Special Purpose Vehicle - Case Study Example

Special Purpose Vehicle (SPV) Introduction: Over the past few years there has been observed that the rate of industrial growth and development has increased at a rapid pace. This mainly due to the fact that with the coming of the industrial age there has emerged an era of infinite demands, market growth and the scope has increased tremendously. There are even till date being invented and discovered new innovative methods to ensure that the production can be carried out in a more economic and efficient method which is both sustainable as well as prosperous. Special Purpose Vehicle: There have been many new developments that have been experienced in the industrial sector in the 21st century. These developments have most often than not tried to develop new methodologies of economic productivity and efficiency. One of the important economic developments that have taken place post the industrial revolution in the 21st century is the development of the SPVs The SPVs are the special purpose vehicles are also known as the special purpose entities (SPE). These are usually called SPVs in the European continent. It is a legal entity that is usually constituted by the parent company to ensure that the unit is free from the risk of bankruptcy. These are also thus referred to as the ‘Bankruptcy- remote entities’. These are usually limited, they are either an offshoot of the parent company or they may even be separate legal entities. They are usually limited companies or have a limited amount of partnership with the parent company. The Investopedia (an international guide in the economic sector), defines the special purpose entities as “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.  They are also referred to as a "bankruptcy-remote entity" whose operations are limited to the acquisition and financing of specific assets.” (Investopedia, online) The special purpose entities that are created are usually set up with a specific goal or aims and they function to usually fulfill only these specified functions. Thus, the role that can be played by such entities are limited, but with time most of them become functional units which at times also achieve self dependence and free existence separate completely from the mother company. In the present project for the sake of an example to serve as a case study we shall look at King Abdullah Economic City. The project is one the biggest mega projects that was un-curtained in the year of 2005 by the King of the Islamic nationality of Saudi Arabia, Abdullah bin Abdulaziz Al Saud. It was a major project, which called for the setting up of a system which intended to ensure that Saudi Arabia be able to establish itself as a top nation state for investment and economic destinations by the year of 2010. The project was set up along with 5 other five economic cities. The total area that was to be bought under development under the King Abdullah Economic City was approximately 66.8 square miles, say around 173 square kilometers. It was located along the coast of the Red Sea. There was ensured that the city was set up in an area which was in close proximity to the economic centre of the country, Jeddah. The project is being constructed by Emaar, which is a Dubai based public joint stock company (AME info.com, 2008). The project that was undertaken had the initial budget of around 80 billion dollars, which is equal to around SR 300 billion. The city was to be built in two stages, the first stage is planned to reach completion by the year of 2010, while the second phase is suppose to ensure that the city reaches it complete glory by the year of 2020 (Mouawad M, 2008). The basic aim of the city was to bring in more domestic and foreign investment directly to ensure the diversification of the oil based economy of the nation state. The other main aims that the project aims at fulfilling are the ensuring creation of available jobs for about a million of the country’s population, while it also looks at providing residency to half a million of the country’s population. It also will look to attract tourists and act as an active contributor to the foreign exchange. Requirements for the setting up of SPVs: The process of setting up of the SPVs is quiet similar to the one that is entailed while setting up a separate company or agencies. It requires the entire legal framework that is required to set up a company. As mentioned earlier the special purpose entity is a separate legal entity. It has to be ensured that the financial aspect of the SPV is treated in a complete isolation from the parent or main company. In fact this is one of the most important characteristics of the SPV. It acts in a completely free economic, financial and legal method from the mother company. Thus for the setting up of the SPV there are required sponsors and promoters. The sponsors of the system ensure that there is complete isolation of the assets of the SPV that is set up from the main company. It has already been mentioned that the company has a completely isolated identity, thus, it is free from the fluctuations that may be experienced by the mother company. Also it has to be realized that the SPV is functional as a separate entity (Shepherd W, 1996 pp.44-50). The managerial functions of the company are carried out in a separate head, and that of the SPV is under a separate head. The SPV is legally free from the mother company, and can thus enter into and leave contracts, be sued and carry forward law suits against other legal entities, and can perform other such legally unrestricted actions. Thus, the most important factor that needs to be considered while setting up of the SPV is that the distance between the mother company and that of the SPV have to be maintained and ensured. If this distance is not present then the new agency would just act as a subsidiary for the main company and not qualify for a SPV. The SPV is suppose to self dependent and must not rely on the mother company for administrative, economic and financial purposes. But more often than not it has been observed that this does not hole true for most of the SPVs that are set up. They either collapse or become sick units. One of the major reasons for their collapsing is that the SPVs are usually set up as means through which the purpose of the mother company can be advanced, and once these goals have been accomplished, the sponsoring to these dry up and their working becomes inefficient. These are thus usually small termed organizations instead of maturing into independent self sufficient units like they are suppose to in theory. Advantages of SPVs: As already mentioned above the SPVs are special vehicles that are used by the companies or the mother company to ensure that the assets of the company are secure and that the taxes that the company is liable to pay are less or reduced to the ones they would have to pay if the SPV was absent. The main reason why the SPVs or the SPE are created by companies is to ensure that there securitization of their assets. These are usually used by companies to secure loans. Another important factor why the SPVs are set up by the companies is to help reduce the risk and sharing of the risk. There has been realized by most of the companies that the SPV is a very competent method which when adopted help ensures that the risk that is involved is reduced. The assets of the company are transferred to the SPV, and these are highly legalized and completely isolated from the main company’s assets. These thus allow for other investors to come in and share the risk