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LABUAN INTERNATIONAL CAMPUS

ISLAMIC ASSET MANAGEMENT


GE 31703
INDIVIDUAL ASSIGNMENT: SPECIAL PURPOSE
VEHICLE

Prepared for

: Madam Farah Shazwani

Prepared by

: Muhammad Hazzizul Bin Abdu Raji

No. Matric

: BG 12110317

Subject

: Islamic Asset Management

Due Date

: 12 December 2014
What is SPV?

Special Purpose Vehicle / Special Purpose Entity, or SPV is an entity created by a


company for a specific, limited or temporary purpose in order to isolate, transfer or mitigate
risk upon the company itself. SPV often are a partnership of the company where the debt is
transferred to a dummy corporation, taking it off its balance sheet and isolating any risk
regarding with the debts, loans or other instrument. Since the SPV is usually a subsidiary
company set up by the parent company complete with asset and liability structure, the SPV is
very much secure even when the parent company goes bankrupt. This legal structure makes
SPV a suitable options for a company to reduce its risk of financial bankruptcy, acquire a loan
from a bank to satisfy the company expansion, and even transfer asset or liability upon the
SPV to reduce the burden upon the parent company.
The most used form of SPV transferring risk into is securitization option, as it dealt
with the visible forms of off-balance sheet with involvement of selling registered, rated
securities in the capital markets. Securitization process involves the following process;

The process above mentioned the typical types of securitization; pooling and
tranching (slicing) of assets. Pooling method minimizes the potential of adverse selection
problem regarding with the selection of the assets to be sold to the SPV. Tranching involves
the division of risk of loss based from underlying assets. Assets are sliced into parts, each
hold in order to minimize risk of loss or cost that came upon the task of securing the asset.

Most securitization method provides a safe outlet for a company to be involved with
SPV since it has a stable and popular market, as well as a variety of options to call for.
There are several issues regarding with SPV in regards of understanding the relation
of the SPV to the parent company. For example, from its legal sense, the SPV entity is an
entirely another part of the company which is used to isolate bankruptcy, as seizure may
occur should that happen, will burn all the asset of the company to the ground. Therefore,
most SPV are set up as a partnership, trust funds (charitable and purpose), corporation and
limited liability companies.
The key issue on SPV is that whether SPV is situated off-balanced sheets or not in
relation with some other entity, mainly the parent company. The issue arise that the transfer of
receivables, assets or liability are considered as a sale or a loan accounting purpose; should
the condition of transferred is met, it is considered as a profit or loss on the sales.
The prominent features of SPV is that it is used to counter bankruptcy. If a situation
occurs where the parent company enter bankruptcy, the firms creditor cannot seize the assets
of the SPV, making the SPV unable to be legally bankrupt. Restriction can be applied to the
SPV in order to further minimize the chance of bankruptcy, by imposing restriction on
objects, power or purpose, ability to incur indebtedness, merging, consolidation, dissolution,
liquidation, winding up, asset sales, transfer of equity interests, and amendments to the
organizational document detailed separateness, and security interests over assets detailed in
U.S legal criteria for recycled SPV.
Taxes are implied in SPV, as it is tax-neutral (profit are not taxed). Most SPV are
treated as exempted companies, protecting them from tax by giving tax holiday in span of
twenty to thirty years tops. However, the SPV can be imposed by taxes based on their
geological location, and must include the financial taxes upon the selection of geological
location. As such, the payment of taxes differs from nation either from the SPV or the parent
company.
However, SPV are often falls on the pitfall of shortages of cash due to the constrained
business activities and inability to incur debt. Due to credit enhancements, SPV have a highly
recommended balance sheet reputation and credit worthiness, making loan transfer from
parent to SPV is easy.

