Short-term borrowings for investing in long-term bonds and other assets
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A structured investment vehicle (SIV) is a non-bank financial entity set up to purchase investmentsdesigned to profit from the difference in interest rates – known as the credit spread – between short-term and long-term debt. The long-term debt investments frequently include structured financial products like asset-backed securities (ABS), mortgage-backed securities (MBS), and credit card securitizations. Hence the name, structured investment vehicle.
The investments are financed by the SIV issuing commercial paper and using the capital thereby obtained to buy long-term debt securities that pay a higher yield than the commercial paper issued by the SIV does. The commercial paper obligations are continually rolled over so that the entity does not have to liquidate its long-term investments prior to maturity. SIVs are also known as conduits because they create a permanent channel for capitalizing investments.
SIVs are operated by a professional investment management team, and are less regulated than other investment pool vehicles, partly because they are typically established as offshore companies specifically to avoid regulations that banks and other financial institutions are subject to.
SIVs enable the managing investment team to earn higher returns on investment by leveraging investments in a way that banks cannot due to capital requirements set by the government. Prior to the 2008 financial crisis, SIVs were frequently held as off-balance-sheet assets by banks.
History of Structured Investment Vehicles
Nicholas Sossidis and Stephen Partridge created the first structured investment vehicles at Citigroup in 1988. The two London bankers launched Alpha Finance Corp and Beta Finance Corp as a response to the volatility of the money market at the time. Investors were unsatisfied with the unpredictable returns in the money market and were looking for a stable vehicle that would yield more stable returns on their investments.
Alpha Finance offered a maximum leverage of five times its capital, with each asset requiring 20% of capital, while Beta Finance provided a maximum leverage of 10 times its capital with leverage based on the risk weightings of its assets. The pioneers of the two Citigroup SIVs later left the bank to establish their own financial management firm, Gordian Knot, in Mayfair, London.
Subsequent SIVs raised their leverage to 20 and 50 times, and the number of SIVs gained traction rapidly. By 2004, there were 18 SIVs valued at $147 billion. In 2007, Moody’s Investors Service rated 36 SIVs with a value of $395 billion.
However, when the 2008 financial crisis erupted, most SIVs were either restructured or became distressed and failed because of their heavy investment in sub-prime mortgage-backed securities. Many investors were caught unaware because little was known about SIVS and what assets they had invested in. Toward the end of 2008, no SIVS remained in operation.
Structured Investment Vehicle (SIV) vs. Special Purpose Vehicle (SPV)
A structured investment vehicle (SIV) is a type of special purpose vehicle that earns a profit on the difference in interest between long-term securities and short-term debts. A special purpose vehicle (SPV), on the other hand, refers to a broad category of investment vehicles that may qualify as on-balance-sheet or off-balance-sheet items.
An SPV is created for a specific purpose and used by companies to isolate the originating firm from financial risk. Most SPVs are set up as orphan companies by depositing assets in a trust and hiring an administrator to provide professional management and to ensure that there is no direct financial connection with the parent institution.
SIVs are specifically funded by issuing commercial papers, but SPVs may be funded in a variety of ways, including the issuance of equities and long-term bonds. Both SIVS and SPVs are commonly registered as offshore companies to avoid paying higher taxes in the home country of their parent institutions and to avoid strict financial regulations.
Related Readings
FAQs
Structured Investment Vehicles (SIVs) and Special Purpose Vehicles (SPVs) are financial instruments used to raise capital and manage risk. Key differences: SIVs issue short-term debt to invest in longer-term assets, profiting on the spread. SPVs hold assets to remove risk from the balance sheet.
What is a structured investment vehicle in simple terms? ›
A structured investment vehicle (SIV) is a pool of investment assets that attempts to profit from credit spreads between short-term debt and long-term structured finance products such as asset-backed securities (ABS).
What are structured vehicles give examples? ›
One example is the credit arbitrage vehicle, also known as a Structured Investment Vehicle (SIV). A typical SIV is a company which seeks to 'arbitrage' credit by issuing debt or debt-like liabilities and purchasing debt or debt-like assets, and earning the credit spread differential between its assets and liabilities.
What is the difference between CDO and SIV? ›
A marked difference between CDOs and SIVs is the quality of the underlying assets. While CDOs generally have asset eligibility requirements, a CDO's assets may be of varying quality ratings.
What is the disadvantage of SPV? ›
Despite the benefits set out above, there are detriments to incorporating an SPV that you should consider before implementing this structure. One drawback is the added complexity that comes with adding additional companies into a corporate structure. Managing an additional entity can be time-consuming and costly.
What is an example of a structured investment? ›
A reverse convertible note (RCN) is an example of a structured investment product. A simple illustration of a structured product is a $1000 CD that expires in three years. It doesn't offer traditional interest payments, but instead, the yearly interest payment is based on the performance of the Nasdaq 100 stock index.
Are structured investments a good idea? ›
Are structured notes a good investment? Structured notes present interesting investing opportunities for savvy investors and those looking to diversify their investments. Structured notes allow for personalized risk and good returns based on how underlying assets perform.
What are the different types of structured investment vehicle? ›
The long-term debt investments frequently include structured financial products like asset-backed securities (ABS), mortgage-backed securities (MBS), and credit card securitizations. Hence the name, structured investment vehicle.
What is an investment vehicle? ›
An investment vehicle is a financial account or product used to create returns. The term can generally refer to any container investors use to grow their money. Most often it includes stocks, bonds, and mutual funds, can carry high or low risk, and exists as part of a larger investment strategy.
What is a debt issuing vehicle? ›
A Special Purpose Vehicle (SPV) set up specifically to issue a debt security or securities. It is set up by a company or a group of companies to create instruments that are off the company's Balance Sheet. The SPV exists for a specific period of time and is then disbanded.
An asset-backed security (ABS) is a type of financial investment that is collateralized by an underlying pool of assets—usually ones that generate a cash flow from debt, such as loans, leases, credit card balances, or receivables.
Are CDO still used? ›
When the housing bubble burst and subprime borrowers went into default at high rates, the CDO market went into a meltdown. This caused many investment banks to either go bankrupt or be bailed out by the government. Despite this, CDOs are still in use by investment banks today.
Is a CDO a debt security? ›
A collateralized debt obligation (CDO) is also a fixed-income security that pays interest based on a bundle of underlying debt; but this pool can include a much bigger variety of loans and types of debts.
What is a CDO in the big short? ›
In the movie The Big Short, a synthetic collateralized debt obligation (CDO) is a complex financial instrument that combines multiple mortgage-backed securities (MBS) and allows investors to bet on the performance of these securities.
What is the difference between an investor who is risk neutral and one who is risk averse? ›
Nonetheless, offered two investment opportunities, the risk-neutral investor looks only at the potential gains of each investment and ignores the potential downside risk. The risk-averse investor will pass up the opportunity for a large gain in favor of safety.
What is the difference between unique risk which can be diversified away and market risk which Cannot? ›
Systematic risk is not diversifiable (i.e. cannot be avoided), while unsystematic risk can generally be mitigated through diversification. Systematic risk affects the market as a whole and can include purchasing power or interest rate risk.
What is risk difference v risk ratio? ›
A risk ratio is the probability (or risk) of an outcome in one group di- vided by the probability in another, whereas the risk difference is the probability of an outcome in one group minus the probability in an- other.
What is asset specific risk vs factor risk? ›
Active factor risk is the risk due to portfolio's different-than-benchmark exposures relative to factors specified in the risk model. Active specific risk are risks resulting from the portfolio's active weights on individual assets. It is also known as asset selection risk.
