Fixed income investment instruments are attractive additions to any portfolio. Nevertheless, it is still important to understand the fundamentals behind them. For fixed income asset-backed securities (ABS), we’ve discussed the basics of securitisation.
Now, we’ll cover special purpose vehicles, or SPVs. SPVs are central to creating a proper ABS, as it is the underlying entity that allows for the instrument to be created.
SPVs isolate assets
During securitisation, the originator selects the assets that they want to use to raise funds. Rather than creating an ABS through its own business, which may cause increased risk and liabilities for the originator and may create suspicion among investors, these assets are “sold” to an SPV that will hold those assets for the investors.
The originator usually is the entity that creates the SPV, overseeing the ABS, but one step removed since the SPV is a separate entity. However, the originator’s reputation and experience usually carries over to the SPV, hopefully creating investor confidence.
There are many reasons why an SPV is used. Mainly, the SPV is created purely to hold these assets. There are no employees and are usually managed through a service or trustee arrangement with the originator. Furthermore, it is common practice to structure an SPV so that it can avoid bankruptcy, thus protecting the assets.
SPVs make ABS possible
The assets are now separate from the originator and in a form that can be monetised without creating direct debt for the lender. The SPV then sells bonds (the ABS) using the assets as collateral to pay for them. The ABS investors, in turn, receive set payments through the trustee.
“Because SPVs are strictly structured and controlled, the assets are protected even if the originator goes through financial difficulties,” explains Richard Cayne. Of course, there is always risk, but with proper education and guidance from a trusted source, you can benefit from adding ABS instruments to your portfolio.
