For real estate enterprises and construction enterprises, resolving financing difficulties remains a major challenge in their continuing operations. Under tighter monetary policies and regulation, there is a certain demand in the market for financing through asset-backed securitization (ABS), the development of which is currently on the rise.
In the past, a significant number of real estate enterprises could raise financing through IPOs, bond offerings, etc. For example, a significant number of enterprises sought financing through listings between 2007 and 2009, and from 2012 to 2013, real estate enterprises sought financing through medium-term notes and short-term financing. However, these methods remain within the scope of simple equity or debt financing, adding to the enterprise’s overall debt burden or reducing the enterprise’s overall rights and interests. In comparison, while ABS does increase an enterprise’s debt, it also gradually increases the enterprise’s quality assets.
What makes such a result possible is the design of the structure of the ABS transaction. In the course of the ABS process, the enterprise will establish a special purpose vehicle (SPV) to which the underlying assets (e.g., the real estate or construction enterprise’s purchase balance receivables, property management fees and accounts receivable) are transferred. These types of cash assets will be recovered in future and become earnings. Accordingly, through such a method, the enterprise splits off certain assets to make them liquid, giving it access to present value earnings, and thus making existing assets of the enterprise liquid, and improving them.
More specifically, it is the enterprise’s underlying assets that are transferred and placed under the name of the SPV, splitting them off from the original assets and realizing risk isolation or even an off-sheet effect. If the underlying assets are stable, removing them from the balance sheet allows them to become light assets and to achieve the objective of asset-light financing. Given that such underlying assets have a term, it is possible through ABS to convert the future value of the funds into present value. Once liquidity is generated, the real estate or construction enterprise’s objective of vitalizing existing assets can be realized. Furthermore, the enterprise may, based on its particular circumstances, opt for a careful or large-scale ABS product design, depending on the type of claims. Accordingly, ABS is quite flexible and broad, providing more levels and more types of, and more liquid, financing products.
For legal counsel in the ABS legal practice, how to select and how to transfer the underlying assets and isolate risks are key, and also pose relatively major challenges. For example, can the claims of a certain company all be transferred to an SPV? Will the creditors accept the same? Will the relevant authorities accept the same? These are questions that must be handled with care. As compared to common law jurisdictions that have extensive experience with such forms as REITs, China, as a civil law jurisdiction, has to expend great efforts to achieve asset isolation. For example, can we achieve our objectives under the framework formed by such written laws as the Trust Law, Civil Code, Contract Law, Company Law, and Partnership Law? How do we achieve these objectives? These are also questions that require careful thought and addressing.
China’s regulators, including the China Securities Regulatory Commission, China Banking Regulatory Commission and Asset Management Association of China, have issued relevant working guidelines for the administration of underlying assets by way of a negative list and the issue of asset isolation. Based on relevant administrative regulations and regulatory documents, we can see that one of the means of achieving isolation still relies on the recordal system for the relevant product. Against such a background, lawyers need to duly carry out their due diligence work, conducting legal due diligence of the underlying assets, investor suitability, whether the debtors have the capacity to pay, whether the anticipated recovery of the receivables can be achieved, etc.
Although the state’s macro-level recordal system provides a certain degree of protection for asset isolation, given potential litigation disputes, whether the underlying assets are under the name of the SPV or that of the original company needs to be spelled out in detail in the legal documents and the listing of relevant responsibilities. If in a legal action or arbitration case a third party, other than the parties to the asset transfer, makes a claim, will those pose a challenge to the existing system? Currently, if the parties use arbitration or mediation, they generally can arrive at a satisfactory resolution of their dispute. However, if the design of the transaction structure is not sound or the handling of documents improper, the third party could still institute a legal action against the original holder of the assets, making the isolation of the assets unattainable. All of these tasks require the concerted co-operation of such professional “gatekeepers” as lawyers, financial advisers and accountants.
The author would argue that since such current practical issues as land, government finances, etc., are involved, the real estate industry still cannot immediately achieve a full transformation in form. After all, there is still certain rigid demand that exists in the market and commercial real property has yet to be incorporated into regulation and policy negative lists, and has relatively spacious room for expansion and operation.
However, continuing large-scale speculative land investment will be hard to maintain, and Chinese enterprises have to return to the real economy. Furthermore, real estate enterprises are a type of financial enterprise that, on the whole, should be supporting the real economy. For real estate enterprises that conform with the real economy, ABS is helpful in their financing. Such real estate enterprises include feature towns, tourism, real property, commercial real property, etc.
Before opting for ABS, an enterprise should consider carefully, for example, whether it has achieved a certain size that would cause the underlying assets to have a certain degree of diversity and liquidity. If the enterprise’s assets have not reached sufficient scale, the degree of recognition by the market public and individual investors will be relatively low, and insufficient liquidity will give rise to a less than ideal rating, causing higher professional costs and interest costs if the enterprise opts for ABS.