SPV also oppose risks to the parent company such as lack of transparency with often
the extreme usage of multiple layers of securitization assets that can be impossible to track,
monitor and asses the risk that bears within. The problem of SPV underperforming may
damage the reputation of the parent company. The poor performance also can attract a high
degree of attention and assumption to the companys balance sheets, and the parents balance
sheet as well, as the affiliation of both the SPV and the parent company are open to
interpretation from various sources, often bad interpretation given from the coup de grace of
ENRON 2001.
With the underperforming creates the poor performance, it signals a rippling effect to
the associated company, as affiliated SPV can be affected by this sort of damaging relation, as
it will have its tolls on the parent and the orphan. Poor performance can also leads to
inaccessibility of access to the capital market, as a company affiliated with a poor performing
SPV may injured its own parent company in ever hoping to acquire a financing.
Many people believe that the lax regulation of SPV on the balance sheet to be
rewarding, but in fact it is a double-edged sword, as the lax regulation is the main attraction
of the vehicle from time to time, the lax regulation also poses an indirect risk as to whom
does the risk hold true, the SPV or the parent company? Question may arise for the fact that
the SPV operates either on behalf of the parent company or a set-up subsidiaries designed
either to host loans or to conduct business? Or is it permissible for a fact that the SPV carries
all the risk and burden of a loan in part of the parent company, with or without assistance
from the latter? The loose existence of the regulation may create a loopholes that can damage
the company for a short or long term without them knowing it from the first place.
How SPV Mitigate risk?
SPV are used to reduce the financial risk of bankruptcy as well as to provide the
parent company a reachable subsidiaries to relate, transfer and place an asset or liability upon
which the parent company can get their hands off in order to preserve the balance sheets to a
much safer number. This means that the SPV act as a form of risk mitigation for the parent
company against the ever changing environments of the financial worlds; from inflation, tax
increase, resource wastage or shortage, abundant worker, limited options and bankruptcy.
SPV uses the method of securitizations, asset transfer, financing, risk sharing and
financial engineering to reduce risk from the parent company or the SPV itself.

Securitization uses bonds or certificates to transfer mortgage onto or to others by


acquiring issued certificates and sold them as marketable securities. The method proves
effective as it converts high risk instrument such as mortgage which have a limited market
validity value and high interest package into more secure options to provide financing and
other types of financial activities.
Assets transfer involves the transfer of assets that is either non-transferable or difficult
to transfer without SPV. SPV enables the parent company to have a single self-contained
package that can be sold, transferred and contained rather than to split it up for various parties
that can cost numerous payment of permits to be acquired.
Financing is another method of risk mitigation used by SPV to reduce the risk from
the parent company. SPV can be used as a front for a new financing method or ventures
without increasing the burden of the parent company as well as not trying to confuse
shareholders. Since debt will reduce dividend gained by shareholders, many will object to
another method of financing via loans or debts. By setting a SPV, shareholders could
maintain their dividend number without compromising the need for financing the company
via loans. The financing also provides another options, as the SPV can focus on financing a
specific projects without investing directly in the parent company
Risk sharing is used to relocate the risk from the parent company to the orphan
company (SPV) with the keen principles of bankruptcy remoteness, as it is heavily used as
a distinct legal entity with no prior connection with the parent company. Since the case of
ENRON and Lehman Bros, court ruling determines that the assets of the SPV must be
accounted with the originating firm.
SPVs off-balance-sheet accounting can be overused to achieve the most desirable
financial and capital ratio or to maintain a regulatory requirement for a company to get a
loan, attract shareholders, auditing purpose or just purely to hide excessive loss and debt from
the firm to the shareholders and the public.
In essence, SPV is a widely selected, popular and easy way to mitigate risk for a
company fearing the looming threat of bankruptcy. With multiple ways to transfer, transform
and allocating risk, SPV can became useful to a company which does not want to burden
themselves anymore with the heavy toll of debt financing. However, SPV has a dangerous
and yet surprisingly provide a false sense of security, as the performance of SPV and their
parent company is tethered to each other vice versa, with one would damage the other in

reputation, chance of financing, and management if not handled carefully. SPVs lax
regulation is one of the choosing reason of this method, may also lead to downfall since its
impossible to keep track of all those off-balance sheet transaction if things gone awry.

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