With the continuing development of public-private partnerships (PPPs) in China, financing has become the key to the realization of PPP projects. The combination of asset securitization, as a financial means for financing projects, and the PPP has gradually won the encouragement and support of the state at the policy level.
In December 2016, the National Development and Reform Commission (NDRC) and the China Securities Regulatory Commission (CSRC) jointly issued the Notice on Tasks Relating to the Promotion of Asset Securitization for PPP Projects in the Traditional Infrastructure Sector (document No. 2698). The Shanghai Stock Exchange, Shenzhen Stock Exchange and the Asset Management Association of China also simultaneously opened green channels for PPP asset securitization, each expressly specifying the principle of “rapid review upon filing, and enhancement of efficiency” for the PPP asset securitization filing stage.
The characteristics of PPP projects of stable investment returns and long payback period are consistent with the requirements of asset securitization in respect of the underlying assets.
The criteria for underlying assets required by the CSRC’s Administrative Provisions for the Asset Securitization Business of Securities Companies and the Subsidiaries of Fund Management Companies are as follows: compliance with laws; clear title; ability to generate an independent and predictable cash flow and specifiable property rights or property; and the specific form thereof being enterprise receivables or, alternatively, such property rights as lease claims, credit assets, beneficial interests in trusts, etc., or immovable property or beneficial interests in immovable property, such as infrastructure, commercial property, etc. The requirements in respect of underlying assets of the Guidelines for Asset-Backed Notes of Non-Financial Enterprises (Revised Draft) issued by the National Association of Financial Market Institutional Investors are essentially identical to the above-mentioned criteria.
The scope of PPP projects set out by the Ministry of Finance and the NDRC includes: urban infrastructure and public services, e.g., water supply, heat supply, gas supply, sewage and garbage treatment; low-income home ownership projects; underground utility tunnels; highways; railways; airports; urban light rail and other such transport facilities; and medical and senior care service facilities.
From the scope it can be seen that such projects essentially all have the characteristics of a long payback period and a stable cash flow, and are suitable for use as securitized underlying assets. They are also convenient for providing funding for these projects through securitization. Accordingly, the first batch of PPP securitization projects of the NDRC and CSRC involve sewage treatment, heat supply and tunnel contract claims. All eight projects on the recommendation list for the second batch of PPP securitizations (five accounted for by transport facility projects, two by heating projects and one by a sewage treatment project) are infrastructure-type projects that are characterized by a stable and long-term cash flow.
However, not all PPP projects can serve as underlying assets for securitization. Currently, PPP projects for which securitization can be carried out need, in principle, to be projects that have already been incorporated into the Ministry of Finance’s PPP model project list, the NDRC’s PPP project database, or the PPP project database published by the Ministry of Finance. However, the securitization of such standard PPP projects still presents many problems.
First is the issue of financing costs. For a period of time recently, funding costs dropped, resulting in financing costs for securitization being higher than bank interest rates and cooling the enthusiasm of many enterprises for securitization. With tight funding in recent times, the costs of securitization have again been pushed higher. In short, securitization currently does not present many cost advantages over other financing instruments, and only for better products are there clear financing cost advantages.
Second is the basic requirement of securitization for a stable and predictable cash flow. Accurate market predictions and past performance are important bases for judging cash flow and also important indicators for credit rating. Document No. 2698 also requires that a project that is to be securitized has been completed and operating for at least two years. However, many PPP projects have not yet been completed, or if they have been, they have not been operating for two years, meaning that only certain existing infrastructure projects satisfy the conditions and can generate a stable cash flow. Accordingly, securitization is not a suitable financing instrument for PPP projects in their early stages.
Third is the issue of mismatching periods. The duration of a PPP project is usually 10 or 20 years, whereas the life of securitization products currently on the market is generally less than five years. Accordingly, a single securitization product cannot cover the entire period of a PPP project, and its financing limit does not satisfy the investment requirements of a PPP project, or the requirements in respect of the divestment of certain funds.
Fourth is that, in PPP asset securitization, the underlying assets are generated by concession income and fiscal subsidy income. Concession income is closely dependent on the concession rights, but at present laws are silent as to whether a dedicated plan, as a special purpose vehicle (SPV), can serve as an entity that acquires concession rights and becomes their owner. And where concession rights are not transferred, the cash flow required for the securitization of PPP project operating income is difficult to specify and transfer, as is its isolation from risk.
Finally is the fact that an asset securitization transaction is an asset transfer process, the income after such a transfer vests in the PPP project company, and if the private party and other investors inject funds into the PPP project company in the form of claims they can achieve divestment by way of debt repayment, but the equity of the PPP project company cannot be divested, as such divestment involves the issue of a capital reduction.
Accordingly, the participation of a financial institution is required at the very outset when designing the PPP plan, and an appropriate financing structure needs to be designed, leaving a channel for the withdrawal of funds after securitization. Only in so doing can securitization of a PPP project be done in a convenient manner.
Chen Xiuli is a partner at V&T Law Firm in Shenzhen. She can be contacted on +86 755 8302 6455 or by email at email@example.com
Zhang Zhixiao is a partner at V&T Law Firm in Beijing. He can be contacted on +86 10 8225 5588 or by email at firstname.lastname@example.org