Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

6.2 Special Purpose Vehicles⁴

A special purpose vehicle (SPV), sometimes called a special purpose entity (SPE), is a legal entity (for example, a company or limited partnership) created typically to isolate a firm from financial risk. A company will transfer assets to the SPV for management or use the SPV to finance a large project without putting the entire firm or a counterparty at risk. Jurisdictions may require that an SPV is not owned by the entity on whose behalf it is being set up.

SPVs aim essentially to change bankruptcy rules so that, if a derivative counterparty is insolvent, a client can still receive their full investment prior to any other claims being paid out. SPVs are most commonly used in structured notes where they use this mechanism to guarantee the counterparty risk on the principal of the note to a very high level (Triple-A typically), better than that of the issuer. The creditworthiness of the SPV is assessed by rating agencies who look in detail at the mechanics and legal specifics before granting a rating.

An SPV transforms counterparty risk into legal risk. The obvious legal risk is that of consolidation, which is the power of a bankruptcy court to consolidate the SPV with the originator. The basis of consolidation is that the SPV is substantially the same as the originator. This would mean that the assets transferred to the SPV are treated as a part of the assets of the originator. Thus, the isolation of the SPV becomes irrelevant. Consolidation may depend ...