Fact Box: Special Purpose Vehicle (SPV)

February 16, 2013

Cabinet approves setting up of SPV for TAPI gas pipeline
The Union Cabinet has given nod to set up the Special Purpose Vehicle (SPV) for the $9-billion Turkmenistan-Afghanistan-Pakistan-India (TAPI) pipeline project. It has also granted permission to GAIL (India) to join the SPV.
The Dubai-based SPV, TAPI Ltd., will scout for consortium leader, who will develop and operate the project, arrange finances and be accountable for safe supply of gas through the pipeline.
TAPI Ltd. needs an initial contribution of $20 million, that is, $5 million from an identified entity from each of the four-participating countries. All four nations have inked an Inter-Governmental Agreement (IGA) along with a Gas Pipeline Framework Agreement (GPFA) which includes necessary provisions for security and safety of the pipeline.
Now lets see:

What is an SPV?
What is the difference between a company and an SPV?
How an SPV is set up?
What are the benefits of creating an SPV?

What is an SPV?
SPV is the acronym for Special Purpose Vehicle which is also called Special Purpose Entity. An SPV is primarily a business association of persons or entities eligible to participate in the association meant for a single, well-defined and narrow lawful purpose. No SPV can be formed for an unlawful purpose, or for undertaking activities which are contrary to the provisions of law or public policy. An SPV is very similar to a company which is mainly formed to raise funds by collateralizing future receivables.
What is the difference between a company and an SPV?
Although both these entities are established as per Company Act and also follow the all the regulations in the Company Act, the difference lies in the purpose. The company, as distinguished from an SPV, may be called a general purpose vehicle. A company may do several things which are mentioned in the memorandum of association (MoA) or permitted by the Companies Act. An SPV may also do the same, but its scope of operation is limited and focused. The MoA is quite narrow in the case of an SPV. This is primarily to provide comfort to lenders who are concerned about their investment.

How an SPV is set up?
An SPV is set up with the help of its promoter(s) or sponsor(s). The sponsoring company diverts some of its assets from the rest of the company into an SPV. This isolation of assets creates a distance b/w the SPV and the sponsoring company which is important as it provides comfort to investors by almost insulating the SPV from the ups and downs of the originating entity. What is significant here is the distance b/w the sponsoring company and the SPV. In the absence of adequate distance b/w the sponsor and the new entity, the later will not be an SPV but only a subsidiary company. A good SPV should be able to stand on its feet, independent of the sponsoring company. Unfortunately, this does not happen in practice.

What are the benefits of creating an SPV?
The key advantage is that it helps in separating the risk and freeing up the capital. As a result, the SPV and the sponsoring company are protected against risks like insolvency, which may arise during the course of operation. The SPV also allows securitization of assets without disturbing the managerial relationship. Under the arrangement, any predictable income stream generated by secure assets can be securitized.