involved and also helps assure that these assets are free from any fluctuations that may be experienced by the mother company. The SPV also ensure that the amount of investments increase and allow for a number of other investors to participate in the debt sharing and financing of the organization. These two can be easily observed in the case of the King Abdullah Economic city. Firstly, the system that has been adopted for the setting up of the project calls for securitization of the funds that have been provided for. Also, the main purpose that the projects look to serve is that it wants to realize greater in vestment in the region and ensure that there is greater domestic and foreign investment (McCann A: Export and import bank of US, online). The setting up of the project allows for perspective investors to invest in the economic growth and development of the region in collaboration with other investors. This has also helped ensure that the assets of the state are completely and legally separated from the unit. Thus, it looks for stabilization of the assets, risk sharing and reduction and help generate more investment in the region. Another important role that is fulfilled by the SPV is that it allows for better property investment and management. It has been realized that through setting up of the SPV the property sales and gains can be better managed. This is mainly due to the fact that the tax legislations of different countries, there are countries that have separate legislation for corporation and capital and property gains and sales (Mckune K O, ABC archives). Thus, for tax reasons it is easier for companies to place property under these SPV units and then sell these. This would thus come under capital or corporate gains and sales and not property sales. This is thus an efficient method to ensure that taxes are controlled and managed. SPV and financing processes: The SPVs also allow for the off balance sheet financing. This is really important in the case of KAEC. In such as system companies often create the SPVs to finance and maintain the records for the building of projects. This is done to ensure that no liability be reported on the company’s balance sheets. The company maintains the financing through the SPVs and the assets that are placed under it. This is also true in the case of KAEC where it has been realized that the through the maintenance of the SPV the balance sheets can be better managed and the daily financial transactions that occur during the construction are controlled and more efficiently executed. The transactions can be carried to ensure that the project is not threatened by bankruptcy and also there are cases where there has been experienced swapping of the transaction so the mother company with the SPV. This is done to ensure that the assets are managed more economically. The financing aspect of the SPVs came into the limelight with the case of Enron scandal. In this scandal the mother company of Enron used the SPVs as a method to hide much of its debts. This can one of the greatest pitfalls of SPV. It came into the limelight in the year of the 2001 when it was realized that the mother company of Enron was using the SPV to hide losses that it had incurred and also to fabricate earnings. In the year of 1994 the tower Financial also used the same method through the SPV to ensure that they could hide their debt. This company later filed for bankruptcy. This is thus one of the biggest pitfalls that can be experienced in the setting up of the SPV. The executives of a number of companies create this for covering up of losses, and these are usually not discovered as the SPV maintain separate balance sheets which are completely different from the balance sheet of the mother country. There have been found many cases of securities fraud against executives in this relation and the sentences have extended from payment of fines to prison sentences. The SPVs have also been used by a number of companies as methods to evade property taxes. There are nations where the property can be owned by only certain nationality. The SPVs have thus been used as vehicles to move around such legislations so that the main purpose of the mother company can be served. The SPVs are also used by investors to develop areas indirectly, so that the taxes can be better managed. In such cases, the SPVs are not directly owned by the investors. They ensure that the land is owned by the SPV, and then the investors are assigned the role of official tenants and the then develops such land. This is thus used as methods to evade taxation. Thus, there can be misuse and abuse of the SPV by investors and corporations to achieve their own ends. Sustainability of SPVs: The role of the SPV has become important in the current day and age. The SPV help in better management of the funds and assets of the investors and the corporations. They also help in risk management. There thus has to be developed a system where the sustainability of the SPVs can be ensured. Most of the SPVs that are developed end up acting as double agencies for the mother companies and once the objectives have been realized these fall into mismanagement and end up as sick units or file for bankruptcy. There has to be realized that the SPV can function as separate units and the assets that are assigned to it can be utilized to ensure that the SPVs develop and grow. The management can be conducted better through them and they act as better buffers against the risk that is undertaken. This is easily reflected in the case of KAEC which is a SPV which shows all signs of evolving into a sustainable entity (Thorold C, 2008, BBC News). It is completely equipped with its own transport, educational, industrial, economic system and structuring and helps present an example of the future of the SPVs which can be developed into completely independent entity, where the purpose is not just serving the ends of the mother company but also efficient and economic management of the resources and assets that are placed under it, not just as a buffer for taxes and property exchanges for the mother company. There have been methods developed to ensure that abuse of the SPV does not carry on. This includes IFRS, International Financial Reporting Standards, which has the relevant standard of IAS 27. There is also the IASB with the exposure draft of ED 10, which deals with the subject matter. The SPV are thus important economic entities but their role is still evolving and growing. It is only through experience that this will finally be established. Reference: .AME info.com 2008: Emmar, the economic city signs MoU with Mar GCC to establish manufacturing facility in KAEC, pub July 2008. McCann A: Export and import bank of US: Structured and project finance; Financing Environmental Exports, accessed on December 31 2009 at http://66.102.9.132/search?q=cache:NHa_B561Wt4J:www.acec.org/advocacy/committees/pdf/anncon09_mccann.pdf+Export+and+import+bank+of+US:+Structured+and+project+finance.&cd=4&hl=en&ct=clnk&gl=in. Investopedia: What is SPV, accessed on December 31, 2009 at http://www.investopedia.com/terms/s/spv.asp. Mckune K O: SPE’s- Who, What, Why, Where, When and How; ABA seminar, archives of ABC Mouawad J 2008: The Construction Site called Saudi Arabia, January 20, 2008, pub The New York Times. Shepherd W 1996: Integrating Islamic and western finance, Global Finance, May 10, 1996, pp 44-50, Finance in Islam. Thorold C, 2008: New cities rise from Saudi desert, BBC News June 11, 2008, accessed on December 31, 2009 at http://news.bbc.co.uk/2/hi/middle_east/7446923.stm. Read More