Variable Interest Entity (VIE)

Summaries

Special Purpose Vehicle (SPE) is usually created to lower the cost of borrowing (because the asset is more protected and isolated for the lender)

SPE’s activities are detailed in governing documents.

SPE: usually small equity => need sponsor to guarantee => sponsor will receive pro rata profits or residue interest (variable interest)

Interpretation Number 46(R) – Consolidation of Variable Interest Entities

FIN 46(R)

–        if a firm is considered as the VIE, it must be consolidated by the beneficiary firm (which is exposed to the majority of  the loss risks or residual benefits)

–        Not just voting power, but also:

o        Insufficient at-risk equity investment (if the equity at-risk is <10% required to finance the entity’s activities) (by the investors who provide the equity)

o        Shareholders lack decision-making rights

o        Shareholders do not absorb the expected losses

o        Shareholders do not receive the expected residual returns

Example of variable interests:

a)      Debt guarantees

b)      Asset Purchase Options

The risks and rewards of a VIE are not distributed on the basis of the stock ownership.