Joint Forum Calls for SPE Risk Transparency

By Lisa Valentine

The Joint Forum, a panel comprised of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS) recently published a study called “Report on Special Purpose Entities” which advocates policy changes to improve the regulation of SPEs.

An SPE (also called Special Purpose Vehicles, or SPVs or affectionately "bankruptcy-remote entity") is an entity created to acquire and finance specific assets and liabilities. The assets in most SPEs are protected from creditors in the event of bankruptcy. Perhaps the most well-known example of SPE abuse is Enron: SPEs were a major tool Enron execs used to hide losses.

The use of SPEs increased in the few years before 2007 but the vehicle has since fallen somewhat out of favor. However, as markets recover, expect to see the usage of SPEs increase.

The Joint Forum clearly and correctly states that SPEs by their nature are not problematic and that SPEs have been used successfully for many years to provide liquidity to markets help markets run efficiently. The problem is that sometimes the parties to the SPE transaction don’t really understand the risks involved. 

Below is a synopsis of what the forum recommends:

• Market participants need to analyze and monitor the risks of a SPE throughout the life of a transaction and pay attention to changes in the risk profile. Bottom line is to keep reassessing risk.
• When determining risk, look at all factors that increase the complexity of the transaction, including the way the SPE is structured.
• Regulate SPEs depending on complexity.
• Monitor on an on-going basis the quality of transferred exposures compared to the risk profile of remaining portfolios and determine how this will impact the balance sheet.
• Aggregate, assess and report SPE exposure risks the same as other types of risks.
• Standardize definitions, documentation and disclosure requirements of SPE transactions and communicate any divergence from standards to investors.
• Regulators should monitor SPE activity and stay attuned to any developments that can lead to systemic weakness.

Of course, these are only recommendations and each country can interpret or even ignore them as they see fit. However, let’s not over-regulate SPEs as they do serve an important purpose for efficient markets. The parties entering into an SPE transaction just need to do so with their eyes wide open. It’s called due diligence.