The China Securities Regulatory Commission (CSRC) recently invited public comments on the "Guidance on public offering of infrastructure securities investment fund (trial)" 《公开募集基础设施证券投资基金指引（试行）》("Draft Guidance"), which sets out the draft rules for China's first publicly-listed infrastructure real estate investment trusts ("China REITs"). For further details on the Draft Guidance, please refer to our previous client alert.
The public consultation for the Draft Guidance is a very positive and significant step towards a China REIT regime that can deliver long-term benefits for investors and asset owners. To facilitate this, we submitted the following recommendations for the consideration of CSRC:
- Ensuring a suitable balance between protecting investors' interests and attracting the best owners, managers and assets;
- Promoting China REITs' growth through acquisitions for investors' long-term benefit; and
- Enhancing China REITs' domestic and international competitiveness.
In more detail
An effective and successful REIT regime attracts the best quality owners, managers and assets and ensures robust corporate governance.
In this regard, our submission covered several proposals to widen the eligibility of qualifying assets while still ensuring that minority investors are protected. For example, we suggested permitting China REITs to own assets that have less than three years of operating history, provided they can still demonstrate the stability of their cash flow (through the nature of their underlying assets, e.g. toll roads, or other means), may allow otherwise attractive (but non-qualifying) assets to be acquired by China REITs.
We also suggested that the corporate governance provisions applicable to the daily management of China REITs should, to the greatest extent possible, be consistent with those for other companies and/or funds listed on the relevant stock exchange. This approach facilitates consistency and transparency for all investors, and ensures the same potential growth for China REITs as an asset class compared with other listed investments.
Acquisitions are fundamental to a REIT's long-term growth and ultimate success. Enabling China REITs to expand their assets under management through proactive strategies will help them attract new investors, improve their liquidity and better distinguish them from existing quasi-REITs.
Having regard to the intrinsic requirement requiring China REITs to distribute at least 90% of their annual profits each year, it will be challenging for China REITs to accumulate an "acquisition war-chest" from asset cash flow, and they will necessarily need to raise funds through equity and/or debt capital markets to finance acquisitions. This is customary in other REIT markets. To facilitate this for China REITs, modifications could be considered to, for example, relax the proposed borrowing restrictions that prescribes a 20% gearing ratio limit and prohibits borrowing for acquisition purposes.
Having a highly skilled and experienced asset management team is also attractive to investors and critical to the growth of a REIT. Accordingly, in addition to infrastructure operation experience (and infrastructure investment management experience which is presently optional), we propose that the three chief responsible officers of the REIT also collectively have other balanced and diverse skills that will be necessary to manage the C-REIT (such as capital markets, investor relations and regulatory compliance) when vetting their suitability. Where the original owner does not have extensive fund management experience, they may consider establishing joint ventures with domestic or international asset managers. This may require a clarification of the Draft Guidance requirement for the proposed fund manager to already be incorporated for three years.
To facilitate the adoption of the proposed regime, original owners will need to be convinced that China REITs are not only the most sensible and attractive option compared to international alternatives, but also compared to other domestic alternatives such as ordinary listed companies or funds.
In this context, certain proposed restrictions (such as the requirement for the original owner to hold at least 20% interest in the China REIT for at least five years) may warrant closer consideration, since the risks that such restriction seeks to address also applies to domestic companies/funds and overseas REITs.
China REITs could also gain a significant international competitive advantage if they can be traded on the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect ("Stock Connect"). REITs are presently excluded from the list of Stock Connect eligible securities, notwithstanding their conservative nature (i.e. gearing limits, limited investment mandates and minimum distribution requirements). A relaxation of this restriction would expand the investor base and trading liquidity of both China REITs and Hong Kong REITs, helping them compete with other established regional REIT markets.
As the China REIT regime matures, there may be investor interest to expand the list of eligible asset classes in the future (including e.g. commercial and retail properties) subject to prevailing policy considerations. In this regard, we note that REITs do not necessarily encourage speculative behaviour as they tend to hold their investments for the long-term, since REIT investors typically seek cash flow rather than short-term capital gains. Expanding the list of eligible asset classes, as and when appropriate, would also facilitate the necessary critical mass to compete domestically and abroad.