CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 1 © Rajah & Tann Singapore LLP MAS Responds To Feedback On Enhancements To REIT Regulatory Regime Summary On 9 October 2014, the Monetary Authority of Singapore (“MAS”) issued a consultation paper (“Consultation Paper”) containing proposals to strengthen Singapore’s real estate investment trust (“REIT”) market. The key proposals were featured in our earlier client update, which can be found here. The consultation closed on 10 November 2014. On 2 July 2015, MAS issued its response (“Response”) to the feedback received. Taking into account industry feedback, MAS has refined its proposals and will implement key measures to accord REIT unitholders better protection and greater accountability while providing REIT managers increased operational flexibility. This update takes a look at the Response. Strengthening Corporate Governance Statutory duty to prioritise interests of REIT unitholders MAS will proceed with the proposal to impose a statutory duty on the REIT manager and its individual directors to prioritise the interests of the unitholders over those of the REIT manager and its shareholders, in the event of a conflict of interest. A breach of this statutory duty will subject the REIT manager and any director of the REIT manager to both criminal and civil liability. Revised Board independence requirements In the Consultation Paper, MAS sought feedback on two options to enhance the independence of a REIT manager’s board of directors (“Board”). Option 1 requires at least half of the Board to comprise independent directors, if unitholders are not given the right to appoint directors of the REIT manager. This requires the REIT manager to make the appropriate modifications to its articles of association as well as the trust deed, to set out procedures for appointment and removal of its directors. Option 2 requires at least a majority of the Board to comprise independent directors. This has the advantage of being a uniform requirement consistently applied to all REIT managers, but will result in higher compliance costs. Under both these options, an “independent director” must be independent from any management and business relationship with the REIT manager and the REIT, any substantial shareholder of the REIT manager and any substantial unitholder of the REIT, and must not have served on the Board of the REIT manager for a continuous period of 9 years or longer. In addition, the Chairman of the Board cannot be an executive director or a person who is a member of the immediate family of the Chief Executive Officer. MAS has decided to proceed with Option 1. The MAS has also clarified that a controlling shareholder of the REIT manager who is also a unitholder of the REIT will have the right to vote on the appointment of the directors of a REIT manager and that a director of a trustee-manager of a business trust stapled to a REIT, can be appointed as an independent director of the REIT manager. Some respondents had suggested that the proposed definition of “independence” ought to be aligned with that in the Code of Corporate Governance (“CG Code”). However, MAS has decided to proceed with the CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 2 © Rajah & Tann Singapore LLP proposed definition, as it is of the view that it is important to establish strong corporate governance standards, given the inherent conflict of interests faced by a REIT manager. Remuneration of directors and executive officers MAS had earlier proposed to require REIT managers to disclose in the REIT’s annual report (i) the remuneration policies and procedure for setting remuneration of directors and executive officers, (ii) the remuneration of each individual director and Chief Executive Officer, on a named basis, and (iii) at least the top five key executive officers of the REIT manager, on a named basis, in bands of S$250,000. After considering feedback, MAS has refined this proposal – it will now only require a REIT manager to disclose, in the REIT’s annual report, its remuneration policies and procedure for setting remuneration for directors and executive officers, and disclose whether the remuneration comprises other components. The other remuneration proposals in (i) and (ii) will be applied to REIT managers on a comply-or-explain basis, similar to the requirement for companies listed on the Singapore Exchange Limited. MAS has also decided, in response to feedback, that it will not proceed with its proposal to prohibit the remuneration of directors and executive officers to be (i) paid in the form of shares or interests in the Sponsor or its related entities or (ii) linked in any way to the performance of any entities other than the REIT. However, such remuneration must be disclosed in the REIT’s annual report, together with an explanation as to why such arrangements would not result in a misalignment of interests between the REIT manager and unitholders, or the mitigating measures instituted to address any potential misalignment. MAS will proceed with its proposals to require the remuneration of non-executive directors to be a fixed sum and to restrict the remuneration of the executive directors of a REIT manager from being linked to the gross revenue of the REIT. The remuneration of the executive directors should instead be linked to appropriate metrics which take into account the long-term interest of the REIT and its unitholders. Audit Committee requirements MAS will proceed with the proposal to stipulate a minimum of three directors for the Audit Committee of the REIT Manager, in alignment with the guidelines in the CG Code. Directors whose responsibilities in the Sponsor’s group relate only to control or back-office functions are allowed to be a member of the REIT manager’s Audit Committee, as such persons may have the relevant expertise to contribute to the Audit Committee. Where an Audit Committee has a Sponsor’s nominee as a member, there must be a minimum of three other directors who are independent. Accountability of REIT managers MAS had sought views on whether the current approach of relying on unitholders to initiate a review of the REIT manager’s appointment is effective or whether regulatory