Special purpose entity

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A special purpose entity (SPE) (sometimes, especially in Europe, "special purpose vehicle") is a body corporate (usually a limited company of some type or, sometimes, a limited partnership) created to fulfill narrow, specific or temporary objectives, primarily to isolate financial risk, usually bankruptcy but sometimes a specific taxation or regulatory risk.a[›]

A special purpose entity may be owned by one or more other entities and certain jurisdictions may require ownership by certain parties in specific percentages. Often it is important that the SPE not be owned by the entity on whose behalf the SPE is being set up (the sponsor). For example, in the context of a loan securitisation, if the SPE securitisation vehicle were owned or controlled by the bank whose loans were to be secured, the SPE would be consolidated with the rest of the bank's group for regulatory, accounting, and bankruptcy purposes, which would defeat the point of the securitisation. Therefore many SPEs are set up as 'orphan' companies with their shares settled on charitable trust and with professional directors provided by an administration company to ensure there is no connection with the sponsor.

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[edit] Uses

Some of the reasons for creating special purpose entities are:

  • Securitization: SPEs are commonly used to securitise loans (or other receivables). For example, a bank may wish to issue a mortgage-backed security whose payments come from a pool of loans. However, these loans need to be legally separated from the other obligations of the bank. This is done by creating an SPE, and then transferring the loans from the bank to the SPE.
  • Risk sharing: Corporates may use SPEs to legally isolate a high risk project/asset from the parent company and to allow other investors to take a share of the risk.
  • For competitive reasons: For example, when Intel and Hewlett-Packard started developing IA-64 (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.
  • Financial engineering: SPEs are often used in complex financial engineering schemes which have, as their main goal, the avoidance of tax or the manipulation of financial statements. Possibly the most famous example of a company using SPEs to achieve the latter goal is Enron.
  • Regulatory reasons: A special purpose entity can sometimes be set up within an orphan structure to circumvent regulatory restrictions, such as regulations relating to nationality of ownership of specific assets.
  • Property investing: 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.

[edit] Abuses

Special purpose entities were one of the main tools used by executives at Enron, with which to hide losses and fabricate earnings, resulting in the Enron scandal of 2001.

[edit] Accounting guidance

Under US GAAP, a number of accounting standards apply to SPEs, most notably FIN46R that sets out the consolidation treatment of these entities. There are a number of other standards that apply to different transactions with SPEs.

Under International Financial Reporting Standards (IFRS), the relevant standard is SIC12 (Consolidation—Special Purpose Entities).

[edit] See also

[edit] Notes

^ a: For example, it is quite common for tanker fleets to have each tanker owned by a separate special purpose entity to try and avoid group liability in relation to widely drawn anti-pollution laws.

[edit] External links