Focus on recent developments in securitisation of commercial property

A: On 15 March 2013, the China Securities Regulatory Commission (CSRC) issued the Administrative Provisions for the Asset Securitisation Business of Securities Companies, manifesting the newest developments in China’s legal system for securitisation of commercial property.

As compared to previous regulations, such as the Guidelines for the Pilot Projects for the Enterprise Asset Securitisation Business of Securities Companies (for Trial Implementation), the administrative provisions expressly specify for the first time that commercial property and other such immovable assets may serve as underlying assets for asset securitisation.

The provisions also expand the scope of financial institutions that may engage in the commercial property securitisation business. Pursuant to article 45 of the administrative provisions, the offering and transfer of asset-backed securities on the exchanges specified in article 6, by securities investment fund management companies, futures companies, securities financing companies and other companies subject to CSRC regulation, as well as commercial banks, insurance companies, trust companies and other such financial institutions, are governed by the administrative provisions mutatis mutandis. Accordingly, the entities that may engage in the securitisation of commercial property have been expanded to cover almost all existing financial institutions.

The administrative provisions strengthen the circulation arrangements for asset-backed securities. Article 6 says “asset-backed securities may, in accordance with regulations, be transferred on a stock exchange, the quotation and transfer system of the Securities Association of China, the securities company over-the-counter market or other CSRC-recognised exchange”. This provision is conducive to the trading and circulation of asset-backed securities, and to the realisation of the asset securitisation of commercial property.

Q: Pursuant to the administrative provisions, how is the securitisation of commercial property achieved?

A: The third paragraph of article 2 specifies that a securities company engaging in asset securitisation business may adopt a “dedicated plan” or other such special purpose vehicle, and taking the types of initial assets managed by it as the yardstick, it may use either of the following two methods for the securitisation of commercial property:

A dedicated commercial property investment plan. If the initial assets under management are funds, this is similar to a real estate investment trust (REIT). The main points in the establishment of such a “dedicated plan” are as follows: the manager establishes the dedicated plan to collect proceeds and offers asset-backed securities to investors; the manager invests the proceeds in commercial property (may hold property rights, equity in property project companies, or purchase the right to returns on property for a certain period of time); and the asset-backed securities holders are repaid from the cash flow generated by the lease and/or sale of the property.

A dedicated commercial property asset plan. If the initial assets under management are commercial properties, this is similar to a real estate asset trust (REAT). The main points in the establishment of such a “dedicated plan” are as follows: the commercial property owner – i.e. the original beneficiary of the underlying assets – places the commercial property, or the right to the returns from it, in trust with the manager, for which the manager receives the right to the returns in the trust; the manager offers asset-backed securities representing the right to returns in the trust to raise proceeds and delivers the proceeds to the original beneficiary; and the asset-backed securities holders are repaid from the cashflow generated by the lease and/or sale of the property.

Q: What are the major legal obstacles to the securitisation of commercial property at present?

A: First, a lack of a system for the registration of property trusts. Engaging in commercial property securitisation whether by means of a “dedicated plan” as a special purpose vehicle or a “trust” as the vehicle involves the issue of the registration of property trust ownership.

At present, the Shanghai Trust Registration Centre is responsible for registering only the financial products designed and dealt in by financial institutions using the trust law, and is not responsible for the registration of property trust ownership. The lack of a property trust registration system could result in the inability to genuinely separate the underlying asset and original beneficiary risks, and the underlying asset and manager risks.

Second, unclear tax policies. Pursuant to current tax policies, the taxes paid by a property transferor are land value-added tax and business tax, and those paid by the transferee are deed tax, and both the transferor and transferee are required to pay stamp duty. In the course of commercial property securitisation, there is a strong possibility of two property transfers, the first being the purchase of, or the securing by way of a trust of, the property, and the second being the sale of the property upon the expiration of the term of the “dedicated plan”.

With respect to the property trust act, whether land value-added tax, business tax and deed tax are required to be levied separately on the transferor and the “dedicated plan” calls for further study. If an arrangement has been designed for the “dedicated plan” where the original owner buys back the commercial property, whether land value-added tax, business tax and deed tax are required to be levied separately on the “dedicated plan” and the original owner again at the time of the buyback also calls for study.

Third, trust and entrustment controversy. The draft for comment appearing before the issuance of the administrative provisions expressly stated that the Trust Law was one of the bases relied on for its formulation, whereas the administrative provisions do not rely on the Trust Law as a basis. Accordingly, is the relationship between the manager of a “dedicated plan” and the entrusting party in fact a trust relationship, or an entrustment contract relationship? At present, a definite interpretation is lacking.

Fourth, special issue of the securitisation of the “right to returns from” commercial property. The administrative provisions do not prohibit using the right to returns from commercial property to structure asset securitisation. It is undeniable that there is quite a distance between taking the “right to returns” to structure commercial property securitisation and true asset securitisation. In adopting this method, the ownership of the commercial property continues to vest in the original beneficiary, making it impossible to genuinely realise the intrinsic requirement of the fundamental principle of asset securitisation, namely separation from the risks of the original beneficiary.

Zhang Xianzhong is a partner at AnJie Law Firm