SPV (special purpose vehicle) is a company registered in in Hong Kong as a subsidiary established to run as a means of securing assets of the mother company if it faces bankruptcy. They help to protect a project or entire business from insolvency problems or establishing leases that are credited on the income statement as opposed to being reflected as a liability on a balance sheet. Accordingly, you can use the SPV for scrutinizing assets, establishing joint ventures, and isolating corporate assets. Think of SPVs as an ordinary company that follows all the regulations during establishment, but the main shareholders include the parent company.
The main reason why investors select Hong Kong as the ideal place to run their SPVs is that it has a very favourable tax regime. Besides, it has ratified a number of tax treaties. If you are considering opening a business in Hong Kong, this will be a great option, and it is wise to take a deeper look at its advantages.
Special purpose vehicles in Hong Kong
SPVs in Hong Kong can take the form of a partnership, corporation, or even trustee. However, the selected form must meet the following criteria.
- It must be fully or partially owned by a non-resident in Hong Kong.
- The special purpose vehicle must be registered outside Hong Kong.
- It does not engage in other activities or trading apart from holdings.
- It must not be registered as an excepted private liability company.
An SPV can be established to hold and administer the investor’s excepted private company from Hong Kong Special Administrative Region. If the company has been incorporated outside Hong Kong, it is advisable to look for expert advice from experts.
Off-balance sheet and on-balance sheet SPVs
This type of SPV records its assets, equity, and liabilities on its individual balance sheet as opposed to the parent company balance sheet as debt or equity. Many parent companies prefer using this arrangement for better management of assets and liabilities.
Off-balance-sheet special purpose vehicle helps to cover/mask important information from investors who do not understand the complete financial status of a company. As an investor, it is important to take a deeper look at the parent company information and that of the SPV before making a decision to invest in a company. If you do not carry a comprehensive review of all the assets, there is a risk of suffering a problem similar to the Enron’s financial collapse.
On-Balance Sheet SPV
Unlike the off-balance special purpose vehicle, the off-balance SPV puts the assets, liabilities, and equity on the liability side of the company balance sheet. Many companies prefer the off-balance sheet SPVs because of the following;
- The level of risk is brought down by the arrangement.
- It keeps the funding costs as low as possible.
- As a stand-alone, the financial flexibility is higher.
- The parent company can secure higher credit rating.
- Better asset and liability management.
- It can be used to keep down regulatory capital requirements and for trust on preferred securities.
Some of the key examples of SPVs include;
Who can use SPVs?
It is a general practice for banks, institutions, and business owners to use SPVs. Because SPVs can assist to improve financial management by enhancing your tax efficiency, many foreign companies prefer them to enhance their position locally and internationally. However, you need to be aware of the capital gains tax depending on the location of the SPV.
FII (Foreign Institutional Investors) use SPVs to get access to investment opportunities abroad. This method is applied when the target country has closed the door to FII. For example, some countries close FII from some countries or cap their investments.
Governments used SPVs through agreements via private sectors to realize faster growth and stay away from red tape. By using SPVs, governments can fast track projects and conclude them without interference from the established agencies.
Some examples of SPVs include:
Before its collapse, Enron transferred its fast rising stock to an SPV and got a note or cash in return. The respective special purpose vehicle used the transferred stock as hedging asset that reflected on the company’s balance. Then, Enron guaranteed the SPV total value as a method of keeping risk low.
When the stock prices started going down, together with the value of SPV stock, the guarantees had to be forced into play. Enron found it difficult to clear the amount owed to creditors and investors, resulting in the infamous financial collapse.
While the company fully disclosed the financial info as well as conflicts of interest arising from the balance sheet between the company and SPV, few investors comprehended the gravity of the problem. This culminated to the disastrous ending.
Luxor Capital SPV
Around March 20165, Luxor Capital (A Hedge Fund of $3.8 billion) announced it would put 4-illiquid securities (about 12% of investment) in an special purpose vehicle. The securities included exposure in the food delivery service, Delivery Hero (a private equity investment) and Ascent Resources (a drilling company) and Altisource Asset Management.
After months of losses, the fund started returning the remaining 88% of the investor money. The remaining will be cleared after the illiquid investments are sold off.