Document No. 463 may have a notable impact on BT projects

On 24 December 2012, the Ministry of Finance, the National Development and Reform Commission (NDRC), the People’s Bank of China and the China Banking Regulatory Commission (CBRC) jointly issued and implemented the Notice on Putting a Stop to Illegal Financing Activities by Local Governments (Document No. 463). The notice sets out provisions in respect of the scope of application of the BT (build-transfer) model, the provision of security in breach of contract by local governments, etc.

Existing issues

Confusion of concepts. The expression “where agent-construction system construction is to be adopted with year-by-year repurchase (BT) with fiscal funds” in Document No 463 treats agent-construction and BT as one. The term “agent-construction” means the government selects a professional project management entity, through an invitation of bids, that is responsible for the investment management of a government-invested public works construction project, and for the construction organisation that carries on the work, and effects delivery to the entity that will be using it once the project is completed.

In general, the construction funds therefor are allocated by the government, with the agent-construction entity solely responsible for management of their use. In contrast, the term ‘BT’ means that the government bestows on the investor the responsibility for investing in, financing and constructing the project, and after completion of the project, the investor transfers it to the government, and the government pays the repurchase price to the investor in accordance with the BT contract. There are marked differences between the two terms in the legal status of investors, the party for project financing, the ownership of the project and repurchase issues – they are in fact two completely different construction models. It seems Document No. 463 gives rises to a confusion of concepts.

Ambiguity of the scope of application. Before the issuance of Document No. 463, the BT model could be used in the construction of all urban infrastructure and utilities projects, including public roads, urban streets, subways, replacement housing, ports, waterworks, primary land development, river control, etc.

Document No. 463 specifies that agent-construction system construction may be adopted with year-by-year repurchase (BT) with fiscal funds only for projects for which government debt can be taken out in compliance with the law or State Council regulations, such as public rental housing, public roads, etc. The foregoing provision may be understood either as only including public rental housing and public road projects, or including other projects in addition to those. The concept of “government debt” has yet to be clearly defined.

It is believed that the unclear definition in Document No. 463 is bound to lead to different understandings by local governments and by banks and other financial institutions, thereby resulting in a limitation in the scope of application of BT projects in practice.

Prospects unclear for projects presently being carried out. Document No. 463 does not expressly address how the following matters are to be dealt with: projects for which BT financing has been adopted, but for which laws or the State Council have not specified that government debt can be taken out; projects for which the early stage invitation of bids for a BT investor has been completed; and projects for which a BT contract has been executed but the work on which has yet to commence, or for which a BT contract has been executed and construction of which is in the contract performance period.

Possible limitations on investors’ normal repurchase payment guarantees. It is a common practice in the industry to specify in a BT project contract that the government undertakes to include the project in its medium and long-term investment plan, and to provide to the investor in each repurchase year the document of the people’s congress approving the inclusion of the repurchase payment in the annual fiscal budget, which serves as an annex to the contract. The abovementioned government undertaking is not what is legally meant by the provision of security, but it does have the function of protecting the investor’s lawful interests. But Document No. 463 forbids local governments from issuing such direct or disguised security agreements as guarantees, undertakings, letters of comfort, etc. It cannot be excluded that some local governments will, on such grounds, refuse to issue the abovementioned normal undertaking documents, thereby weakening their capacity to ensure investors’ repurchase payments.

Positive impact

Government. BT projects fall within the scope of fiscal solvency of a local government, without exceeding local fiscal revenues. Document No. 463 requires that a government must, where agent-construction system construction genuinely needs to be adopted with year-by-year repurchase (BT) with fiscal funds, rationally determine the scale of construction and put in place a year-by-year fund repayment plan based on the project construction plan, solvency, etc. This provision enhances the reliability of governments’ repurchase funds and reduces investors’ investment risks.

Financing platforms. In compliant BT projects, the BT authorising entity and repurchasing entity are the government, and the investing and constructing entity is the investor. In practice, however, due to financing needs, it is common for the local government financing platform company to be the authorising and repurchasing entities, although all the payments are still provided from local finances.

In respect of the foregoing non-compliant practice, Document No. 463 particularly specifies that a local government “may not undertake to use the anticipated revenue from the grant of reserve land as the source of funds for repaying the debt of a financing platform company”, and reiterates that a local government at any level may not mortgage or pledge the state-owned assets of an authority, institution or association as security for the financing of a financing platform company, may not assume liability for repayment in respect of the financing of such company, and may not provide security for the repurchase (BT) agreement of such company.

As a result, the debts of a financing platform company will have to be assumed by the company itself, thereby compelling local governments to forego the practice of having a financing platform company serve as an entity to a BT project contract.