Issuance of asset-backed securities (ABS) products for real estate financing has seen robust growth since 2015. According to data by the Asset Management Association of China (AMAC), a total of 24 such products have been issued to date, including five quasi-REIT products, eight ABS products for property management fees, eight ABS products against the rights to receive operating incomes, and three mortgage balance ABS products.
Outstanding among those is the China Universal AMC Capital – Shimao Asset-Backed Specific Plan (ABSP) on Mortgage Balance, the first ABS product for mortgage balance in China that was listed for trading on the Shanghai Stock Exchange (SSE) on 8 December 2015. Underlying the ABSP is the mortgage balance payment (i.e. balance payable by a home buyer using mortgage financing) receivable by the project units of Shimao Group in tier-1 and tier-2 Chinese cities. According to China Chengxin International Credit Ratings, the issuer rating and the senior debt rating on the ABSP are both “AAA”.
The Shimao ABSP is a financial innovation with benefits in two ways: on the one side, it not only helps Shimao Group access low-cost funding, but also enables the group to make more efficient use of its existing assets (mortgage balance), thereby optimizing its financial structure; on the other side, the ABSP represents a new type of low-cost wealth management product on the capital market, benefiting both investors and homebuyers indirectly. The ABSP is another demonstration of the notion that any asset that can generate stable cash flow can be securitized. It also gives great impetus to the development of real estate finance in China, with its remarkable market popularity pointing to the significant potential of asset securitization in real estate.
In April, our lawyer team provided legal services for what could possibly be the fourth mortgage balance ABS product, which was also an ABSP. The services we provided mainly covered the following three aspects: drafting relevant legal documents; conducting legal due diligence; and issuing legal opinions. Below, this article elaborates on relevant legal services by drawing from experiences gained from this ABSP.
Drafting legal documents
In asset securitization, lawyers are required to draft various kinds of legal documents in order to determine the responsibilities, rights and interests of the parties involved. Among the most important legal documents are the ABS subscription agreement, the standard terms and conditions for asset-backed plans, the asset sale and purchase agreement for asset-backed plans, the difference payment letter for asset-backed plans, the keep-well commitment letter for asset-backed plans, the asset services agreement for ABSPs, the custody agreement for ABSPs, and the redemption commitment letter for ABSPs.
In light of the characteristics of mortgage balance ABS products, our lawyers focused on the following two aspects during due diligence investigation: (1) the profiles of business participants, including the profiles of the originator and the project company with which the originator will sign an agreement to transfer its claims, as well as the profiles of the guarantor, the manager, the custodian and the asset servicer; and (2) the profiles of underlying assets, including the development of projects involving the underlying assets, the pre-sale of commodity housing, project development loans, and the formation of mortgage balance.
The profiles of underlying assets are key to the due diligence performed by lawyers during mortgage balance ABS practices. First, lawyers needs to determine whether the accounts receivable contracts corresponding to the underlying assets are authentic, and whether the amount specified in such contracts is fixed or prone to diminution.
To determine the authenticity, legality and effectiveness of underlying assets, lawyers can refer to the commodity housing sale contracts and loan contracts that involve the underlying assets, as well as the information on the contracts registered with real estate authorities and the advance notices on registration issued by them, and the mortgage ledgers issued by banks.
Second, lawyers must review whether the underlying assets involved are transferable, and verify whether there are any limits on the transfer of assets, whether such transfer is subject to consent or approval, and what notices must be issued. Such a review can be performed by referring to relevant documents such as the articles of association of the originator.
Finally, lawyers must verify whether there is any mortgage right, pledge right or any other security interest on the relevant underlying assets. The verification can be performed by referring to documents such as the interviews with the originator and the related loan contracts or guarantee contracts, as well as by making inquiries via the Accounts Receivable Pledge Registration System of the People’s Bank of China.
Lawyers need to make sure that the assumptions adopted by the firm are consistent with the facts, and that such opinions only involve matters as of the reference date, and contain no guarantee for the future status of legal matters. Such opinions generally cover: the eligibility of the parties involved in an ABSP; the legality of the legal documents regarding the ABSP; the authenticity, legality, effectiveness, ownership of rights and interests, and encumbrances of underlying assets; the legality of the transfer of underlying assets; opinions with regard to the exclusion of the underlying assets from negative lists; the effectiveness of risk isolation by the ABSP; the legality and effectiveness of the credit enhancement arrangements for the ABSP; and other material matters that may affect the interest of ABS investors.
Mortgage balance ABS has further expanded financial product portfolios in China, while adding more layers to China’s financial market. With ABS growth accelerating, law firms must fulfil their duties by playing their role in key aspects such as legal verification.
Liu Xiaoming is a senior partner at Long An Law Firm, based in its Beijing headquarters. He can be contacted on +86 10 6532 0366 or by email at [email protected]
Yang Kun is a Shanghai-based senior partner at Long An Law Firm. He can be contacted on +86 21 6085 7666 or by email at [email protected]