Structured Investment Vehicle (SIV)

A structured investment vehicle (SIV) is a non-bank financial entity that is designed to purchase investment targeted to profit from the gap in interest rate – known as the credit spread – between short term and long term debt. Structured Investment Vehicle is also known as a conduit because they create a permanent channel of capitalizing investment. It makes use of leverages by issuing commercial papers with varying maturities. In SIV, the long term investment often includes structured financial products such as mortgage-backed securities and asset-backed securities. SIV can also include credit card securitization. 

The first set of SIVs were created in 1988 by two employees from Citigroup - Nicholas Sossidis and Stephen Partridge. These two men launched the Alpha finance Corp and the Beta Finance Corp. the two SIVs were established as a result of the volatility of the market at this time. Due to the constant fluctuation in market price, investors were looking for a more stable vehicle that guarantees a stable return on investments.

Alpha Finance Corp offers maximum leverage of five times its initial capital, with each asset requiring 20% its capital. In the same vein, Beta Finance Corp provides a maximum leverage of 10 times its capital based on the risk level of its capital. However, after a while, the two men left the bank to establish their own financial management firm referred to as Gordian Knot, in Mayfair, London. Nevertheless, since then, SIV has continued to play an important role in causing the subprime mortgage crisis.

The subsequent SIVs established after these two raised their leverage from the initial 10% to 20% and 50% respectively. With this increase, the number of SIVs has grown rapidly.

How Structured Investment Vehicle Works.

In Structured Investment Vehicles, investments are financed by the SIV. SIV is a type of commercial purpose fund that borrows for the short term. The SIV issues a commercial paper to an investor who then use the capital obtained from the commercial paper to purchase long term debt securities that pay a higher yield than the capital gotten from the structured investment. In order to maintain the maturity of these securities, the commercial papers are continually rolled to cover the duration of maturity. 

Aside from the long term asset mentioned in the first paragraph, SIV assets can also include less risky tranches of Collateralized Debt Obligations (CDOs) the SIV earns from the spread between incoming cash flows (principal and interest payment on ABS) and the highly-rated commercial paper that is issued.

Structured Investment Vehicle vs Special Purpose Vehicle

On the one hand, the first thing to note is that the Special Investment Vehicle is a subtype of Special Purpose Vehicle that earns its profit through the gap between long term investment and short term debt. On the other hand, a Special Purpose Vehicle is wider and broader than SIV. It extends to on-balance-sheet and off-balance-sheet items. SPVs are often used specifically by companies to isolate the originating firm from financial risks. Also, SPVs are often set up by orphan companies. 

Both SPV and SIV are specifically funded as offshore companies to avoid paying higher taxes.