Asset securitization and the PPP model


The rapid development of the public-private partnership (PPP) model is closely related to the central government’s efforts to address the issues of local government debt. Local governments have long invested in infrastructure and public services projects by taking on debt through financing vehicles. Such moves have fuelled economic and social development, but have also led to a host of problems such as a lack of control over the size of local debt, elevated financing costs, and the failure to include revenues and expenditures under budgetary management.

黄再再 Huang Zaizai
黄再再 Huang Zaizai

In 2014, the State Council issued the Opinions on Strengthening the Management of Local Government Debts, calling for rigorous management of local debt and expressly stating that governments should not take on debt via private or state enterprises. It is against such a background that PPPs have grown rapidly as a new public service supply model, which can guard against and address government debt risk.

Under the PPP model, the government selects private investors that are capable of investing, operating and managing infrastructure projects on merit by letting them compete against each other. The government and the selected private investors then sign contracts to specify their rights, obligations and interests based on the principle of equal negotiations. Private investors provide public services and the government pays corresponding consideration to them based on the results of public services performance appraisals.

The PPP model has the following characteristics:

First, infrastructure and public services projects usually require huge investment. Of the second batch of pilot PPP projects published by the Ministry of Finance (MOF), 31.1% require investment of between RMB1 billion (US$153 million) to RMB5 billion, 7.8% need investment of RMB5-10 billion, and 7.2% have an investment of more than RMB10 billion.

Second, long operational periods. The Notice on Further Improving the Exemplary Work for Public-Private Partnership Projects, issued by the MOF, states that the period of co-operation between the government and private investors should, in principle, be no less than 10 years. In the MOF’s Operating Guidelines for the Public-Private Partnership Model, it is even required that the contract period of projects under the Build-Operate-Transfer (BOT), Transfer-Operate-Transfer (TOT) and Rehabilitate-Operate-Transfer (ROT) models should generally last from 20-30 years.

Therefore, traditional financing methods such as loans are insufficient to satisfy the capital demand of PPP projects, making it necessary to combine the use of a number of funding methods. After private investors are determined, there will be two stages based on the operation process of PPP projects, namely project design and construction, and project operation.

At the stage of project design and construction, since the underlying assets have yet to form, projects can only be financed by project companies via loans or equity financing. In practice, since PPP project companies are usually financially weak, they need private investors (shareholders of PPP project companies) to guarantee their financing, putting huge financial pressure on private investors.

After PPP projects enter the operating stage, there are mainly three types of mechanisms to generate investment returns, namely fee payment by users, viability gap funding (VGF) and fee payment by the government, all of which can generate cash flows. At this point, funds can be raised via asset securitization so as to allow private investors to exit or alleviate their financial pressures. So it seems necessary to combine PPPs with asset securitization and convert cash flows of PPP projects into securitized products that can be invested while promoting the PPP model.

In terms of the transaction structure, there are two basic ways of securitization for PPP projects:

Asset securitization of future income. The Administrative Provisions on the Asset Securitization Business of Securities Companies and Subsidiaries of Fund Management Companies, issued by the China Securities Regulatory Commission (CSRC) in November 2014, state that underlying assets include “real properties or the right to income from real properties such as infrastructure and commercial properties”. Therefore, asset-backed securities products can be designed based on the future income of PPP projects.

However, since future income is uncertain, attention needs to be paid to the following points during transaction structure design: (1) reasonably select the originator (asset transferor). The amount of future income depends on whether the originator’s business can be conducted normally, so it is important that the originator has the ability to continue operations and be free of any major operating, financial or legal risks; (2) develop measures to collect and monitor cash flows. To ensure timely collection of future income, a cashflow collection mechanism should be designed, and such cashflow should be monitored via account supervision; (3) design credit enhancement structures. To guard against volatility risk of future cashflow, companies can design credit enhancement structures by making good shortfalls or providing excess coverage to make products more attractive.

Notably, the Guidelines for the Underlying Asset Negative List for the Asset Securitization Business, issued by the Asset Management Association of China in December 2014, states that “underlying assets with local governments as the direct or indirect debtors” should not be used as the underlying assets of asset-backed securities. However, the same Guidelines also specify that “fiscal subsidies to be paid or borne by local governments under the public-private partnership model in accordance with publicly disclosed pre-agreed provisions on incomes” are excluded. Therefore, fiscal subsidies in PPP projects can also be used as the underlying assets of asset-backed securities.

Dual-SPV structure featuring “trust scheme + asset-backed specific plan”. Under a dual-SPV structure, the trust company issues a trust loan to the PPP project company, which uses the future income of the PPP project as a pledge for the loan, thereby including the future income of the PPP project in the trust scheme. Then, an asset-backed specific plan is launched, with the right to benefit from the trust as the underlying asset.

It should be noted, however, that pursuant to the Guidelines for the Underlying Asset Negative List for the Asset Securitization Business, under a dual-SPV structure, the ultimate investment target of a trust scheme cannot be an asset type included in the negative list. Hence, when designing an asset-backed securities product with a dual-SPV structure, it should be examined whether the underlying asset of a trust scheme complies with relevant regulations.

Huang Zaizai is a partner in the Beijing office of Tian Yuan Law Firm. He can be contacted on +86 10 5776 3979 or by email at