3.4 Management of Working Capital 65principles take a stricter view on derecognition (see section 3.3.2) and
consolidation compared with the earlier rules.^156
As the assets are transferred to the SPV, it has to be determined whether the
SPV must be consolidated as a subsidiary of the originator. According to IFRS, all
“subsidiaries” must be consolidated. A “subsidiary” means an entity, including an
unincorporated entity such as a partnership, that is controlled by another entity
(known as the parent).^157 The obligation to consolidate the SPV thus depends on
the existence of control.
“Control” means the power to govern the financial and operating policies of an enterprise
so as to obtain benefits from its activities. Control is presumed to exist when the parent
owns, directly or indirectly through subsidiaries, more than half of the voting power of an
entity. However, it can exist even when the parent owns less than half of the voting
power.^158 There is a special rule based on the principle of “substance over form” for special
purpose entities (SPEs). SPEs should be consolidated where the substance of the relationship
indicates that the SPE is controlled by the reporting enterprise. This may arise even where
the activities of the SPE are predetermined (the SPE operates on “autopilot”).^159
Credit enhancement. Generally, the SPV will obtain a better credit rating for
securities that it will issue if the receivables to be securitised are relatively
homogeneous and payments made by the originator’s customers are relatively
predictable and reliable. In addition, the credit rating can be improved through
credit enhancement.
Credit enhancement can take various forms. It can be internal or external. The
sources of credit enhancement can be: the SPV; the cash flow; the originator; and
third parties such as banks. Covenants are an important component of the credit
enhancement package.
Internal credit enhancement. Internal credit enhancement relates to the assets of
the SPV.
First, investors will require that their lending to the SPV is adequately secured
on the SPV’s assets. It is not enough to ring-fence the assets through the separate
legal personality of the SPV (see Volume II). The security package may consist
of: a security interest in the receivables; any collateral for the receivables
themselves (for example, building mortgages); insurances taken out by the SPV;
and the SPV’s bank account.^160
Second, the SPV can use over-collateralisation. Over-collateralisation occurs
where the pool of assets is of greater value than is needed to support the payments
due to the investors. This is designed to help to ensure that if there is a shortfall in
(^156) IAS 39 (Financial Instruments: Measurement and Recognition); IAS 27 (Consolidated
and Separate Financial Statements); and SIC-12 (Consolidation—Special Purpose Enti-
ties).
(^157) For key definitions, see IAS 27.4. For German law, see § 290 HGB.
(^158) IAS 27.13.
(^159) SIC-12.
(^160) The Law Commission, Registration of Security Interests, paragraph 6.37.