What is a special purpose vehicle

Updated: Mar 21 2005, 05:30am hrs
In his Budget speech, finance minister P Chidambaram has proposed the setting up of a financial special purpose vehicle (SPV) to fund projects in the infrastructure sector. The proposed SPV is expected to lend funds, especially debt funds of longer maturity, directly to eligible projects to supplement loans from banks and financial institutions. The SPV, according to the proposal, will become a vehicle for channelising funds for projects in the roads, ports, airports, and tourism sectors.

SPV is also called special purpose entity (SPE) or special purpose corporation (SPC). In the recent past, it was the Enron debacle that popularised this word, though for the wrong reasons. The collapse of the Enron SPV notwithstanding, the term SPV continues to be a buzzword in the financial sector. FE takes a Closer Look at the concept of the SPV and its implications for the sponsoring company, investors and infrastructure:

What is an SPV

The acronym stands for special purpose vehicle. The word vehicle can be interchanged with market entity. In the US, the term used is special purpose entity (SPE). The name SPV is given to an entity which is formed for a single, well-defined and narrow purpose. An SPV can be formed for any lawful purpose. No SPV can be formed for an unlawful purpose, or for undertaking activities which are contrary to the provisions of law or public policy. An SPV is, primarily, a business association of persons or entities eligible to participate in the association. According to Joy Jain of PricewaterhouseCoopers, an SPV is mainly formed to raise funds by collateralising future receivables.

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. Like a company, the SPV is an artificial person. It has all the attributes of a legal person. It is independent of members subscribing to the shares of the SPV. The SPV has an existence of its own in the eyes of law. It can sue and be sued in its name. The SPV has to adhere to all the regulations laid down in the Companies Act. 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. A company may do many things which are mentioned in the memorandum of association (MoA) or permitted by the Companies Act. An SPV may also do the same, but its scope of operation is limited and focused. If it is not so, the SPV had better be called a company. 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. According to some estimates, the worldwide securitisation market has increased from $1.2 billion of transactions in 1985, to $544 billion in 2003. Basically, a company can leverage future earnings to raise funds.

Will the SPV help in raising funds for the infrastructure sector

The funds requirement for this sector are huge. There are different organisations, like the Infrastructure Development Finance Company (IDFC), Power Finance Corporation (PFC), Indian Rail Finance Corporation (IRFC) etc., which are engaged in raising funds for development of infrastructure sector projects for the sectors they are involved in. The proposed SPV, which is likely to be a government company, will add to the availability of long-term funds for infrastructure sector projects.