Asset securitization, an important financing instrument, has seen rapid growth in the Chinese market in recent years. As the investment in public-private partnership (PPP) projects is large, their terms of operation long, and their cashflows usually relatively stable and predictable, organically combining PPP projects and asset securitization is conducive to driving the development of the real economy, expanding financing channels, reducing financing costs and revitalizing existing assets.
State policy encourages the securitization of PPP project assets. The Opinions of the State Council on Strengthening the Administration of Local Government Debt in 2014 signalled the push to use the PPP model. Investors or special purpose vehicles could seek debt financing through such market means as bank loans, corporate bonds, project revenue bonds, asset securitization, etc., and assume the liability for debt repayment. In June 2017, the Ministry of Finance, the People’s Bank of China and the China Securities Regulatory Commission jointly issued the Notice on Matters Relevant to the Compliant Carrying Out of Asset Securitization for Public-Private Partnership Projects (document No. 55). Pursuant to this, a PPP project proposing to carry out asset securitization is required to satisfy the following conditions.
A PPP project is required to comply with relevant procedural and substantive provisions
First, procedurally, the approval procedure needs to be carried out strictly in accordance with regulations, the implementation plan needs to be objective and reasonable, the project needs to have passed a value-for-money assessment and fiscal affordability demonstration, and have been entered into the Ministry of Finance’s comprehensive information platform PPP project database and the NDRC’s PPP project database, and its procurement procedure needs to be lawful and compliant.
Second, substantively, the PPP project contract system needs to be sound, the risks reasonably allocated and co-operation among the public party, the private party and project participants smooth. Third, construction quality of the project is required to satisfy relevant standards, the project should be able to operate in an ongoing, safe and stable manner, and the performance capacity of the project should be relatively strong.
Clear, unencumbered title
Document No. 55 stresses that title to the rights to the project revenues, the equity and the contractual claims that are to serve as underlying assets, are to be independent and clear, and not encumbered with a pledge or security for other financing. If, at the outset, the project company has pledged the right to the project revenues as security, and equity has been pledged to a financial institution as security for a project loan, such encumbrances need to be removed before the offering of the asset securitization product, and it has to be ensured that no such encumbrances are created during the life of the asset securitization product.
Asset securitization-related provisions need to be included in the PPP project contract
Document No. 55 also requires that asset securitization be carried out according to the contract. The public and private parties should specify the respective parties’ rights and obligations in the PPP contract, and the sponsor (the original beneficial owner) may, according to the contract, decide at its own discretion whether to proceed with asset securitization. Two separate circumstances are distinguished in practice: projects for which a PPP contract has been executed; and projects for which a PPP contract has yet to be executed.
(1) For the first type, if there is the intent to offer an asset securitization product, then the issue of amending the contract needs to be addressed. The project company for a PPP project is usually invested in, and established jointly by, the representatives of the private party and public party. What the public party places greatest emphasis on is the investment/financing, construction and operational capabilities of the selected private party, and accordingly it will usually specify in the PPP contract that it prohibits or restricts the transfer of equity by the project company. If the shareholders of the project company propose to use their equity in the project company as the underlying assets for asset securitization, they must consult in advance with the public party on amending the restrictive provisions.
(2) For the second type, the public and private parties should pay attention to adding provisions regarding their respective asset securitization rights before executing the contract. The asset securitization sponsor (original beneficial owner) in a PPP project may be the project company or, alternatively, another relevant entity such as the shareholders of the project company, the creditors of the project company, the contractors that provide construction support for the project company, etc. Specific provisions should be set out, permitting qualified entities of the parties to offer asset securitization products on the basis of such assets as project company revenues and claims, project company equity, etc.
Asset securitization available for projects that have operated for less than two years
Document No. 2698 of the NDRC specified, as one of the conditions for securitization of the assets of a PPP project, that, “the project must have been completed and been normally operating for at least two years, have established a reasonable payback mechanism, and have generated an ongoing and stable cashflow”.
Document No. 55 relaxes the two-year operation restriction. As long as the expected cash flow generated by the project company can cover the project’s financing interest and the shareholders’ investment returns, it may carry out asset securitization. This is good news for those projects that have relatively good expected revenues.
A project is required to have been completed and been operating for at least two years only under the following two circumstances: (1) a shareholder offers an asset securitization product with the equity of the project company serving as the underlying assets. In such a case, the offering by the controlling shareholder and the offering by another shareholder may not exceed 50% and 70% of the current value of the cashflow generated by the equity, respectively; and (2) where the application of the project company, as sponsor, has been accepted through the offering authority’s green channel, the project is required to have been operating successfully for at least two years.
In practice, the number of PPP projects that satisfy the conditions for asset securitization are relatively few, but in practical operation numerous alternative methods are available. Asset securitization is one of the diverse channels open for financing PPP projects, such that, when designing the most appropriate financing framework, it is necessary to do it based on the specific circumstances of the project.
Author: Wang Jihong is a partner and Liu Ying is an associate at Zhong Lun Law Firm in Beijing