VIE question

[mheithy]

im reading through intercorporate again on consolidation of SPEs. just had a question for you guys

GAAP says that its a VIE if either…

1. equity at risk is insufficient to support activities w/o outside financial support, or

2. equity investors lack either the ability to make decisions, obligation to absorb losses, or right to receive returns

Can someone ELI5? Im not really getting who are the equity investors in this case. thanks!

[Tuchsford]

Honestly not sure on this - bumping it up so someone who understands can help explain for both our sakes.

[mheithy]

yeah i get the general idea of why consolidation is needed but im having trouble understanding the different moving parts

[thinkwiseandact]

Since banks avoided consolidating SPEs with their financial statements in the period around the financial crisis, I infer the sponsoring companies are usually not the owners. I guess management is the owner, or some individuals related to management to maintain the control.

[Tuchsford]

@mheithy

yeah i get the general idea of why consolidation is needed but im having trouble understanding the different moving parts

Same here, but the whole concept of equity at risk is confusing. Basically, if a question about a SPE/VIE comes up, know to consolidate and the impacts under US GAAP / IFRS.

[sig]

Think back to Enron.

For example, one of Enron’s SPEs, Swap Sub, was used to create hedging instruments for one of the company’s investments. However, for it to remain off balance sheet (at that time there was no such term as VIE), one of Enron’s executives became the general partner of Swap Sub even though he contributed very little equity. The contribution was not enough to absorb losses if it had incurred. In other words, if losses had incurred, Enron would have to absorb that loss. This is the very definition of “equity at risk is insufficient to support activities w/o outside financial support.”

Number 2 should be fairly straightforward.

[sig]

@sig

Think back to Enron.

For example, one of Enron’s SPEs, Swap Sub, was used to create hedging instruments for one of the company’s investments. However, for it to remain off balance sheet (at that time there was no such term as VIE), one of Enron’s executives became the general partner of Swap Sub even though he contributed very little equity. The contribution was not enough to absorb losses if it had incurred. In other words, if losses had incurred, Enron would have to absorb that loss. This is the very definition of “equity at risk is insufficient to support activities w/o outside financial support.”

Number 2 should be fairly straightforward.

If you go into details of Enron’s SPEs, it becomes extremely convoluted. However, this example should be enough for you to understand. Afterall, the term VIE was created because of Enron.

[Tuchsford]

@sig

Think back to Enron.

For example, one of Enron’s SPEs, Swap Sub, was used to create hedging instruments for one of the company’s investments. However, for it to remain off balance sheet (at that time there was no such term as VIE), one of Enron’s executives became the general partner of Swap Sub even though he contributed very little equity. The contribution was not enough to absorb losses if it had incurred. In other words, if losses had incurred, Enron would have to absorb that loss. This is the very definition of “equity at risk is insufficient to support activities w/o outside financial support.”

Number 2 should be fairly straightforward.

This is actually super helpful, thanks. Schweser did a fairly cursory overview, so the concept didn’t totally sink in, but your example is really helpful.

[rgk]

@Tuchsford

@sig

Think back to Enron.

For example, one of Enron’s SPEs, Swap Sub, was used to create hedging instruments for one of the company’s investments. However, for it to remain off balance sheet (at that time there was no such term as VIE), one of Enron’s executives became the general partner of Swap Sub even though he contributed very little equity. The contribution was not enough to absorb losses if it had incurred. In other words, if losses had incurred, Enron would have to absorb that loss. This is the very definition of “equity at risk is insufficient to support activities w/o outside financial support.”

Number 2 should be fairly straightforward.

This is actually super helpful, thanks. Schweser did a fairly cursory overview, so the concept didn’t totally sink in, but your example is really helpful.

Agreed, this drove it home for me. Thanks!