Enron. Enron
was a US company, whose main business was trading in electricity and other electricity commodities.
Enron was the first company to spot a niche in the energy market. In the 1990s, it converted itself
from a humdrum producer and seller of energy to a market-maker in energy-related products and
became an energy bank. It almost single-handedly created a market for energy contracts and swaps.
These were just what a deregulated energy market needed. Then it started creating many off-balance
sheet SPVs and raised huge debts through them. The company had hidden its debt by moving its
non-performing assets to the SPVs and even booking revenues on these sales. The Board of Directors
of these SPVs were related to the management of Enron which was a clear conflict of interest. The
company penalized all its employees who protested against what was happening within the company.
Initially Enron was using SPVs appropriately by placing its energy related business into separate legal
entities. What they did wrong was that they apparently tried to create earnings by manipulating the
capital structure of the SPVs, hide their losses. The real failures of Enron relate to lack of
transparency, corporate arrogance, a cozy relationship with its auditors (which prevented the latter
from blowing the whistle), a somnolent board, and poor external vigilance (the SEC and the rating
agencies acted only after Enron’s share prices crashed). Due to accounting loopholes, these vehicles
became a way for CFOs to hide debt. In order to maintain transparency, there should be no
interlocking management: The managers of the off balance sheet entity cannot be the same as the
parent company in order to avoid conflicts of interest. The scope and importance of the off-balance
sheet vehicles were not widely known among investors in Enron stock but after the Enron collapse,
the public has come to know for the first time the all kinds of obscure SPVs floated by US companies.

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Public-Private Partnership Case Studies:-
Below are 3 case studies of PPP Model of SPVs:-

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SBI to Raise Capital through SPVs - Case Study:
Country’s largest bank State Bank of India was looking at setting up a special purpose vehicle (SPV)
for its real estates, an option being considered as a means of raising capital from markets.
The idea of setting up an SPV for raising capital from markets was floated at a meeting of finance
minister and heads of public sector banks. Under the proposal, a bank could set up an SPV to which it
will transfer its real estate assets. The bank then can pay rental or lease to the SPV to create an
income stream for the SPV. Based on this income stream, the SPV will raise money from markets.
Later the idea was dropped as SBI is now considering to set up a holding company for the purpose of
raising capital. One of the Senior Officials said, “It (setting up a holding company including all
subsidiaries) is one of the possibilities (for raising capital)… currently, there is no clear view on this,”.
The proposal for setting up of a holding company with the government requires regulatory
clearances.
Conclusion:-
Creating a SPV is simple but maintaining it is a tedious job. It involves all secretarial compliances like
conducting of requisite board meetings, general meetings as prescribed by law, maintain of statutory
registers, filing of various forms and returns etc. As the board of directors of such subsidiaries are the
employees of the holding company, the meetings are reduced to mere formalities. However, non-
compliance of any provision of law can create trouble at the time of disposal of the SPV, in the form
of unnecessary delays. Therefore, creation of SPV must be considered after deliberating all other
options available such as executing an exhaustive agreement which clearly defines the rights and
liabilities of both the parties without creating any separate entity.
Sources:
1. wilmingtontrust.com
2. Pwc
3. Investopedia
4. Economic Times
5. Financial Express
6. Pppinindia.com