The steady progress of infrastructure public REITs has seen an increase in demand from original equity holders to take part in fund governance as strategic investors. With this in mind, revisiting the establishment of a standing body as an optional means of fund governance can provide new ideas for original equity holders to defend their rights and interests.
The establishment of a standing body by the general meeting of public fund shareholders is one of the highlights of the 2012 amendment to the Securities Investment Fund Law. However, because the duties of a public fund manager cover all matters of fund operation in practice, there is little incentive to set up standing bodies, and few public funds have so far done so.
Fund governance needs
According to regulatory requirements, in addition to being the seller of infrastructure assets, the original equity holders of public REITs should also hold at least 20% of the fund shares as strategic investors. In cases where original equity holders have the need to “consolidate balance sheets”, their holding of fund shares is typically over 50%.
According to the Fund Law, each fund share has one voting right, and each fund share held by a shareholder has equal voting rights. Therefore, the voting mechanism based on the number of fund shares held makes it difficult to fully realise the demands of the original equity holders/strategic investors to further participate in the fund’s governance.
The standing bodies are elected by the general meeting of fund shareholders, based on the number of votes, and their establishment and operation can further meet the needs of the original equity holders/strategic investors to participate in the governance of the fund through the agreement of the fund contract under the current legal framework.
Scope of authority
The scope of authority of the standing body is mainly divided into statutory authority and agreed authority. The statutory authority is the authority specified in the law, mainly the right to convene, propose and supervise. The agreed authority is the scope of authority granted to the standing body according to the fund contract.
(1) Statutory authority. The standing body has the right to convene the fund shareholders’ meeting and to propose the replacement of the fund manager and fund custodian, and to propose the adjustment of the remuneration standard of the fund manager and fund custodian.
The standing body has the responsibility to supervise the investment operation of the fund manager and the custody activities of the fund custodian.
Given that there are few standing bodies established in the market, it is difficult to find a reference on how to exercise the right of supervision. It is suggested that the key to supervision be adjusted to the supervision of the compliance process of investment behaviour, the focus be put on whether the corresponding investment decision-making procedures comply with laws and regulations and the requirements of the fund manager’s company rules.
(2) Agreed authority. Based on the entrustment relationship between the fund shareholders’ meeting and its standing body, investors may delegate the authority of the fund shareholders’ meeting to the standing body through the means agreed in the fund contract, but shall follow the principle of priority of the interests of the holders and the exceptions of laws and regulations.
The standing body shall follow the principle of priority of the interests of the holders. The scope of authority of the standing body shall be based on the premise that the interests of the holders be protected first. For matters that do not have substantial adverse impact on the interests of the shareholders, the existing Guidelines for the Filling of Securities Investment Fund Contracts authorise the fund manager and the fund custodian to agree on matters without convening a general meeting of the shareholders. For such matters, the standing body can be added as the reviewing body to reflect the protection of investors.
Certain specific matters shall not be authorised to be considered by the standing body. First, those that are explicitly required to be considered by a general meeting of fund shareholders under the laws and regulations. Among the public REITs, article 32 of the Guidelines for Publicly Raised Infrastructure Securities Investment Funds (for Trial Implementation) specifies that under certain conditions, the consideration of major adjustments to the purchase or sale of infrastructure projects, infrastructure fund expansion, related-party transactions, dismissal of external management institutions, investment objectives, investment strategies, etc. shall be considered in a general meeting of fund shareholders and passed by a specified percentage of shareholders.
Meanwhile, the Fund Law stipulates that the conversion of the fund’s operation, the replacement of the fund manager or fund custodian, the early termination of the fund contract, or the merger with other funds shall be approved by at least two-thirds of the voting rights held by the fund shareholders participating in the general meeting. The consideration of the above-mentioned matters needs to be validly passed by a specific percentage of the general meeting of fund shareholders and cannot be delegated to the standing body for consideration.
Second, matters involving the investment management activities of the fund. Article 50 of the Fund Law stipulates that the general meeting of fund shareholders and its standing body shall not directly participate in or interfere with the investment management activities of the fund. It should be noted that although the standing body needs to supervise the investment operation of the fund, the supervisory acts do not involve specific operational decisions on investment, and therefore do not conflict with the supervisory rights mentioned above.
To sum up, the governance structure of a standing body in public REITs can meet the demands of the original equity holders/strategic investors for the protection of their own interests. Meanwhile, it also respects the regulatory requirements for the fund manager to operate the fund property independently and autonomously, and highlights the institutional value of the amendment of the Fund Law, which is a new model worth trying.
Matthew Ching is a partner and Wang Zida is an associate at Jingtian & Gongchen
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