On 18 March 2018, the CPC First Plenary Session of the Committee for Comprehensively Deepening Reform, chaired by President Xi Jinping, deliberated and passed the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions. On 27 April, the official version of the guiding opinions was formally released. The guiding opinions consolidates the regulatory standards for the assets management business and becomes a notable regulation that marks a new era of asset management.
The guiding opinions and PPP new policies. The publishing of the guiding opinions is a key step to prevent and contain financial risks, to guide money flowing to the real economy, and to better serve in economic transition and structural optimization. Meanwhile, the new public-private partnerships (PPP) policies also try to prevent PPP projects from turning into new financing platforms, and control the increase of local government debt. Those policies are essential to prevent systemic financial risk, as well as the guiding opinions.
Implications of guiding opinions on PE to invest in PPP projects. Along with the publishing of the guiding opinions is the paradigm that PE participating in PPP projects will be mainly affected in the following aspects.
First, there will be lots of limits on PE to invest in PPP projects “in equity in name but in debt in fact”. The guiding opinions requires getting rid of the practices of guaranteed redemption. Financial institutions must not raise funds on their own, or entrust other financial institutions to redeem a product that will be difficult to redeem; or provide any direct or indirect, explicit or implicit guarantee or repurchase undertaking for the non-standardized debt assets or equity assets invested by asset management products. Therefore, the space for PE products investing “in equity in name but in debt in fact” will be squeezed further.
Second, PE must not adopt multi-layer embedment to participate in PPP projects. In practice, multi-layer embedment and tunnel services are very common in asset management business, which serves an importanct role for financial institutions to circumvent regulations to achieve profits. In PPP projects that involve PE, this phenomenon is also very common. Usually, the wealth management products of banks invest in PE products through a trust plan, and the PE products invest in PPP projects. This mode includes two layers of embedment and is now inconsistent with the guiding opinions. Therefore, such practice needs to be adjusted and amended in the future.
Third, the maturity mismatch between the duration of a PE product and the co-operation period of a PPP project will be further highlighted. Normally, the co-operation period of a PPP project is 10 to 30 years, while the duration of a PE product is three to five years, which cannot match the PPP project. In previous practice, several products with short duration would be issued in succession, and operated collectively, to meet the much longer duration requirement of projects invested in by PE.
However, the guiding opinions forbid the financial institution to carry out or participate in fund pool business characterized by roll-over product issuance, collective product operation and separate product pricing. Therefore, for a PE product to invest in a PPP project, there will be a big problem regarding whether the duration requirement of a PPP project can be met.
Finally, for a PE product to invest in a PPP project, the tiered percentages will be extremely limited. The guiding opinions forbid privately-raised products that invest in a single underlying investment to have tiered units (privately raised products must be deemed as investing in a single underlying investment if the percentage of its investment exceeds 50%).
Therefore, if a PE product invests in a single PPP project, the PE product should not have senior units and subordinate units. Therefore, it is not allowed for a private investor who brings PE to be the shareholder of a special purpose vehicle (SPV) company to buy subordinate units of the said PE product to amplify the lever ratio and to promise or guarantee principal and returns for the holder of the senior units. It is also the main purpose of the guiding opinions to control the lever ratio and restrict the investment “in equity in name but in debt in fact”.
Summary and Outlook. In the course of development in recent years, PE has played a significant part in project finance, especially in project capital finance.
However, in the context of financial security, both the guiding opinions and PPP new policies try their best to monitor and control debt risk in society to guard against systematic financial risk.
Therefore, against this background, the model of PE investing in PPP projects should be adjusted correspondingly. In the future, there will likely be some PE as real shareholder to invest in PPP projects with good profits and cashflow and some methods of withdrawal for PE, such as equity transfers, ABS, IPOs, etc., will become popular.
WANG JIHONG is a partner and TANG HONGWEI is a senior associate at Zhong Lun Law Firm
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