the release of the Notice on Work Related to Promoting the Pilot Programme of Real Estate Investment Trusts (REITs) in the Infrastructure Field, and the Guidelines for Publicly Offered Infrastructure Securities Investment Funds (for Trial Implementation) (Exposure Draft) on 30 April 2020 marks the official start of the pilot programme of public offering of REITs in the domestic infrastructure field.
Since the comprehensive promotion of the public-private partnership (PPP) model in the fields of infrastructure and public services began in 2014, there have been a large number of PPP projects in China. Based on the above-mentioned notice and guidelines, this article makes a preliminary review of the structuring, issuing procedure and dilemma of the PPP+REITs model.
In accordance with article 72 of the Securities Investment Fund Law, article 4 of the notice and article 2 of the guidelines, the basic structure of the PPP+REITs model is PPP + publicly offered funds + asset-backed securities. That is: (1) fund managers and asset-backed securities managers set up and manage infrastructure funds and infrastructure asset-backed securities, and the original owner (shareholder of the PPP project company) holds no less than 20% of the infrastructure fund share; (2) the original owner sells the equity of the project company to the infrastructure asset-backed securities; and (3) the infrastructure funds invest in the asset-backed securities to realize the actual control of the PPP project company.
Relevant parties in this structure should meet the following requirements: (1) the REITs fund manager and asset-backed securities manager are controlled by the same controller; (2) the REITs funds custodian and the asset-backed securities custodian are the same person; and (3) the asset-backed securities hold all the equities of the project company.
(1) Recommendation. In accordance with the notice, the provincial development and reform commissions mainly give special opinions on whether the project conforms to the major national strategies, macro-control policies, industrial policies, fixed assets investment management laws and regulations, and whether it encourages the raised funds to be used to supplement shortcomings in infrastructure. On the basis of the special opinions issued by the provincial development and reform commissions, the National Development and Reform Commission (NDRC) will recommend qualified projects to China Securities Regulatory Commission (CSRC).
(2) Filing. In accordance with the guidelines, the establishment and completion of filing of the infrastructure asset-backed securities is the precondition for the registration of infrastructure funds. When applying for registration of REITs funds, the fund manager shall submit to the CSRC explanatory material including, but not limited to, the specification of asset-backed securities, legal opinions and filing material with the Asset Management Association of China.
(3) Review. In accordance with the guidelines, when applying for registration of REITs funds, the fund manager shall submit to the CSRC a no-objection letter from the specific stock exchange approving the listing of infrastructure funds.
(4) Registration. After the NDRC recommends the qualified projects to the CSRC, the latter will independently perform the registration procedure and make independent decisions in compliance with the laws and regulations, and the principle of marketization. After being approved by the CSRC for registration, the fund manager can raise funds by offering fund shares publicly, and set up infrastructure REITs.
Restrictions on operation period and payment mode. In accordance with article 3 of the notice and article 7 of the guidelines, for the PPP+REITs model, the project must be “operated for more than three years”, “the income mainly comes from payment by users”, and “does not rely on non-recurring income such as subsidies from third parties”.
According to the 2019 Annual Report of the National PPP Integrated Information Platform Management Database Project, there are 629 user-paid projects with an investment of RMB1.4 trillion (US$202.3 billion), accounting for 6.7% and 9.6% of the management database, respectively.
Therefore, taking the above-mentioned requirements as the standard, among the existing PPP projects, the number of projects that really meet the requirements is limited, and the operation period and payment mode are the problems and dilemmas that the PPP+REITs model needs to focus on.
Restrictions on the transfer of equity and franchise. In accordance with article 2 of the guidelines, the infrastructure asset-backed securities must “hold all the equities of the infrastructure project company”, and the infrastructure funds must “penetrate to obtain the full ownership or franchise of the infrastructure project”.
Based on the previous experience of PPP projects, they basically involve franchise issues. Although the Administrative Measures for the Franchising of Infrastructure and Public Utilities do not restrict the transfer of franchise in the form of equity transfer, in practice, PPP contracts generally restrict the transfer of equity of project companies by social capital parties.
Under the PPP+REITs model, the equity of the government-funded representatives also needs to be sold to the asset-backed securities. Therefore, how to get the approval and co-operation of local government and competent authorities is also an obstacle that the PPP+REITs model needs to overcome.
Conflict between pledge and release of usufruct. In the PPP projects undertaken by the authors, in order to implement the project financing, the project company usually pledges the project’s usufruct to commercial banks as loan security at the early stage of construction.
Article 7 of the guidelines provides that, “the original owners enjoy full ownership or franchise, and there are no economic or legal disputes and other rights”. Therefore, if the PPP+REITs model is adopted to securitize the charging usufruct as the underlying asset, the pledge on the usufruct must be released first, and sufficient funds are needed to repay the creditor bank loan, or replace it with equivalent property. This conflict brings difficulties to the PPP+REITs model to a certain extent.