Various regulators have implemented the most stringent financial regulatory policies in recent years to prevent systemic financial risks. Controls in the real-estate market are also escalating gradually. The RE industry involves the most numerous financial products. It is highly dependent on finance to the extent that it can even be said it is of the essence. However, the current financial regulatory policies and RE control situation are simply “double kill” to enterprises involved in the sector.
Various regulators have put in lots of work into financial regulation. Enterprises in the sector face all-round containment on financing. “Financing difficulties” and “cash shortage” are predicaments that such enterprises have been confronting in recent years, mainly due to comprehensive containment from the regulators. The National Development and Reform Commission suspended RE enterprises’ issuance of corporate bonds to finance commercial projects. The China Banking Regulatory Commission issued several documents to rectify the chaos in the banking and trust industries. Also, it severely punished many banks and trust institutions for violating regulations related to “transfusing blood” to RE enterprises.
The Asset Management Association of China suspended registration and filing of private equity funds for lending activities. It also refused to accept from PE asset-management plans, which securities and futures operating institutions set up, registration and filing of ordinary residential projects in 16 “hot” cities. Moreover, China Insurance Regulatory Commission further rectified the misuse of insurance funds.
So far, with the exception of standard loans for property development, other financing channels of RE enterprises, such as bond issuance, banking, trust, asset management, funds, insurance and so on, have been blocked almost completely.
Asset securitization is way out for RE financing. While RE financing has been fully tightened, attention should also be paid to other options available under the policies. The State Council issued the Opinions on Actively and Firmly Reducing the Leverage Ratio of Enterprises on 22 September 2016 to encourage an orderly development of corporate asset securitization. Moreover, the Guiding Opinions on Regulating Asset Management Business of Financial Institutions also clearly gave a green light to the asset-securitization business.
Asset securitization refers to the business activities of issuing asset-backed securities, based on the cash flow generated from underlying assets as repayment support and the credit enhancement achieved through structuring and other methods. Simply put, asset securitization is financing through the sale of the future cash flow of underlying assets. For financing, original equity holders sell their legally held underlying assets that can generate sustained and stable cash flow to special asset-backed programmes that asset managers have established. Such programmes acquire underlying assets with the funds raised from investors and distribute the proceeds to the latter.
Corporate asset securitization involves numerous participants and complicated legal relationships. Original equity holders own the underlying assets, usually the financing party or, perhaps, the affiliate or the bridge party of the financing party (common in the asset securitization with the dual SPV structure). They assist the parties with actual needs in financing. Asset managers are the subjects, usually securities companies, subsidiaries of fund-management companies and other financial institutions, which the China Securities Regulatory Commission recognizes. These institutions establish and manage special programmes for the benefit of investors, and sign relevant agreements and fulfil statutory and agreed obligations on behalf of the special programmes. Investors refer to qualified investors, who subscribe for the beneficiary certificates (asset-backed securities) of special programmes and meet the requirements of the Interim Measures for Supervision and Administration of Private Equity Funds. Asset-backed securities shall be issued to no more than 200 qualified investors.
Investors sign a subscription agreement with an asset manager and hand over the subscribed funds to set up a special programme. This allows the investors to obtain the asset-backed securities and become holders of the asset-backed securities. The manager signs an agreement on the sale and purchase of underlying assets with the original equity holder on behalf of the special programme. The underlying assets are bought from the original equity holder with funds from investors for purchase of asset-backed securities. After the underlying assets are transferred to the special programme, the cash flow that the underlying assets generate also goes into the said programme for the manager to distribute to investors. In most cases, because the original equity holder is more familiar with the underlying assets, or has ongoing responsibilities and obligations to specific users in the underlying assets, the manager usually entrusts this person/entity to be an asset-service agency to be responsible for collecting cash flow of the underlying assets. Original equity holders, managers and investors are the core trading subjects in asset securitization. In addition, managers will also entrust law firms, accounting firms, rating agencies, custodian banks, guarantee institutions and underwriters to provide legal, financial, rating, custody, credit enhancement and underwriting and other services.
Although the transaction structure of corporate asset securitization is complex, the stock assets can be used for financing in asset securitization, in line with the current policies of controlling incremental debts in the financial sector and can convert non-standard assets into standard assets not subject to the current financial policies on limiting financing with non-standard assets. At the same time, off-balance-sheet assets are acceptable, which helps optimization of the financial statements of original equity holders. Therefore, RE enterprises, in the context of current financial regulation and RE control, should focus on the financing methods of asset securitization, such as asset securitization of house-purchase balance payments, asset securitization of property management fees, commercial mortgage-based securities and real estate investment trusts, etc., while making good use of stock assets for financing to further expand funding channels.
Wang Jihong is a partner and Tang Hongwei is an associate at Zhong Lun Law Firm
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