Special purpose vehicle (SPV)

A special purpose vehicle (SPV), also called a special purpose entity (SPE), is a separate legal entity that has very limited and specific purposes written into its governing documents. These documents spell out exactly what the SPV can and cannot do.

For example, in —which are investment vehicles that pool together many loans—the SPV's documents typically allow it to buy specific types of loan portfolios, issue debt securities to investors, sign transaction agreements, and manage the underlying loan pool. The SPV cannot engage in other business activities outside of these specified purposes.

SPVs are often set up in offshore locations like the Cayman Islands. However, hedge funds have started using other jurisdictions as well, especially after regulatory changes affected some traditional offshore financial centers.

During major financial disruptions—particularly the 2008 financial crisis and the COVID-19 pandemic—many hedge funds found themselves in a difficult position. Large numbers of investors wanted to withdraw their money (called "redemptions"), but many of the fund's investments had become illiquid, meaning they could not be easily sold for cash.

Many funds lacked the proper legal structures to handle this situation. They didn't have "" provisions that would allow them to separate illiquid investments from the rest of the fund. They also weren't prepared to completely suspend all investor withdrawals.

Fund managers found a practical solution: they created new SPVs and transferred the illiquid assets into these vehicles. Each departing investor received a proportional ownership interest in the SPV based on their stake in the fund at the time they requested their money back. Instead of receiving cash, these investors got SPV ownership interests that represented their share of the illiquid investments.

This approach worked because most fund agreements allow managers to make ""—giving investors actual assets instead of cash—to satisfy redemption requests.

For these SPV-based redemption strategies to work legally, funds must have provisions in their governing documents that allow them to make in-kind distributions instead of cash payments. Several court cases, including litigation involving a fund called Gottex, have established the legal framework that governs such distributions.

Courts have determined that in-kind redemptions must meet three key requirements. First, the distributed items must actually qualify as distributions under applicable law. Second, the items must be genuine assets that the fund legitimately owns. Third, the value of the distributed items must exactly equal the amount the investor is entitled to receive for their redemption.

SPV interests distributed to departing investors meet all three criteria. They represent real fund assets, and their valuations match the relevant redemption amounts. This distinguishes them from other financial instruments like participation notes, which failed to meet these legal tests in earlier court cases.

When hedge funds create SPVs for handling redemptions, they face several important structural decisions. They can organize the SPV as a partnership, limited liability company (LLC), statutory trust, or corporation. Each structure has different legal implications.

Delaware trusts offer particular advantages in this situation. Here's why: when a fund creates an SPV structured as a partnership or LLC, departing investors might not be legally bound by the SPV's operating rules unless the fund's original documents specifically give the fund manager power-of-attorney to sign agreements on behalf of investors.

Trust structures solve this problem entirely. Under trust law, beneficiaries automatically become bound by the trust agreement's terms, even if they never signed the document themselves. This eliminates the legal uncertainty that could arise with other entity types.

Fund documents typically include detailed disclosures about the manager's ability to make in-kind distributions instead of cash payments for redemptions. These disclosures specifically mention that the distributed assets might include interests in special purpose vehicles that hold the actual investments, participations in the actual investments, or participation notes and similar derivative instruments that provide returns related to specific securities owned by the fund.

When hedge funds sponsor CLOs, they face a particular challenge called "consolidation risk." This risk arises because the fund manager and the CLO vehicle are closely connected: the same team often manages both entities, the fund typically provides initial assets and keeps some of the riskier securities, and the fund may be the vehicle's only source of future capital.

To address this concern, CLO documents include provisions designed to achieve "bankruptcy remoteness"—a legal concept that helps ensure the CLO's assets remain separate from the hedge fund's assets if the fund faces financial distress.

Rating agencies—which evaluate the creditworthiness of CLO securities—typically require legal opinions confirming that the CLO would not be consolidated with the fund in a bankruptcy proceeding. They also require certifications that loan transfers to the CLO represent true sales rather than financing arrangements, especially when loans have been held for extended periods before transfer.

Bankruptcy remoteness is achieved through several standardized contractual protections built into the SPV's governing documents.

The vehicle typically requires that an or manager—someone not affiliated with the hedge fund—must consent to any bankruptcy petition or major restructuring. This prevents the fund from unilaterally putting the SPV into bankruptcy.

The entity maintains strictly limited purposes as defined in its organizational documents. This prevents creditors from making broad claims against assets that were intended for specific, narrow uses.

The organizational agreements include "separateness provisions" that prohibit mixing the SPV's assets with those of affiliated entities. The SPV must maintain independent financial records and corporate identity, clearly demonstrating that it operates as a separate entity from the fund.

All transaction documents include standard "limited recourse" language, meaning creditors can only look to specific assets for repayment, and "non-petition provisions," which prevent creditors from forcing the entity into bankruptcy. Legal counsel confirms that all transactions between the fund and the SPV occur at arm's length with fair consideration and market-rate management terms.

While crisis-driven liquidity management represents one major use of SPVs, hedge funds employ these structures for several other strategic purposes:

Risk isolation allows funds to separate investments with unique risk profiles from the main fund, protecting other investors from specific risks while still allowing participation in potentially profitable opportunities.

Co-investment opportunities enable the fund to offer certain investors the chance to participate in specific deals alongside the main fund, often with different fee structures or terms.

Tax optimization can create more favorable tax treatment for certain types of investments by holding them in appropriately structured vehicles.

Regulatory compliance helps funds address specific regulatory limitations or requirements that might otherwise prevent them from making certain investments.

Structured credit investments facilitate participation in complex transactions like CLOs or collateralized debt obligations (CDOs) that require separate legal entities.

Bankruptcy remoteness protects important assets from potential claims against the main fund, as discussed in the previous sections.

who manage must account for their use of SPVs in regulatory filings and compliance programs. Under the SEC's , advisers must determine whether SPVs should be treated as separate advisory clients requiring independent audits, or whether the SPV's assets should be included in the main fund's financial statements.

—a regulatory filing required for large hedge fund advisers—specifically requires funds to report SPVs as portfolio investments. Advisers must provide "look-through" treatment, meaning they report the underlying investments held by the SPV rather than just reporting the SPV interest itself.

When SPVs are created by registered investment advisers, the advisers may designate these vehicles as "" on , which can streamline the registration process for complex multi-entity structures.

The SEC extended the compliance deadline for certain SPV reporting requirements under Form PF until October 1, 2026. This extension reflects the implementation challenges that managers face when overseeing structures involving multiple interconnected vehicles.