A Comparison between SIVs and SWFs in the Financial System; a Question for Heavier Regulation

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A Comparison between SIVs and SWFs in the Financial System; a Question for Heavier Regulation                              FNN 308 Financial Institutions and Markets                                                                          Ardelean Mihai- Andrei      Ivan k. Cohen                                                                                                                        September 10, 2008           

A Comparison between SIVs and SWFs in the Financial

System; a Question for Heavier Regulation

                                Ardelean Mihai

                   FNN 308 Financial Institutions and Markets

                                        Ivan K. Cohen

September 10, 2008

Investors and policymakers have been concerned in recent years about a potential collapse of the hedge funds creating panic in the financial markets. That being said it looks as if one of the main threats to financial stability comes from the venerable risk from borrowing funds for short term in order to investment in long term products which are illiquid.

In parts of markets where not many people knew about their existence, regulators are trying to understand what is happening in these so called SIVs (Structured Investment Vehicles). A ‘bunch’ of investment assets attempting to make a profit from credit spreads between short term debt and long term structured finance products, for instance ABS (Asset backed Securities). ABS are financial securities backed by loans, leases or receivables against certain assets other than mortgage backed securities and real estate. From investors’ point of view, ABS are a substitute for investments in corporate debt.

Funding for Structured Investment Vehicles derives from the issuance of commercial paper which is short term debt financial instrument. More exactly its short maturity is within 270 days. The commercial paper is typically rolled over or continuously renewed. The funds received through the issuance of commercial paper are then invested in longer term assets that are less liquid but such assets pay higher yields. Thus the profits come from the spread between the incoming cash flow which is the principal and the interest payments on ABS and the high rated commercial paper. Structured Investment Vehicles often make use of high leverage in order to generate higher returns.

SIVs are also known as ‘conduits’ and are less regulated than other financial instruments, and usually kept off the balance sheet by large financial corporations such as investment and commercial banks. These SIVs gathered regulators’ attention during the housing bubble and the beginning of the subprime crisis in 2007. Tens of billions of dollars were written down of their value off the balance sheet as investors were trying to flee from subprime mortgage related assets.  

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Investors were caught off guard by the large losses because SIVs specifics are publicly known at a small scale, and this includes basics of the type of assets held and the regulations that determine their actions. SIVs fundamentally allow the financial institutions engage in such leverage in a way that the main company or the so called parent company would not be able to exceed the capital requirement regulations.  

Sovereign Wealth Funds (SWFs) are sums of money coming from countries’ reserves, which are placed aside for the purpose of investments that will profit the economy of the country ...

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