Are special purpose vehicles a good idea?
Posted on January 27, 2017 by Tom Healy
Special Purpose Vehicle (SPV) is a general technical term that covers a multitude. It refers to a wide variety of arrangements whereby a financial entity is established for a ‘special purpose’ as the title suggests. The National Asset Management Agency is a type of SPV set up to buy distressed assets from bust banks and seek to work off these loans over time and recoup some of the loss for the state. In this case, the vehicle established is said to be ‘off the books’ (not to be confused with the widespread shadow economy in which cash changes hands to avoid tax)
‘Off the books’ activity is deemed to be a commercial undertaking in which costs are mostly covered by a commercial revenue stream. It is important not to confuse ‘off the books’ with yet another type of SPV in the form of public-private partnerships (PPPs). PPPs were much in vogue in the 1990’s and pre-crash noughties when Governments entered into binding agreements with private companies to build or maintain or provide a service for a specified fee recouped from user charges. PPPs have been common place in the building of roads, schools including even social housing before the crash. For an assessment of PPPs in Ireland see a paper presented by Dr Eoin Reeves of UL at a NERI seminar some years ago [Public-Private Partnerships in Ireland: A Review of the Experience]. The capacity of public private partnerships to deliver social goods and to save the Exchequer money in the long-run is unconvincing even when the economy was booming (or is again in many sectors). Dr Rory Hearn in his book Public Private Partnerships in Ireland Failed experiment or the way forward? recounts the experience of PPPs in the failed social housing projects of the noughties.
In contrast to PPPs, ‘Off the books’ publicly owned entities are largely funded from sources other than direct grants from Government or exchequer. Bus Eireann or Dublin Bus are ‘off the books’ as would nearly all publicly owned transport companies be in Europe since their revenue stream largely comes from passenger fares (albeit with significant Government subsidies which fall below the 50% threshold of total revenue). The beauty of SPVs, at least in the public domain, is that they remove publicly controlled or owned activity from usual government spending accounts. In this way they are deemed to be ‘off the books’ and beyond the reach of the EU ‘fiscal rules’ (for example).
If Government wants to fund investment in water infrastructure and avoid large-scale capital investment which appears ‘on the books’ and therefore a charge on Irish ‘fiscal space’ then the Government has less money to spend on hospitals, schools, roads not to mention current spending on pay, social welfare, etc. So, the Government can establish an SPV such as Irish Water (IW) and ensure that its revenue stream in the form of water charges from businesses, schools, charities and households is more than 50% of its total revenue stream. In this way, IW could be moved off books after an initial period of setup. It could borrow on international capital markets just like any other corporation except that this one is publicly owned.
But hold on …..
what if most people living in households will not or cannot or should not pay for water on the basis of usage but, rather, on the basis of general taxation regardless of usage? The stream dries up and the European statistical Agency (Eurostat) which is independent of Governments and can only interpret financial transactions on the basis of statistical rules, says that you cannot have IW off the books. In other words it stays ‘on the books’ as it was in the beginning.
Why does any of this matter? It matters if Governments want to keep within the EU fiscal rules AND avoid raising taxes (be they direct corporate, direct personal or indirect).
My view is that it is a good idea to set up an SPV when it is a good idea to set up an SPV. In other words, doing the right thing from the point of view of economic, social and environmental policy is what counts. If the main reason for setting up an SPV (any type of SPV) in the public domain is to ‘get around the fiscal rules’ then it is probably a bad idea in the first place. In any case Eurostat has become particularly astute at spotting rules-avoiding behaviour which retains a strong element of public subsidy or control. This is not to say that Governments have little choice in some instances but to set up SPVs because, otherwise, not to do so would entail a huge charge on public finances that would not be politically feasible. Take housing as an example.
To begin to make a dent on the huge housing waiting list Government needs to ensure that at least 10,000 new social and affordable houses are constructed each year for many years (and it would take at least two years to crank up the public delivery system to arrive this level of output considering that it was only a few hundred in 2016). Working off an estimate of €150,000 per new unit (assuming that VAT, development charges and profit margins are stripped out) would cost very roughly €1.5 billion each year in additional public capital spending. A public agency could deliver this if it had a mandate and a budget of €1.5 billion per annum. However, because of the fiscal rules the Government would have to raise income tax or USC or VAT or local property tax or corporation tax (heaven forbid such a thing!) or cut some area of public spending (suggestions on a postcard to Government Buildings). The much loved ‘tax buoyancy’ argument doesn’t really work here because a new discretionary spending measure has to be undertaken ‘within’ agreed fiscal space or matched by an adjustment on the revenue and spending side (same thing). If you don’t have the money you can’t spend it. At least that is the theory.
Now the fiscal rules are rigid even when it comes to capital spending (although there is slightly more wriggle room in the case of capital spending due to time allowed for convergence to a technical benchmark). Fiscal rules are part of domestic and EU law and a majority of voters in the Republic of Ireland adopted the rules in principle in a referendum in 2012 (recall ‘agree to these rules or run the risk of no money for pensions, wages or services after 2014’). We are struck with these rules until such time as Brussels and some larger EU member states decide that it is expedient to ignore them (as Germany ignored the Maastricht rules on growth and stability in its own case [see How the Eurozone ignored its own rules on the Spiegel website]
So, should Government set up an SPV to drive a public and social housing programme ‘off the books’? I think that the argument is a strong one provided that the SPV is well designed, accountable and commercially calibrated to use a nice term. What does ‘commercially calibrated’ mean in practice. It means that new social housing would need to generate a revenue stream by way of rents proportional to household renter income. It might make sense to consolidate a number of existing agencies into one and give it a clear mandate and authority to drive a social housing programme and to draw on capital at low interest rates (might a national solidarity housing bond with long maturity term and guaranteed low interest rate help? Or a Green Bond as part of a European Investment Programme to invest in renewables and build new hyper insulated housing?)
Let me be clear – a publicly owned housing SPV would have to pay for itself and this would mean affordable but cost-recovery rent levels over many decades. It would mean borrowing at low interest rates for long-term investment and recouped from a stream of rental income. It might also work if there was a sufficiently diverse population of social housing renters with those on above average incomes paying rents to subsidise those on below average incomes (it is called cross-subsidisation and works in other European countries). Some modest increases in taxes would be required during the initial start-up phase as well as equity injections from the proceeds of bank sales or NTMA cash balances.
Either that or raise €1.5 billion in full in taxes in stages over Budgets 2018, 2019 and 2020.
These are the choices.
Yet another meaning of the term ‘Special Purpose Vehicle’ is provided by the Great Irish Sell Off involving private equity vulture funds buying up at bargain basement prices vast amounts of distressed and even ‘non-distressed’ assets. Check out the recent RTE documentary on this subject here before it expires on the RTE Player on 8 February. You will be so mad after it ….