When is an SPV yours?

Standard Chartered has withdrawn support from its SIV, Whistlejacket. It appears that like many SIVs, the value of Whistlejacket's assets has been falling fast. The contraction of the ABCP market meant that Whistlejacket had been unable to roll its short term funding. Standard had previously pledged to support Whistlejacket by writing it short term liquidity, effectively stepping in the place of the ABCP buyers. However it appears as if that liquidity line was contingent on the net asset value of the SIV being sufficiently big and, with falling markets, that test was no longer met. Hence any liquidity provided by Standard would not be contractually required - in Basel II terminology it would be implicit support. The consequences of taking Whistlejacket's assets on balance sheet by providing implicit support were presumably too much for Standard Chartered.

This brings us to a difficult question that both regulators and accountants need to answer. When is an SIV yours, i.e. when should it consolidate for regulatory and/or accounting purposes?

A few thoughts.

• Accounting consolidation should follow regulatory consolidation and vice versa. Whatever they do, the regulators and accounting standards folks should agree about when a securitisation is ineffective. If a SPV consolidates, there should be full regulatory capital on it. If it doesn't then some measure of regulatory capital relief should be available.
  
• The IAS (if not the FASB) consolidation rules are based on the ideas of control and benefit. Broadly the test for whether you consolidate a SPV require a test of who benefits from its activities and who controls it. The principles here are not bad, but I would suggest that they don't allow for the idea of contingent control - mostly I do not control the SPV, but if something bad happens (like the closure of the ABCP market) then I get it back. Perhaps in order to clarify the situation consolidation should be automatic if an issuer has a position in multiple positions in the capital structure (such as equity and a supersenior liquidity line). That would at least make the assessment of benefit and control easier.
  
• Regulators must accept that there are legitimate reasons for securitising assets and must provide a safe harbour for good structures. Failure to do this will not just damage the banks - it will damage the financial system.
  
• Regulatory capital relief should be contingent on alignment of interests. Whenever the seller of an asset has an incentive to conceal information from the buyer, and especially if the seller is also the servicer, then clearly trouble is possible.
  
• Regulatory capital relief should be based on the extent of the risk transferred. Overly penal rules which do not have this effect - such as Basel II - simply encourage regulatory arb transactions rather than genuine risk transfer. Despite a number of attempts the supervisors have not yet managed to write rules that do not permit capital arbitrage so there is no reason to believe they can get it right on the next attempt.
  
• If issuers are found to have provided implicit support they should be required to restate their regulatory capital, earnings and balance sheets for all periods when they took advantage of the sham securitisation, and to make public disclosure of this restatement.
  

I do believe that securitisation is a useful tool for the financial system. We are still learning how to use it appropriately. Now a concerted effort is needed to rewrite both regulatory and accounting rules to incentivise effective structures. Making consolidation harder to avoid or capital higher won't do that. It will just encourage another round of game playing which, when the next bubble bursts, will have even worse consequences.