Insurance funds can invest in government land reserve projects through a debt investment scheme in four ways. In the last issue of this magazine, we introduced two of these ways. This article will look at the other two investment structures: indirect investment by insurance funds, and build-transfer franchising.
Indirect investment
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V&T Law Firm
Under this arrangement, a trustee is instructed by a principal to establish a debt investment scheme, through which insurance funds are channelled into a project company jointly funded by the trustee and a developer. The project company will take charge of the development of land reserve projects. The trustee and the developer will be the shareholders of the project company and will share any profits from the development. In this model the trustee, as a shareholder of the project company, has limited exposure to liability during the initial phase of preparing land for development.
With respect to the apportionment of liability between entities, the trustee is exposed to lower risk than in the second model discussed in the previous issue. However, difficulties may arise if the project company is unable to obtain the permissions required for the development in a short period of time.
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Build-transfer franchising
In the build-transfer (BT) model, the government enters into a franchise agreement with an investor (which may be a state-owned enterprise, private company or foreign investment enterprise). Under this agreement, an infrastructure project is franchised to the investor (the franchisee) for financing and construction. Upon completion of the project, the franchisee will transfer the project to the government or its authorized agencies, and the government will pay the franchisee a buy-back price within an agreed period.
Where investment is made in preparatory land development projects using a BT structure, a trustee and a developer will acquire a BT franchise and jointly set up a project company. The trustee will channel insurance funds into the project company via a debt investment scheme, and the project company will conclude a BT franchise contract with the government under which the development costs and profits of the project company will be stated. The project company will be responsible for raising and investing the funds required for development and construction, and for carrying out the construction.
The project company will deliver the completed project to the government, which will pay a buy-back price to the project company. The buy-back price will be paid in stages, generally over three to five years.
After the government pays the buy-back price to the project company, the project company will pay the principal and interest to a custodian in accordance with the debt investment scheme, and the custodian will then distribute this to beneficiaries.
Compared with the other three investment models, BT franchising offers more security for insurance funds and more scope for an increase in value, for a number of reasons.
First, when a local government enters into a BT franchise contract, it must already have secured the buy-back funding for the project. This means the buy-back funding will be incorporated into that local government’s expenditure and investment plans, and will be issued with approval documents from the people’s congress at the same level, as well as a written undertaking by the government’s finance department. In practice, some local governments have set up a financial account exclusively for buy-back funding. After proceeds from land transfers, local tax revenues and other local revenues are submitted to the local treasury, they will be transferred directly to the buy-back fund account. Details of the balance of the account should be made available to investors every quarter. The extra security therefore inherent in the BT franchising model complies with the regulatory requirements of the China Insurance Regulatory Commission for the security of insurance funds.
Second, the government is usually required to guarantee a buy-back project. Guarantees may be provided by means of a letter of guarantee from a bank, or a joint-and-several-liability guarantee by a local state-owned enterprise. In addition to these legally binding, “hard” guarantees, there are some “soft” guarantees, i.e. undertakings by governments which do not have strict legal effect. For example, some local governments may undertake that an investor can carry out the preparation and full-scale development of land, while others may undertake that the land grant fee for a designated a piece of “undeveloped land” in a certain area will first be used to pay the buy-back price to an investor. This kind of double guarantee from the government will serve to ensure a project company can receive buy-back money as scheduled, and will be able to distribute the principal of insurance funds and interest to beneficiaries through a custodian as agreed under its debt investment scheme.
Third, when entering into a BT franchise contract, a project company can often negotiate with the government over investment profits and tax concessions. Given that China has no national legislation governing infrastructure franchising, and the approach to infrastructure franchising varies among local governments, there is plenty of scope for negotiation over the cost structure, return on investment and tax concessions in a development project. This can offer insurance funds a promising outlook for the preservation and creation of value.
Know local regulations
All of the above suggests that in comparison with other models, the BT franchising model is advantageous in terms of security as well as the preservation and creation of value for insurance funds.
However, this model involves more complex legal relations. Familiarity with local regulations in the place where a project is located, as well as the concerns and practices of local governments, are essential factors which determine whether a trustee is able to secure the maximum return on investment.
Wang Jihong is the managing partner of V&T Law Firm. She practises in the field of infrastructure development. Gao Lei is a lawyer at V&T Law Firm
