Compiled by Shivani Mandrawal

Securitisation(Method of converting the receivables of the financial institutions, i.e., loans and advances, into bonds which are then sold to the investors) offers higher quality assets to investors by virtue of the fact that the structures protect investors from the bankruptcy risk of the Originator.

In order to ensure that the assets actually achieve the bankruptcy remoteness, it is essential to move them out of the balance sheet of the Originator and park them with another independent entity, same can be done with the help of SPV.

What is Special Purpose Vehicle (SPV)?

“SPVs allow investors to pool their money together to invest in a single company”

An SPV is employed to purchase the assets from the Originator and issue securities against these assets. Such a structure provides a comfort to the investors that they are investing in a pool of assets which is held on their behalf only by the SPV and which is not subject to any subsequent deterioration in the credit quality of the Originator. The SPV is usually a thinly capitalised vehicle whose ownership and management are independent of the Originator. The main objective of SPV is to distinguish the instrument from the Originator.

Is there a difference between a special purpose vehicle and a company?

• SPVs are mostly formed to raise funds from the market.
• Technically, an SPV is a company.
• It has to follow the rules of formation of a company laid down in the Companies Act.
• It has all the attributes of a legal person.
• It is independent of members subscribing to the shares of the SPV.
• Members of an SPV are mostly the companies and individuals sponsoring the entity.
• An SPV can also be a partnership firm. This, however, is unusual.
• The company, as distinguished from an SPV, may be called a general purpose vehicle.
• The MoA is quite narrow in the case of an SPV. This is primarily to provide comfort to lenders who are concerned about their investment.

How is an SPV established?

Like a company, an SPV must have promoter(s) or sponsor(s). Usually, a sponsoring corporation hives off assets or activities from the rest of the company into an SPV. This isolation of assets is important for providing comfort to investors. The assets or activities are distanced from the parent company, hence the performance of the new entity will not be affected by the ups and downs of the originating entity. The SPV will be subject to fewer risks and thus provide greater comfort to the lenders. What is important here is the distance between the sponsoring company and the SPV. In the absence of adequate distance between the sponsor and the new entity, the later will not be an SPV but only a subsidiary company.

A good SPV should be able to stand on its feet, independent of the sponsoring company. Unfortunately, this does not happen in practice. One of the reasons for the collapse of the Enron SPV was that it became a vehicle for furthering the ends of the parent company in violation of the prudential norms of corporate financing and accounting.

What are the advantages of setting up an SPV?

• The biggest advantage is that it helps in separating the risk and freeing up the capital.
• As a result, the SPV and the sponsoring company are protected against risks like insolvency, which may arise during the course of operation.
• The SPV also allows securitisation of assets without disturbing the managerial relationship.
• Under the arrangement, any predictable income stream generated by secure assets can be securitised. Basically, a company can leverage future earnings to raise funds.

In what ways SPV can be used?

• A parent company creates an SPV to undertake a risky project while protecting the parent company from the most severe risks of its failure.
• In other cases, the SPV may be created solely to securitize debt so that investors can be assured of repayment.
• In any case, the operations of the SPV are limited to the acquisition and financing of specific assets, and the separate company structure serves as a method of isolating the risks of these activities. An SPV may serve as a counterparty for swaps and other credit-sensitive derivative instruments.

Key features desired in an ideal SPV

• An SPV must be capable of acquiring, holding and disposing of assets.
• It would be an entity, which would undertake only the activity of asset securitisation and no other activity.
• An SPV must be bankruptcy remote i.e. the bankruptcy of Originator should not affect the interests of holders of instruments issued by SPV.
• An SPV must be bankruptcy proof. i.e. it should not be capable of being taken into bankruptcy in the event of any inability to service the securitised paper issued by it.
• An SPV must have an identity totally distinct from that of its promoters/ sponsors/ constituents/ shareholders. Its creditors cannot obtain satisfaction from them.
• The investors must have undivided interest in the underlying asset (as distinguished from an interest in the SPV which is a mere conduit).
• A SPV must be tax neutral i.e. there should be no additional tax liability or double taxation on the transaction on account of the SPV acting as a conduit.
• A SPV must have the capability of housing multiple securitisation. However, SPV must take precaution to avoid co-mingling of assets of multiple securitisation. In case of transactions involving various kinds of assets, they should restrict the rights of investors to the specific pool.
• The SPV agreement may not release its employees or trustees from their responsibility for acts of negligence and a wilful misconduct.

Instrument issued by the an SPV should have the following characteristics:

• Be capable of being offered to the public or private placement.
• Permit free or restricted transferability.
• Permit issuance of pass through or pay through Securities.
• Represent the amounts invested and the undivided interest or share in the assets (and should not constitute debt of SPV or the Originator).
• Be capable of being classified as senior / subordinate by differentiation in ranking of security or in receiving payments.
• May be issued in bearer form or registered in the holder’s name, may or may not be endorsable and may be issued in definitive form or book entry form.