In recent years, funds have become an increasingly important means by which investors can participate in public-private partnership (PPP) projects. An increasing number of investors are participating in the equity financing and debt financing of PPP projects through establishing contract funds, funds organized in the form of partnerships, etc. However, due to certain intrinsic characteristics of funds, how they can enter and withdraw from PPP projects are often the focus of heated debate when parties are proposing to co-operate.
Means of entry. There are usually two means by which a fund can enter a PPP project: (1) entering as an original investor in the special purpose vehicle (SPV) established for the project; or (2) entering the project via an equity acquisition or capital and share increase after the establishment of the SPV. However, since the issuance of the Measures for the Regulation of the Trading of the State-owned Assets of Enterprises (Order No. 32), as the transfer of state-owned property rights and capital increases of state-owned enterprises in principle require a public floor transaction, the second means has been used less and less in PPP projects. The aim is to avoid all the red tape involved in the process.
With respect to the first means, in practice, the term of a PPP project is at least 10 years; however, most of the major funds of a fund come from financial institutions, with the terms usually relatively short, between three to five years or so. During the term of co-operation of a PPP project, a fund will generally face the problem of successive recovery or early withdrawal of the investment principal.
Accordingly, when a fund invests in and establishes the SPV, it will, out of consideration for the prompt and convenient recovery or early withdrawal of the capital, commonly take a small portion of the project capital paid by the private party in the PPP project as part of the registered capital of the project company. The largest portion is injected into the project company in the form of a shareholder loan or from the capital reserve. In this way, the fund can conveniently withdraw in future by repayment of the shareholder loan or allocation to the capital reserve by the project company. However, pursuant to the relevant laws of China, project capital is a non debt-type fund, which means the project company does not pay any interest or bear any debt for such funds; and the capital reserve may only be used to expand production and operations, or be converted to increase the registered capital, so it cannot be reduced directly. Accordingly, both of these methods harbour certain defects and risks.
Means of withdrawal. In addition to the two above mentioned methods of shareholder loan and capital reserve that are relatively practical and convenient, but harbour risks and defects, the means of withdrawal also include capital reduction, equity buyback, liquidation and asset securitization.
- Withdrawal by capital reduction: a fund can withdraw during the term of co-operation of a PPP project through the capital reduction procedure specified in the Company Law. Capital reduction will usually entail such legal stages as notification, announcement, debt repayment or provision of security, etc, with the procedure entailing a fair amount of red tape. In PPP practice, a capital reduction will also usually require co-ordination and securing the written consent of such parties as the public party, the creditors, etc.
- Withdrawal by equity buyback: withdrawal by the fund during the term of co-operation of the PPP project is achieved by the public party or the third party designated by it or other private investor buying back the equity in the SPV held by the fund or the fund units in the hierarchical structure. However, in reality, with the increasingly stringent monitoring of local government debt by the state and the express prohibition in the Interim Measures for the Fiscal Administration of Public-Private Partnerships, implemented by the Ministry of Finance in 2016, on the public shareholder or other organization designated by the government buying back the equity held by a private shareholder, withdrawal by a fund through the public party or a third party designated by the government has essentially been completely prohibited.
- Withdrawal through liquidation: the fund achieves withdrawal after expiration of the term of co-operation of the PPP project by recovering its investment principal and reasonable returns through liquidation of the SPV. As mentioned above, due to the fact that the term of co-operation of a PPP project is usually at least 10 years, whereas the life of a fund is usually comparatively shorter, withdrawal by liquidation usually fails to satisfy the fund’s requirements for realization.
- Withdrawal by asset securitization: withdrawal of the fund is achieved by treating the PPP project assets as the underlying assets and the cash flow derived therefrom as the repayment support to offer asset-backed securities and transfer them to investors on the capital markets. Securitization of PPP project assets is an innovative approach currently powerfully supported by the state, with the National Development and Reform Commission, the China Securities and Regulatories Commission, and the Shanghai and Shenzhen stock exchanges having successively issued documents encouraging and promoting PPP project asset securitization and established green channels for business acceptance, review and recordal. Currently, there are four PPP asset-backed securities that have been rapidly accepted by the Shanghai Stock Exchange and Shenzhen Stock Exchange, highlighting the bright prospects for the development of PPP asset securitization. However, in reality, given the relatively stringent requirements in the criteria for PPP asset securitization and the existence of some “original sins” in numerous PPP projects (e.g., unclear title to the assets, difficulties in resolving tax issues, unstable returns models, etc.), a number of specific business issues in PPP asset securitization remain to be further resolved.
In summary, due to the intrinsic long-term nature and low profitability of PPP projects and the intrinsic short-term investment nature of funds (particularly private funds) as well as the relatively limited means available to funds to enter and withdraw from PPP projects, although a not insignificant number of funds are highly enthusiastic about PPP projects, they nevertheless lack the means to participate in them. How to optimize the means for funds to enter and withdraw from PPP projects and attract more funding and resources to participate in PPP projects still require further exploration and study.
Wang Jihong is a partner and Han Jiangyu is an associate of Zhong Lun Law Firm