Read and re-read top of CFAi R22 Pg 67 and I’m not getting the language they use. I understand the idea is lower cost of funding by in a sense sterilizing the risk environment by isolating the asset, but then what goes wrong in finding equity investors? and what does it mean when they say the following: “As a result, another party…must contribute substantial resources–often loans and/or garuntees-- to enable the VIE to secure additional financing needed to accomplish its purpose.” Am I reading this right? I cant be… I read above and in the sections that preceed as well as follow it that we are talking about a safe bet. If they are going to pay out a low rate of return then what is this talk of the sponsor contributing loans? does this mean that the sponsor creates and funds the operation? Thanks, ps is anyone else out there terribly lost when it comes to deliniating the specific differences between ifrs and gaap in R21… had enough trouble figuring out the methods let alone the end of reading questions…
Generally a firm is only required to consolidate another entity into its accounts when it has a significant equity stake in it (ie it can control the board of directors). The VIE structure allowed firms to take advantage of controlling a business, while not reflecting the financial position or performance of that entity through the consolidation process. For example: A VIE can be established with an insufficient equity base (owned by a third party) and a board of directors whose authority is subordinate to the Debt holders (the beneficial firm). On paper the third party controls the firm. In reality it is the owner of the debt that calls the shots. Aplying the standard consolidation rules would allow the VIE (effectively a proxy of the firm) to escape consolidation. This opens up opportunities for the firm to park profits or more importantly losses (see Enron et al), as well as “phoney” transactions out of view. Being required to consolidate on the basis of beneficial ownership is an attempt to address this loophole. As an aside, I think VIEs are a scam in general, and penalise the existing creditors of the beneficiary firm …