Insurance funds to invest in land reserve projects (part 1)

At the end of 2010, the total assets of the Chinese insurance industry topped RMB5,000 billion, and the insurance funds available for use amounted to RMB4,600 billion.

The ways in which insurance funds can be used have been broadened under the new PRC Insurance Law and the Investment of Insurance Funds in Debt Investment Schemes for Infrastructure Notice. In adition, the Investment of Insurance Funds In Immovable Property Interim Measures issued in 2010 allow insurance funds to invest in immovable property, including government land reserve projects, whether by means of debt, property or equity. Debt investment in government land reserve projects offers low risk, a long cycle and guaranteed returns. These characteristics satisfy the regulatory requirements of the China Insurance Regulatory Commission (CIRC), spreading risk and offering the potential to preserve and increase the value of insurance funds.

The participants

The main participants in debt investment in government land reserve projects are the principal, agent, beneficiary, user of funds, guarantor, custodian and the independent supervisor of the investment scheme. Typically, a principal engages an agent to establish a debt investment scheme and enters into a “debt investment scheme investment contract” with a user of funds; a guarantor guarantees the scheduled repayment of the principal and interest; the principal releases funds to the user of funds through a custodian.

After the debt investment scheme expires, the user of funds pays the principal and interest to the custodian who distributes this to beneficiaries; and the beneficiaries appoint an independent supervisor to monitor the agent and the user of funds.

• Principal: the principal may be an insurance company, an insurance group company or an insurance holding company which is approved by the CIRC. The principal engages an agent with funds to set up the investment scheme. After an investment scheme is established, the insurance company, insurance group company or insurance holding company will pay the trust funds into a custody account.
• Agent: the agent may be a trust and investment company, an insurance asset management company, an industry investment fund management company or another specialized management institution which invests in infrastructure projects in its own name as agreed under an investment scheme, according to the intentions of a principal and in the interests of a beneficiary.
• Beneficiary: a beneficiary may be a person who lawfully holds a share of the beneficial interest in an investment scheme and is recorded in its register of beneficiaries, including the beneficiaries designated by a principal at the time of establishment of the investment scheme, and persons who hold a share of the beneficial interest in the future through transfer, inheritance or other legal means. A beneficiary may be a principal, agent or a third party designated by a principal (such as a subsidiary of a principal).
• User of funds: user of funds means a project manager under an investment scheme. In land reserve projects, user of funds usually refers to a developer with first-grade qualifications for land development.
• Guarantor: a guarantor is a third party which provides a guarantee on behalf of a user of funds for the performance of an investment contract for a debt investment scheme. It is usually a financially strong enterprise such as a central enterprise or a financial institution with good ratings.
• Custodian: a custodian is a commercial bank or other specialized financial institution engaged by a principal as stipulated under an investment scheme to be an agent of property.
• Independent supervisor: an independent supervisor is a specialized management institution engaged by a beneficiary as stipulated under an investment scheme to supervise the operations of the party that manages the investment scheme and the agent to safeguard the interests of the beneficiaries.

Mode of operation

According to current Chinese law and practice, we believe insurance funds may invest in government land reserve projects through a debt investment scheme in four ways. In this article, we will briefly look at two of those ways.

Agent not involved in the development

In this structure, an agent sets up a debt investment scheme and is engaged by a principal to inject insurance funds through the scheme directly into a company with first-grade qualifications for land development. A guarantor provides the developer with a guarantee for the scheduled repayment of the principal and interest; a custodian releases the insurance funds to the developer, which uses part of the funds, under the supervision of an independent supervisor, to carry out development and construction works in accordance with the debt investment scheme signed with the agent. After the debt investment scheme expires, the developer pays the principal and interest to a custodian who distributes it to beneficiaries.

This structure involves relatively simple legal relationships, is easy to operate and relatively low-risk, and generates relatively fixed income levels and relatively narrow profit margins. A key requirement is to ensure the guarantor has the capability to provide a guarantee. Therefore, adequate due diligence on the user of funds and on the guarantor must be carried out.

Agent involved in the development

An agent establishes a debt investment scheme as engaged by a principal to inject insurance funds through the scheme directly into a company qualified for development. The agent and the developer form a joint entity to develop the land and share profits. Under this structure, as the agent may share the profit from the development of the land, the profit margins the insurance fund may enjoy are higher than under the first structure, however, the agent will also take more risk during the development process. The agent should control these risks through negotiations between the joint entity and other parties or local governments and the drafting of appropriate contractual terms. (To be continued.)

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.