intervention is deemed necessary. MAS noted that respondents generally agreed that the current approach is broadly effective and did not see the need for regulatory intervention at this time. Alignment Of Incentives Performance fee structure MAS had proposed that the performance fee payable to the REIT manager be computed based on a methodology that links it to an appropriate metric which takes into account the REIT’s and unitholders’ long-term interests. Based on feedback received, MAS had decided that it will not prescribe a list of permissible fee computation methodologies. CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 3 © Rajah & Tann Singapore LLP Acquisition and divestment fees MAS had also earlier proposed that REIT managers be allowed to charge an acquisition or divestment fee only if the fee is determined on a ‘cost-recovery’ basis. A majority of respondents disagreed with this proposal, while others sought clarity on the scope of ‘cost-recovery’ as there is currently no industry norm for this. MAS has decided not to require acquisition or divestment fees on a ‘cost-recovery’ basis , but will require REIT managers to disclose in the prospectus (or in the case of existing REITs, the first annual report after the requirement takes effect) as well as any circular seeking unitholders’ approval for the subsequent revision of fees, the justification for each type of fees charged. Managers will also have to explain the methodology for computing performance fees, and justify how this methodology takes into account unitholders’ long-term interests. Where a REIT’s property is divested to an interested party, MAS had proposed to require the Audit Committee to certify that it (i) is not aware of any other offer with and (ii) has no reason to believe that the divestment can be made on, terms that are more favourable than those offered by the interested party. After considering feedback, MAS will instead require the Audit Committee to confirm that it has undertaken due process to ensure that the terms in an interested party divestment by the REIT are generally in line with that which would have been obtained had the asset been sold to a non-interested party. Operational Flexibility Single- tier 45% leverage limit MAS will proceed with the proposal to adopt a single-tier leverage limit of 45% (up from 35%), as it believes that the single 45% leverage limit strikes a good balance between preventing REITs from overgearing themselves and also reduces mechanistic reliance on credit ratings. 25% development limit MAS will also proceed with the proposal to allow a REIT to undertake development activities up to 25% of its deposited properties as most respondents were supportive of this proposal. As for the additional 15% allowance (over and above the current 10% limit) being utilized solely for the redevelopment of an existing property that has been held by the REIT for at least 3 years, and which the REIT will continue to hold for at least 3 years after redevelopment, MAS has highlighted that specific approval must be sought from unitholders each time the additional 15% allowance is used. Operational Requirements On REIT Managers Adequacy and effectiveness of compliance arrangements Based on consultation feedback, MAS will not proceed with the proposal to require the Audit Committee of the REIT manager to state in the REIT annual reports (i) whether the compliance arrangements of the REIT manager are adequate and effective, taking into account the nature, scale and complexity of the REIT manager’s operations and (ii) the mitigating measures being taken if the Audit Committee is of the view that such arrangements are inadequate or ineffective. Instead, it will provide guidance on compliance-related factors that the Board should consider in its assessment of the adequacy and effectiveness of the REIT manager’s internal compliance arrangements. CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 4 © Rajah & Tann Singapore LLP Professional indemnity insurance As respondents were generally supportive, MAS will proceed with the requirement to allow REIT managers to procure professional indemnity insurance, or in lieu thereof, a letter of undertaking may be provided by the REIT manager’s parent company, where the latter has satisfactory financial standing. Property management function To ensure that the REIT manager takes active steps to evaluate that the engagement of the property manager of the REIT remains appropriate, MAS had proposed to require the REIT manager to ensure that the property management agreement (“PMA”) entered into with a Sponsor-connected property manager does not contain any term that materially restricts the ability of the REIT to remove the property manager. It also proposed that the Audit Committee of the REIT manager to review the compliance of the property manager with the terms of such agreement, at least once every two years and to take remedial action if necessary. Respondents were generally supportive of this proposal. However, taking into account feedback, MAS has decided to proceed with a modified version of the review interval requirement: the Audit Committee should satisfy itself at least once every two to five years (and more frequently if the property manager’s compliance record is poor) that the REIT manager has periodically reviewed the property manager’s compliance with the terms of the PMA and that the REIT manager has taken remedial actions where necessary. The Audit Committee should also document its reasons for its conclusion. The interview of the review by the Audit Committee should be commensurate with the tenure of the PMA. Structuring Of REITs And Asset Acquisition Use of income support arrangements MAS had invited comments on whether the current approach of relying on disclosure to impose market discipline on the use of income support arrangements is effective and if regulatory intervention is deemed necessary. Based on feedback received, MAS has concluded that regulatory intervention is currently not necessary. Stapled securities structure In the Consultation Paper, MAS proposed to require the REIT to have sufficient nexus to the entity that it will be stapled to, with a view to ensuring