C-REIT pilot projects and development prospects

By Fang Rong, Han Kun Law Offices
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The first nine pilot projects for publicly offered infrastructure funds were listed on the Shanghai and Shenzhen stock exchanges on 21 June 2021, marking the official birth of China Real Estate Investment Trusts (C-REITs).

Fang Rong
Partner
Han Kun Law Offices

To overcome the obstacles of issuing REITs under China’s existing laws and regulations, C-REITs adopt a multi-level product structure of “publicly offered fund + ABS (asset-backed securities) + project company”. This is because the Securities Law does not list REITs as a type of security. Even if they can be interpreted as “other securities” under the law, special legislation by the State Council would be required, which would mean their introduction would lag behind the development of the market.

Therefore, the multi-level structure allows the introduction of C-REITs at the lowest cost and which are best suited to current market developments by using the existing legal framework that allows publicly offered funds to invest in ABS and by fully drawing lessons from the market experience accumulated in issuing privately offered REITs with ABS as the carrier.

The Guidelines for Publicly Offered Infrastructure Securities Investment Funds (Trial), issued by the China Securities Regulatory Commission, clearly stipulate other requirements of C-REITs that fully embody the characteristics of REITs as equity-based financial instruments, including: REITs should hold all the equity of the project company; REITs should obtain full ownership or management rights of infrastructure projects, and have full control and disposal rights over infrastructure projects; the fund manager takes the initiative to operate and manage infrastructure projects for the main purpose of obtaining stable cash flow, such as rent and charges of infrastructure projects; closed-end operation is adopted for the fund and the income distribution ratio is not lower than 90% of the annual distributable amount of the fund after combination.

Pilot review

The policy of C-REITs was originally intended to revitalise the existing high-quality infrastructure assets, spur new investment in infrastructure projects, and improve the quality and efficiency of the capital market in serving the real economy. Instead of including commercial real estate in the pilot industries of REITs, it focuses on transportation facilities, municipal engineering, pollution control projects, national strategic emerging industrial clusters and high-tech industrial parks. The underlying assets of the pilot projects reflect the system orientation in industrial parks, warehousing and logistics, toll roads, sewage and solid waste treatment.

On specific asset screening, the National Development and Reform Commission organised a comprehensive audit of the legal compliance, cash flow stability, yields and other aspects of various infrastructure projects to protect the interests of small and medium-sized investors. As for regions, the pilot projects focus on the most active economic development areas – such as Beijing-Tianjin-Hebei, Guangdong-Hong Kong-Macau Greater Bay Area and the Yangtze River Delta – and strive to screen high-quality infrastructure projects.

The main issuers of pilot projects include domestic and foreign-funded enterprises, generally state-owned ones. The first nine enterprises that have completed issuance, and the candidate issuers, are all the leading enterprises in their industries and have a large amount of reserve assets available for raising funds.

In addition, due to the public inquiry mechanism adopted in the share pricing of REITs, fair pricing for state-owned property rights can be achieved through the open market. The state-owned property rights transactions of the pilot projects are all exempted from the procedures for exchange in the specified market under order No. 32, which optimises the transaction process and avoids such uncertainties as failure of REIT issuance due to delisting of third parties, price deviation from the issuance scale and long operation cycle.

Development prospects

Simplifying the product structure. The multi-layer product structure of C-REITs involves many participants, leading to a relatively complex legal relationship. The market expects to simplify the product structure through the improvement and adjustment of institutional rules after gaining market experience.

Possible simplifying paths include: REITs become regarded as a new type of security alongside traditional ones such as stocks, bonds and publicly offered funds, and REITs are directly invested in the real estate or equity of project companies; public offering of ABS, that is, changing private offerings into public ones based on the existing ABS; retaining the existing structure of the publicly offered fund, but REITs, as a special kind of publicly offered fund, can be directly invested in the equity of unlisted companies without making an indirect investment through ABS; REITs use special purpose vehicles as carriers to revise the Securities Law and the Company Law in terms of corporate governance structure, profit distribution and IPO rules.

Optimising the governance structure. The multi-level product structure inevitably requires multi-level governance arrangements. C-REITs involve such multi-level and multi-subject governance arrangements as fund shareholder meetings, fund managers, asset-backed securities holders’ meetings, managers of asset-backed securities, and shareholder meetings, boards of directors (managing directors), and managers of the project company, resulting in such problems as competing for management functions and powers, a long decision-making chain and high management costs.

Subsequently, special attention should be paid to clarifying the management interface, and the responsible subjects and rules of procedure, so as to prevent decision-making efficiency from being affected by the long management chain.

Meanwhile, great efforts should be exerted to: Cultivate REIT managers with asset management capabilities; strengthen the construction of rules in information disclosure and financial audit; pay attention to the decision-making mechanism and implementation rules of connected transactions; establish a reward and assessment mechanism that is more conducive to co-ordinating various stakeholders; and give full play to the role of such external institutions as investment consultants and asset appraisal institutions in the governance structure of REITs.

Establishing a fund-raising mechanism. Continual fund-raising and asset placement are the lifeblood of REITs as an asset management platform. REIT issuers, as the leading enterprises in their industries, all hold abundant reserve assets. From the perspective of continuing to revitalise the existing assets and promoting the virtuous circle of investment, they have strong expectations for raising funds.

However, the existing rules of securities investment funds are of limited reference significance, and the related internal decision-making and external audit filing process, suspension mechanism, asset evaluation and issuance pricing, and information disclosure requirements are to be further explored.

Fang Rong is a partner at Han Kun Law Offices. She can be contacted on +86 10 8524 9486 or by email at rong.fang@hankunlaw.com