Vol 5 (2008) - Issue 1

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Structured Investment Vehicles: A Regulatory Quandary?

SIVs – what are they?

The SIV business model is predicated on taking advantage of the interest rate differential between short and longer term borrowing. By investing in normally highly liquid, and highly rated assets with a weighted average life of circa three years and funding these assets with shorter term liabilities, it was possible to provide healthy returns for the capital or junior note holders. This was on the assumption that the SIV maintained a AAA rating and the note holders continued to roll their financing and that sufficient leverage of these junior obligations was maintained.

A structured investment vehicle has the nature of its operation tightly defined by legal documentation and operating guidelines. These include detailed capital requirements that are captured by a capital model and are required to be agreed up front with the rating agencies.

Vehicles of this type are designed with the intention being able to sell down their assets in the event that liquidity in the short term commercial funding market dried up by holding highly rated asset backed assets that could be readily saleable. The average make up of SIV assets are set out in charts 1–4, below.

Within certain parameters, the manager of the fund is able to switch between different investments in an attempt to maximise returns for the noteholders whilst trying to protect them from potential capital losses by selling any assets that are downgraded or are at risk of downgrade.

These vehicles exhibit a legal structure that is in many ways similar to that of a managed collateralised debt obligation. On the other hand they also have some of the properties of a hedge fund or investment company. These vehicles are not themselves regulated (typically the investment manager or adviser will be) although the constraints and limitations placed on them by the rating agencies impose a certain level of control usually well beyond that of a hedge fund.