that stapled entities with a REIT component remain a predominantly stable yield vehicle. It was proposed that a stapled group had to meet certain operational restrictions, in order to preserve the character of REITs as stable income vehicles and apply these operational restrictions on existing stapled groups (with a REIT component). Existing stapled groups with a REIT component will have a transitional period of six months to comply. Taking into account feedback, MAS will modify the nexus requirement to allow nexus to be established between a REIT and an entity with active operations so long as they are both in the same industry, or if the entity with active business operations is operating a business or providing a service that is ancillary to assets held by the REIT. MAS will also not require the entity that is stapled to a REIT to be the sponsor or a related entity of the sponsor. MAS has also decided not to implement operational restrictions, as the revised nexus requirement will go some way to limit the overall exposure of staple REIT-groups to the risks of running active operations. Enhanced Disclosure Requirements In relation to proposals on what a REIT will be required to disclose in its annual report, MAS has decided on the following: CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 5 © Rajah & Tann Singapore LLP (a) The effect of income support payments on DPU must be disclosed. MAS does not intend to prescribe a negative list of lease structures that may be excluded from being treated as income support. (b) Any material deviation of actual DPU from forecast DPU, together with detailed explanations for the deviation. (c) The total operating expenses as a percentage of net asset value must be disclosed. MAS has clarified that the scope of “total operating expense” must be in line with the disclosure under paragraph 11.1 (i) of Appendix 6 of the Code on Collective Investment Schemes (“CIS Code”). (d) the weighted average lease expiry (WALE) of the REIT on a portfolio basis (in addition to the WALE of new leases entered into the past year). Miscellaneous Amendments Definition of ‘Sponsor’ The Consultation Paper proposed defining a “Sponsor” for the purposes of requirements applicable to a sponsor, as the entity that (i) determines the properties to be injected into the initial portfolio of the REIT at the time of listing, (ii) provides the REIT with a right of first refusal in relation to any asset and (iii) represents itself as a Sponsor in any relevant document. Taking into account consultation feedback, MAS has decided not to define a “Sponsor”. Nominating and Remuneration Committees MAS will proceed with the proposal to require a REIT manager who does not set up a remuneration committee or a nominating committee to explain its rationale in the annual report of the REIT, such explanation to adequately address whether it has a process for (i) sourcing new directors and (ii) developing policies on executive remuneration and determining the remuneration packages of individual directors. It has clarified that both these committees can be combined into a single committee. Other business interests of CEO and Executive Directors MAS will proceed with proposals requiring the REIT manager to ensure that (i) the CEO and executive directors of a REIT manager should not sit on the board of another entity with competing interests and (ii) the CEO and executive directors of a REIT manager are employed full-time in the day-to-day operations of the REIT manager. Further, the CEO of a REIT manager should generally be resident in Singapore. However, if the REIT manager manages a REIT invested primarily in foreign properties, MAS is prepared to consider allowing such REIT’s CEO to be resident in the foreign country where the REIT’s properties are primarily invested in. The REIT manager will need to satisfy MAS that this arrangement does not compromise the effective governance and oversight of the REIT portfolio and REIT management activities. Number of Experienced Representatives MAS will proceed with its proposal for REIT managers to have at least a minimum of three full-time representatives who are resident in Singapore, each with at least five years of relevant experience. Change of control covenants MAS will proceed with the proposal to codify the current position of allowing loan agreements containing a “change of control” covenant if the covenant (i) is required solely by lenders, (ii) can be waived with lender’s consent and (iii) is disclosed in accordance with SGX-ST’s listing rules. In response to feedback, MAS has clarified that it does not intend to apply this criteria retrospectively to all loans, or to require that loan agreements must henceforth contain change of control covenants. CLIENT UPDATE 2015 AUGUST CAPITAL MARKETS 6 © Rajah & Tann Singapore LLP Implementation Timeline Amendments to CIS Code, Notice & Guidelines The amendments to the CIS Code, proposed Notice to all Holders of a Capital Market Services Licence for REIT Management, and Guidelines to all holders of a Capital Markets Services Licence for REIT Management will take effect on 1 January 2016. The proposed amendments to the SFA relating to the statutory duty to prioritise the interests of REIT unitholders over the interests of the REIT manager and its shareholder(s), will take effect on 1 January 2017. Amendments to Regulations The proposed amendments to the Securities and Futures (Licensing and Conduct of Business) Regulations relating to the requirements on Board independence and composition will take effect no later than the first AGM relating to the financial years ending on or after 31 December 2016. This is to allow REIT managers more time to reconfigure their Boards to meet such requirements. Requirements on performance fees To enable REITs to have sufficient time to comply with the new requirements on performance fees, the effective date of requirements on performance fees will be extended to no later than the first AGM relating to the financial year ending on or after 31 December 2015. Resources 1. Consultation Paper on Enhancements to the Regulatory Regime Governing REITs and REIT Managers 2. 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