Institutional and Governance Aspects in corporate form of SPVs in India and

United Kingdom: Good Practices that can be replicated in the Government Sector

A special purpose vehicle/entity (SPV/SPE) is also referred to as a bankruptcy remote entity

whose operations are limited to the acquisition and financing of specific assets. The SPV is
usually a subsidiary company with an asset/liability structure and legal status that makes its
obligations secure even if the parent company goes bankrupt. The investors who invest in SPV
dont get exposed to the existing debt of the Sponsor Company. They are just concerned with
the returns and risks involved in the SPV. The company which is incurring losses can even go
for the option of SPV for its new projects without much investment. The profits of SPV can be
used by the parent company to pay its existing debts. India being a colonial nation under
British rule before depicts almost same laws as existing in United Kingdoms. The structure of
SPVs in both the countries and laws governing the formation of SPVs are almost same.

The term SPV became frequently used in financial circles after the fraud case of The Enron
and Lehman Brothers in U.S. It is a legal entity created to fulfil narrow, specific or temporary
objectives. SPVs are typically used by companies to isolate the firm from financial risks. They
are also commonly used to hide debt, hide ownership, and obscure relationship between
different entities which are in fact related to each other. Normally a company will transfer
assets to SPV for management or use the SPV to finance a large project thereby achieving a
narrow set of goals without putting the entire firm at risk. SPVs allow tax avoidance strategies.
These Special purpose vehicles/entities are an off-balance sheet item. However arguments
have always been there to bring SPVs onto the balance sheet.

Bankers are never concerned with entity as a whole. They are only worried about what
happens with the project/SPVs. SPE can be set up by a different company (not necessarily
initiated by a sponsor company as a subsidiary) in a Take or Pay contract. The sponsor
company can later acquire the SPE according to the contract. Structuring of SPV plays an
important role in its effectiveness. Structuring means how you get the money into the
company. There is a vast difference between a subsidiary and SPE. Off-Balance sheet financing
permits credit to be obtained more readily and at lesser cost.

For example: Two or more entities form another entity to construct an operating plant that will
be used by both the parties. The new entity borrows funds to construct the project and repays
the debt from the proceeds received from the project. Payment of debt is guaranteed by the
companies that formed the new entity.

The idea is to create a new company; totally different company distant from the parent
company for project management. If the project goes bad, then the parent company does not
have to suffer. These SPVs are designed to undertake risky projects. Every SPV structure does
not work perfectly for the task in hand. They are secondary and still provide advantage to the
parent company. SPVs are temporary and unique to a project.

In India , Originator has flexibility in choosing an appropriate legal structure for the SPV based
on its individual requirements whether in form of a company, trust (with or without a
company as a trustee), MF, a statutory corporation, a society, firm, etc., in short all possible
forms of a business entity that is capable of being formed. 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.
While different forms of SPVs have evolved in various markets, Indian mortgage sector has
taken cues from the US market. The securitisation SPV assumes a character different from a
mere conduit in US. National Housing Bank (NHB) has now taken upon itself the role similar to
that being performed by Fannie Mae and Freddie Mac in the US. NHB is presently engaged in
bringing to the market its pilot issue of Mortgage backed securities. The pilot issue has been
under discussion for two years now and currently the structure and the modalities are being
finalised by NHB. Certain other kinds of SPVs would also develop over a period of time.

Some common uses of SPVs are:

Securitisation SPVs are the key characteristic of a securitisation and are commonly used
to securitize loans and other receivables. This was the case recently with the US subprime
housing market 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.
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 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.
Maintain the secrecy of Intellectual property For ex. When Intel and HP started
developing IA-64 processor architecture, they created a special purpose entity which
owned the intellectual technology behind the processor. This was done to prevent the
competitors accessing the technology through pre-existing licensing deals.
Financial Engineering SPVs are often used in financial engineering schemes which have,
as their main goal, the avoidance of tax or the manipulation of financial statements. The
Enron case is most famous example of a company using SPV to achieve the goals.
Regulatory Reasons SPVs 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 sale of property. 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
actual properties, effectively converting property sale gains into capital gains for tax
purposes.
Raising Capital - Such vehicles can be used by financial institutions to raise additional
capital at more favourable 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.
 SPVs and Government sector

There are many benefits of SPVs to the sponsor company. The government undertakings i.e.
PSUs can also adopt SPVs for their new projects. For example: Ratnagiri Gas and Power Pvt
Ltd (RGPPL) is a special purpose vehicle (SPV) formed by GAIL (India) and NTPC to revive the
Dabhol power plant. The good aspects of SPV or benefits to the sponsor company are as
follows:

Asset Ownership An SPV allows the ownership of a single asset often by multiple parties
and allows for ease of transfer between parties. The asset can be owned at lesser finance cost
and without having much liability.
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
authorisation required. The time involved in setting up a subsidiary company is more than
setting up a SPE. There is a lot of time involved in setting up a separate company.
Clarity of documentation It is easy to limit certain activities or to prohibit unauthorised
transactions within the SPV documentation. The SPV can be registered under a parent law if it
is formed as a LLP, Partnership, Joint stock company etc.
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. Many SPVs are incorporated in tax haven jurisdiction.
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.
Legal protection By structuring the SPV appropriately, the sponsor may limit legal liability in
the event that the underlying project fails.
Isolation of Financial Risk By structuring the SPV as an orphan company, the SPV assets
may not be consolidated with the firms on-balance sheet assets and are bankruptcy remote
in the event of bankruptcy or a default.
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.

Government is now adopting incorporation of SPVs for implementation of smart cities. The
SPV will plan, appraise, approve, release funds, implement, manage, operate, monitor and
evaluate the Smart City development projects. Each smart city will have a SPV which will be
headed by a full time CEO and have nominees of Central Government, State Government and
Urban local bodies on its Board. It has started setting up SPVs for manufacture of different
products such as leather. SPVs can be used to set up Micro Small and Medium (MSMEs)
enterprises under the Ministry of Commerce and Industry. Even the domestic firm can set up
SPVs in Global Market if the government provides a proper structure and provisions
governing their formation.

SPVs are beneficial in some ways but they can also prove risky to economy if not governed
properly. These were basically formed by the companies for tax evasion and fraud. Therefore
proper rules and regulations are required to be framed for keeping an eye on these Special
Purpose Vehicles.