Due to the unique legal and market environment, publicly offered real estate investment trusts (REITs) in China’s infrastructure (the Infrastructure Fund) adopt the transaction structure of “publicly offered fund + ABS (asset-backed security)” at the pilot stage. Establishing a sound and effective governance mechanism, and improving protection for investors, are core issues in the construction of China’s publicly offered REITs market, while the “publicly offered fund + ABS” mode has a multi-layered agency relationship, and its governance issues are particularly complex.
This article takes in the international experience and discusses the best scheme of management function distribution and governance mechanism of publicly offered REITs in China.
The main management modes adopted by REITs are the external management mode and internal management mode. An external management mode means that the REIT entities are managed by external managers; an internal management mode means that REITs own real estate assets and asset managers at the same time, and the asset managers manage the real estate assets themselves.
American REITs are generally in corporate form, mostly adopting the internal management mode, while Asian REITs (such as in Singapore and Hong Kong) are generally contractual, mostly adopting the external management mode.
Japanese and Australian REITs are relatively special. Japanese REITs learn from American corporate structure, but adopt the external management mode; Australian REITs are contractual, but some Australian REITs enable REIT holders to simultaneously hold equity in management companies through stapled securities, which can realise internal management.
There are no distinct advantages or disadvantages between the two management modes. Internal management helps to reduce costs, and the governance mechanism is simpler and more flexible. External management has strict internal controls, high independence, and a more reasonable incentive mechanism, and can play the scale effect of professional capabilities.
China’s current “publicly offered fund + ABS” mode is an external management mode, which is similar to that of Singapore and Hong Kong REITs.
Management mode in China
- Role orientation and problems of publicly offered fund managers. The Guidelines for Publicly Offered Infrastructure Securities Investment Funds (Trial) strengthen the professional competence requirements and fiduciary responsibilities of fund managers as trustees who need to take the responsibility of actively managing infrastructure projects, and put forward higher requirements for fund managers’ ability in discovering the value of, and operating, real estate.
However, the specialty of traditional publicly offered fund management companies is their ability in investment research and portfolio investment, and there is still a gap between their management ability and that of property owners or professional real estate investment institutions. It will take a long time for fund managers to comprehensively improve their value creation ability of assets by setting up new subsidiaries or functional departments.
- Distribution of management functions. REITs are a kind of asset management based on a trust relationship. How to reduce the agency cost caused by information asymmetry and interest conflict between REIT holders and managers is the main problem of REIT governance.
If the functions of REIT management are divided into three modules – fund management, investment management and post-investment management, as mentioned above – the guidelines tend to take the managers of publicly offered funds as the main responsibility bearer, who shall be responsible for fund management, investment management and post-investment supervision.
However, there are no special provisions on the functions of programme managers in the guidelines, and the relevant regulatory provisions of publicly offered REITs, and the functions should be implemented in accordance with the relevant requirements of asset-backed securitisation in practice.
The authors understand that the responsibility requirements imposed on publicly offered fund managers, as the main responsibility bearer by publicly offered REITs, will overlap with those imposed on programme managers by supervision in the asset-backed securitisation business, and it is difficult to define boundaries and responsibilities between the two.
Meanwhile, considering the fact that it will take time for publicly offered fund managers to improve their active management ability in real estate, and the asset support programme managers represented by securities traders are familiar with the underlying asset and product issuance process, it is more appropriate for the programme managers to assume the main management responsibilities in a short period of time. Of course, the publicly offered fund managers will not be exempted from their liability.
- Common problems under the structure of REIT-like products and their solutions. From the perspective of product structure, China’s publicly offered REITs have evolved from REIT-like products by grafting publicly offered fund, and the governance problems of REIT-like products will become more prominent under the structure of publicly offered REITs. Generally speaking, the main management responsibilities of REIT-like products are undertaken by special programme managers and private fund managers.
However, only the original equity holders “live in scenarios of the business, have operational capabilities, have access to assets, and have access to debtors or payers”. Therefore, many REIT-like products entrust the property to the related parties of the original equity holders for management or lease management, and private fund managers have very limited control.
Although the current supervision does not support the retention of private funds under the structure of publicly offered REITs in principle, the problem that special programme managers and publicly offered fund managers lack actual control over the underlying real estate also exists, or is even more prominent.
- Value creation under external management mode. For the Infrastructure Fund, the entities with value creation potential include publicly offered fund managers, special programme managers, private fund managers, external management institutions and financial advisers. At present, the pilot project of the Infrastructure Fund will be a value creation mechanism driven by the property owner as the asset end value, and the financial consultant as the pricing end value, under the overall planning of the fund manager, and the leading power of the project will tilt towards the entities with stronger value creation ability.
From the overall supervision thinking of the guidelines, with the improvement of publicly offered fund managers’ active management ability in real estate, the leading power will gradually tilt towards them, and the overall governance system will gradually be simplified and improved.
Qin Maoxian is a partner and Wang Cong is an associate at Jingtian & Gongcheng
Jingtian & Gongcheng
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