Pulling the wool with an SPV

Whoever ad­vised the Minister of Finance to set up a special purpose vehicle (SPV) to finance the cost of building a white elephant of a Parliament House constructed purely to satisfy Prime Minister Lawrence Gonzi’s desire for a monument to him, as well as the empty space where City Gate used to stand in our walled city capital, plus a roofless theatre few welcome, did not do him a particular favour.

The government’s objective remains to try not to add to the public debt using colourful accounting- Lino Spiteri

SPVs are legal entities usually structured to firewall company or government debt by securitising (packaging into bonds) public sector income. For non-accountants like me the internet is replete with definitions and examples. One definition says that a corporation can use such a vehicle to finance a large project without putting the entire firm at risk. Problem is, due to accounting loopholes, these vehicles became a way for chief financial officers to hide debt. Essentially, it looks like the company doesn’t have a liability when it really does. Translated into our minister’s language the proposed SPV is intended to keep the Parliament House etc. financing from reaching the public debt total. Sadly for the minister, SPVs became notorious and globally recognisable because of the misuse by the Enron Group of its Enron spv, eventually leading to Enron’s bankruptcy 11 years ago. Another definition is that SPVs are essentially robot firms that have no employees, make no substantive economic decisions, have no physical location, and are structured in such a way that – supposedly – they cannot go bankrupt.

While SPVs were originally (and still are) used to isolate financial risk, that definition is damning, making one wonder whether the government is aware of what it is trying to lead investors into. I am not suggesting that the proposed SPV will go down the Enron trail. Enron’s collapse, it is well recorded, resulted from the disclosure that it had reported false profits, using unusual accounting methods that failed to follow generally accepted procedures. Both internal and external controls failed to detect the financial losses disguised as profits for a number of years. The auditors failed to bring these illegal policies and unethical party transactions to the attention of Enron’s Audit and Compliance committee.

That should not happen to the SPV proposed by the Minister of Finance. Various finance ministers have experimented with the concept to set up of a financial special purpose vehicle to fund projects in the infrastructure sector. Their proposed SPV is expected to lend funds, especially debt funds of longer maturity, directly to eligible projects to supplement loans from banks and financial institutions. The SPV becomes a vehicle for channeling funds for projects in the roads, ports, airports and tourism sectors.

In Malta’s case it is manifestly obvious that is not the case. Parliament House, the roofless theatre and the gaping City entrance are not infrastructural projects which add value to the island’s ability to generate economic growth.

The government’s objective remains to try not to add to the public debt using colourful accounting. The government could have securitised the rents it receives from the two entities it is pinning to the proposed SPV (after dropping income from Midi). But that would have added to the public debt.

Or it could have followed the implied advice of the Governor of the Central Bank and set up a development bank instead. To the extent that the bank would have lent to the government, that too would have burdened the public debt total.

Instead the government proposes to introduce a concept which has been dishonoured by the Enron debacle and which is used for different purposes by other governments. Rumour has it that the government has been sounding out potential institutional investors. If that was the case it would be interesting if the Finance Minister were to tell the public exactly how such potential investors reacted.

Instead the minister is going public little by little, in the process painting a picture which is quite removed from reality. For instance, with calculated intent he said that the SPV shares (some 30 per cent of the total, against a rumoured earlier plan to go for 20 per cent, would be offered to the public) would give a handsome “profit”, which he quantified.

They will do no such thing. Profit is the outcome of the interplay of risk and reward. In the proposed SPD there will be a yield – not a profit – effectively set by the government, in the same manner that the Treasury sets the coupon on government bonds. Except that bonds have a lifetime. Although the market in them is relatively thin – not liquid enough – the authorities do make a market. It is difficult to see them, through the Central Bank or otherwise, making a market in SPV equity.

The implication is, therefore, that these shares could very well be highly illiquid, more so even than the shares of the corporate bodies listed on the Malta Stock Exchange. Propriety demands that the Finance Minister refrains from marketing the proposed SPV shares in this manner. Hopefully too, financial experts will contribute frankly to a discussion of them and their properties, should the scheme run its course.

Another misleading factor is the observation that the European Investment Bank could be involved in the special purpose vehicle. If so, effectively it too would be buying income that usually goes into the public coffers. There would also be an opportunity cost regarding EIB funds that could be used for other objectives.

In general non-technical terms the government is proposing to capitalise income it is due to receive from facilities leased to private companies to pull wool over potential investors’ eyes by making Parliament pay a rent out of – obviously – public funds, and to parcel up all this financial chicanery as an opportunity which investors should go for.

It remains to be seen whether this ruse will succeed.