As global investors fled Ireland amid the panic of 2009, US hedge fund Davidson Kempner spied an opportunity: It set up a company in Dublin to mop up distressed assets across Europe.
The company, Burlington Loan Management, has since acquired billions of euro of assets, including tranches of bonds in failed Icelandic banks, loans from Spain’s “bad bank”, and debt secured on Irish property. Its interests stretch from the Titanic Quarter of Belfast to the financial quarter of Reykjavik.
Along with 479 other companies, Burlington is registered at Deutsche Bank’s offices in a Dublin business park. It is owned by a charitable trust and has assets of $7 billion (€6.1 billion), yet it has two staff and virtually no taxable profits.
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Welcome to the secretive world of special purpose vehicles (SPVs), an unregulated sector that has belatedly caught the attention of the Irish Central Bank and the International Monetary Fund.
Authorities globally are attempting to get a handle on the risks of such entities, which reside outside the perimeter of the world’s banks. SPVs live in the world of so-called “shadow banking”.
SPVs and their cousins, financial vehicle corporations (FVCs), hold up to €900 billion in assets globally, derived from loans, commodities and more exotic instruments such as insurance “catastrophe bonds”. Their main function is to raise debt to fund the purchase of assets and keep them off the balance sheets of the financial firms behind them. As banks sell riskier assets to conserve capital, they have mushroomed in hubs such as Dublin’s International Financial Services Centre.
The spotlight looks set to grow in a world reeling from the leaked Panama Paper revelations about companies and rich individuals exploiting secretive offshore regimes.
SPVs bring little direct economic benefit to Ireland, beyond enriching the local lawyers and accountants who help set them up.
What they do bring is reputational risk, as when two SPVs linked to the German bank Sachsen Landesbank, laden with US subprime loans, blew up in the IFSC in 2007. The scandal resulted in a €17 billion emergency German state-backed bailout, leading to criticism of Ireland in German political circles.
"Ireland ticks all the boxes as a tax-haven type jurisdiction for SPVs,'' said Jim Stewart, associate professor in finance at Trinity College Dublin. "The argument went that it didn't matter what went on down in the IFSC as the Irish system wasn't exposed.
“But these vehicles create problems for other countries, and I can’t see that tolerance continuing.’’
Limited links, potential risks
The Central Bank estimates that Ireland had about 1,300 such vehicles in 2012, competing with the Netherlands and Luxembourg. It said last year that SPVs and FVCs pose limited links to the Irish system, but highlighted “potential” risks because so little is known about their activities.
The Central Bank ordered SPVs to begin filling data on their activities last year so it can get a handle on what they are up to and assess the risks they may pose to the financial system.
Among the roll call of Irish SPVs is Rosneft International Finance, which was established in the IFSC in 2012 as part of a $10 billion bond issuance programme by Rosneft, the Russian energy giant currently hampered by sanctions.
Beltany Property Finance, a Goldman Sachs-linked SPV that is due to receive the proceeds of the upcoming sale of the developer Twinlite's houses at Tyrrelstown in Dublin, recently pricked the public consciousness. So did the Promontoria SPVs set up here for the US financial giant Cerberus. They have snapped up €19 billion of European distressed property assets.
Neptune Repack 1 was set up in Dublin with a €430 million loan from Morgan Stanley to finance another vehicle, LSF5 Poseidon Realty (Ireland), a Lone Star- linked entity that owns loans secured on German real estate. LSF5 defaulted on its obligations to Neptune in 2010.
None of these vehicles pay anything beyond a token amount of a few hundred euro in corporation tax. Most don’t have any Irish staff.
The only real local upside comes in professional fees for lawyers, auditors, corporate service providers and the Irish Stock Exchange, where many of the vehicles list debt.
Typically, the SPV pays Irish service providers €50,000 to set up, as well as an annual administration fee of up to €80,000, according to a Central Bank paper. No wonder local firms relentlessly tout Ireland abroad as a destination for SPVs.
The vehicles are technically liable for corporation tax of 25 per cent, yet Dillon Eustace tells its international clients that any liability can “be eliminated with appropriate structuring”.
The law firm Arthur Cox highlights "the professional and administration services that are available locally" as well as the ease with which profits can be extracted without attracting a big tax bill.
This may help explain why the law firm Matheson tells its international clients that Ireland is the "jurisdiction of choice" for SPVs. Structured Finance Management, which administers scores of SPVs from Dublin's north inner city, has a similarly worded sales pitch.
“SPVs pay more in tax advice than tax payments,’’ said Trinity’s Stewart.
Economic obscurity
The US, UK, Germany, France, Italy and Russia are the main locations of firms that originate Irish SPVs. Some are set up “to obscure the true economic nature of their activities’’, according to the Central Bank.
SPVs and FVCs are set up as “orphan companies’’ to keep assets off the balance sheet of the originating institutions. The shareholder is generally a trust.
Matheson, for example, repeatedly uses three registered charitable trusts as shareholders for large numbers of its SPV clients. Medb, Badb and Eurydice, named after Irish and Greek mythological figures, are officially registered to “relieve poverty and distress”.
Matheson has defended its use of charities in this way as standard SPV practice. It argues that it is also permitted to do so by the charities’ own corporate rules.
The three trusts own the Matheson Foundation, which donates to organisations such as Temple Street children’s hospital and the Barretstown charity.
In 2014, Medb, Badb and Eurydice took in almost €700,000 in donations and fees for acting as shareholders. They paid out €354,000 in charitable donations, and the law firm holds €1.4 million in cash on the charities’ behalf.
