Pipeline network eligibility for securitising finance lease assets

By Adam Chen and Daniel Hsu, AnJie & Broad Law Firm
Copy link

As one of the most common types of underlying asset in asset securitisation, claims under a finance lease have long been at the forefront in terms of issuance scale and size. In practice, when local platform leasing companies select leased assets for asset-backed securities (ABS), in addition to the requirement that lease claims meet underlying asset standards, the underlying leased assets must also be eligible.

But the question of eligibility for securitisation can sometimes be thorny in a grey area like a pipeline network, raising many questions.

Q: What leased assets can be used?

Daniel Hsu, AnJie & Broad Law Firm
Daniel Hsu
AnJie & Broad Law Firm

A: China’s Civil Code and other laws and regulations clearly state that leased assets under finance lease contracts shall not be fictitious. Otherwise, the contract will be invalid. The Interim Measures for the Supervision and Administration of Finance Lease Companies, issued by the China Banking and Insurance Regulatory Commission in 2020, provides that leased assets of finance lease transactions should be fixed assets. But they did not clarify the definition and scope of fixed assets beyond requiring leased assets to be “genuine”, “of clear ownership”, and able to “generate income”.

In practice, reference is often made to the Accounting Standards for Business Enterprises No. 4 – Fixed Assets, which provides that “fixed assets refer to tangible assets: (1) held for the purpose of producing commodities, rendering labour services, renting or business management; and (2) service life is more than one fiscal year.”

According to judicial practice, in addition to equipment, construction machinery, transportation tools and other movable properties, factory buildings, commercial real estate and other immovables for operation satisfying the above-mentioned standards can also serve as leased assets.

Real estate such as housing under construction, urban roads and security housing, as well as intangible assets such as trademarks, patents and software cannot serve as leased assets because they do not generate proceeds, their disposal is restricted, or they are not tangible assets.

Q: What are the requirements?

A: Usually, leased assets should meet the following requirements: (1) clear and uncontroversial ownership; (2) not subject to rights restrictions such as mortgage and pledge; (3) specific and disposable; (4) commercially reasonable; and (5) not involving national defence, military and other state secrets.

Disposability and commercial rationality are especially important. When applying for a project, it is generally necessary to make clear whether the leased assets are disposable and profitable.

Q: Does a pipeline network meet ABS requirements?

A: Platform leasing companies generally concentrate their businesses in public utilities, infrastructure construction and other government-credit areas. Their finance lease often dabs in public welfare, making the leased assets unable to meet requirements of disposability and commercial rationality.

Since 2020, regulatory authorities have banned the use of urban roads, bridges and culverts as assets under finance lease, and restricted the proportion of structures. However, due to the particularity of the pipeline network, opinions diverge on whether it falls under structures.

Q: Is a pipeline network a structure or movable property?

Adam Chen, AnJie & Broad Law Firm
Adam Chen
AnJie & Broad Law Firm

A: Laws and regulations of China stipulate that “real estate” includes buildings, structures and land attachments, but structure is not clearly defined. The national-standard Classification and Code of Fixed Assets defines “structures” as artificial structures not for production or residence, complemented with a list of structure types.

Among these, water pipelines (water diversion pipelines, drainage pipelines, etc.) and municipal pipelines are clearly classified as “structures”; water delivery pipelines as “transmission pipelines” under general equipment; and oil and gas pipelines as “special equipment for petroleum and chemistry”, under special equipment. All of them are determined as movable property.

Q: Is a pipeline network eligible if attached to real estate?

A: Although the pipeline network needs to be attached to land, housing or other immovable property to play to its function, its status as tangible movable property is not affected. As a leased asset, it retains the attribute of movable property and its independence.

The attachment of such assets to real estate runs the risk of weakening the lessor’s ability to use it as security. However, this is an operational risk for the finance lessor, and does not affect identification of the pipeline network as movable property.

The Supreme People’s Court also held this view in the re-examination and trial supervision of 2017 disputes over a loan contract between Sinohydro Beigu Construction Machinery and Chengdu Yuyi Silk.

Q: Is a pipeline network disposable and commercially reasonable?

A: A pipeline network is movable property and is therefore specific and independent. Although after detachment from real estate, it may suffer from reduced utility and moderate market liquidity, meaning it cannot be disposed of or realised in time. However, if a breach of contract occurs, there is no legal obstacle to the disposal of leased assets pursuant to the lease contract.

In addition, although most pipeline networks do not directly charge users for providing transmission services, most such charges are actually included in the overall costs, except for water and heat transmission pipeline networks in industrial parks featuring clearly provided charging standards. Therefore, pipeline networks are indispensable auxiliary facilities for the lessee’s main business operation and profitability, justifiable in their commercial rationality.

Q: Suggestions for entering a pipeline network as a pool asset?

A: Judging from recent successful finance lease ABS issuances of platform lessors, there is no obstacle to the entry of pipeline networks into the pool of leased assets as long as the disposability, commercial rationality and other eligibility standards are met.

The authors suggest that managers screening pool assets focus on the following aspects in reviewing the eligibility of pipeline networks: (1) confirm the ownership certificate, such as purchase contract, invoice, acceptance certificate or equipment receipt; (2) inspect rights registration such as verifying completion of the finance lease registration on the website of the central bank’s credit reference centre; (3) conduct on-site inspection and due diligence to confirm genuine specificity of leased assets; and (4) review the leased asset evaluation report and internal review documents of the project to avoid purchasing at price highpoint and reaffirming the commercial rationality.

Adam Chen and Daniel Hsu are partners at AnJie & Broad Law Firm

Dong Xiao Zhao Huili AnJie Law Firm International arbitration

AnJie & BB Law Firm

28/F, K. Wah Center, 1010 Huai Hai M. Road
Shanghai 200031, China
Tel: +86 21 2422 4845
Fax: +86 21 2422 4800

E-mail: adam.chen@anjielaw.com


Copy link