The Uses and Abuses of Structured Finance

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The discovery that Enron Corporation created many special purpose entities to hide assets and debt from the general investing public has created a distorted view of the uses and legitimacy of structured finance and special purpose entities (SPEs). The general perception is that structured finance and SPEs serve no real economic purpose but are used to mislead and deceive the investing public. Lost in public and political discussions of structured finance has been the role of structured finance as a sound risk management tool, dating back to the early 1970s and widely used by many U.S. corporations and financial institutions today.

Enron made perverse use of structured financing vehicles that hardly conformed to prevailing industry standards or convention. Indeed, many of Enron’s vehicles were contrived to hide or delay the impact of poor investment decisions, hide debt, and manipulate revenue streams on certain derivatives transactions. Because of the simultaneous failure of a number of the usual safeguards surrounding the use of those structures, Enron was able to create structured financing partnerships that bore virtually no resemblance to those soundly constructed by most corporations today.

In contrast, most structured finance transactions today are designed in such a way as to create an arm’s-length distance between the originator of the SPE and the investors in the SPE to achieve corporate separateness. Furthermore, the legitimate purposes of structured finance transactions–risk management, liability management, accessing alternative funding sources, and maximally leveraging internal expertise–have little in common with the purposes for which Enron created many of its SPEs.

Current efforts to revamp fundamental aspects of structured finance because of Enron’s perverse application of a useful concept amount to “shooting the messenger” and will likely have the effect of turning worthwhile projects into economically unviable ventures if regulatory and capital compliance costs are raised considerably, as they have been.

Barbara Kavanagh

Barbara T. Kavanagh is a principal at CP Risk Management LLC.