All of the directors of the three registered charities are partners in Matheson’s various financial, tax and transaction advisory departments.
SPVs and FVCs are obliged to publish audited accounts, and many issue prospectuses for debt listings. Still, it is often impossible to understand the exact nature of the transactions because underlying contracts are not revealed.
"If there is no major direct Irish investment, which appears to be the case, then there would be little chance of any burden upon the Irish taxpayer if one of these vehicles blew up. But the reputational risk is of concern,'' said Shaen Corbet, a finance lecturer at Dublin City University.
Compass points
The international reach and risks of Irish SPVs are underscored by the story of Compass Traderec Ad, which is administered by a Dublin trustee. Almost 15 years ago, Compass borrowed $190 million to buy invoices due to a UK commodities company, RBG Resources, which in turn was linked to a US company, Allied Deals.
It later transpired that the invoices were part of a $750 million fraud. Virendra Rastogi, one of the businessmen linked to the scheme, was sentenced to more than nine years in prison by a UK court. British authorities sold off some of Rastogi's assets last year.
The Irish SPV financed its purchase of the dud receivables through a loan from a German bank, which was never repaid. Compass Traderec Ad says it expects to be liquidated.
The Financial Stability Board, the leading global authority monitoring shadow banking, says much of these activities are of benefit to the global economy, by oiling the wheels of a financial world.
However, Gareth Murphy, the head of markets supervision at the Irish Central Bank, told a conference in 2014 that "we know that there are also a number of not-so-good reasons for shadow banking, such as regulatory arbitrage and spurious financial innovation".
Corbet, meanwhile, highlighted increased regulatory sensitivity in a post- Panama Papers world: “I would be concerned if something went wrong with a number of SPVs in Ireland. It could deter foreign direct investment.’’
Gary Palmer, chief executive of the Irish Debt Securities Association, the industry's representative body, said SPV structures are set up on a "tax neutral" basis but that parties invested or linked to the SPVs are still liable for tax.
“These activities contribute significantly to the economy in terms of the amount of employment it supports,’’ Palmer said.“In excess of 1,000 people are working in this area through corporate services providers’’ for SPVs.
Reporting requirements
Though vehicles aren’t regulated, some of their activities have come under the spotlight. Those that engage in derivatives trading are subject to EU reporting requirements. At home, the Central Bank is stepping up its scrutiny, following a recent suggestion from the International Monetary Fund. SPVs must now submit details of their activities and originators.
“The data collected . . . is reviewed on an ongoing basis and feeds into a number of Central Bank functions, including financial stability, statistical analysis, economic research and supervision,” it said.
An official source said that a team of economists are due to raise the issue of SPVs with the Central Bank's financial stability committee in coming months. The regulator would not comment, but its governor, Philip Lane, is known to have taken an interest in the potential risks of shadow banking.
Industry lobbyists see the writing on the wall and want to move ahead of the regulators zeroing in on this darkest corner of the shadow banking world.
The Irish Debt Securities Association, said Palmer, has “commenced consideration of an appropriate framework for SPVs, called an I-SPV, with the ambition to have the best-in-class legal and governance structure to support the next stage of SPVs and securitisation financial instruments.”
Meanwhile, SPVs keep on acquiring assets. Burlington Loan Management's last known deal was reportedly a £55 million (€68.7 million) purchase of Project Lanyon, a Bank of Ireland portfolio linked to 700 residential homes in Northern Ireland. Its loans to the Titanic Quarter are set to expire at the end of this year.
Those worried about the unknown risks of SPVs continue to ponder whether a future catastrophe could sink Ireland's international reputation for financial probity. Shadow banking hub: Dublin's IFSC The Irish Financial Service Centre, established in 1987 as a low-tax zone, has evolved into one of the world's largest shadow banking hubs. It has assets of €2.3 trillion, more than 10 times the size of the economy.
In 2010, world leaders tasked the Financial Stability Board in Washington with mapping the global non-bank financing world. The financial crisis had demonstrated that this world harbours financial spillover risks to the mainstream system.
The FSB estimates that non-bank lenders had assets of $36 trillion in 2014. Despite the size of the sector here, Ireland only contributed to the FSB review for the first time last year.
An example of how trouble in the shadow banking sector could affect the mainstream system would be a sharp fall in asset prices. This could prompt investors in shadow banking entities to withdraw their cash from funds, forcing them to sell holdings and driving down asset prices.
The FSB review found that €1.6 trillion of the assets were Irish-domiciled “investment funds”, which are regulated. Others, such as money market funds, which account for nearly €400 million of assets, are subject to new rules.
Financial vehicle corporations, similar to SPVs but involved in securitisation, have had to file data with the European Central Bank since the crisis of 2009. They still aren’t directly regulated.
Last year, the Irish Central Bank decided to illuminate the darkest area of the shadow banking world by directing SVPs to file quarterly returns on their activities.
The industry says it co-operated with the Central Bank, despite reservations over the cost of compliance and the regulator's authority. Special Purpose Vehicles: Some Irish examples SC Private Cars 2010-1 Established in Dublin in 2010 to raise debt to purchase €1 billion of car loans originated by Santander Consumer Bank in Germany. It had no staff, paid €150 in corporation tax annually and was dissolved in 2013.
Kastra Investments Set up in 2010 to raise $77 million of debt, via Luxembourg and the Cayman Islands, for Providence Equity Partners to buy media and technology companies.
Yellow River Finance No 1 Set up to buy “insolvency claims” in 2008. Its ultimate originator is unclear in its documents. It bought more than $70 million (€61.3 million) of claims and paid €60,000 fees annually to local accountants and lawyers.
