China Securities Regulatory Commission (CSRC) has issued the formal rules on publicly listed infrastructure real estate investment trusts (China REITs), which are set out in 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）) published on and effective from 7 August 2020 ("Formal Guidance").
- Key takeaways
- Key amendments to the Draft Guidance
- We are available to discuss
The Formal Guidance contains several key amendments to the Draft Guidance (as defined below), including:
- Allowing China REITs to hold multiple asset-backed security plans.
- Relaxing the restrictions on the underlying assets of China REITs, including, amongst others, the restrictions on the operating period and income diversification.
- Changes to the borrowing restrictions applicable to China REITs and allowing loans to be used for acquisition purposes.
- Modifying the distribution requirements by allowing certain customary adjustments to distributable profit.
- Clarifications regarding the original owner shareholding lock-up period.
- Providing more detailed guidance regarding applications and operations, including on disclosure, approval and reporting.
The Formal Guidance will provide more flexibility for China REITs to expand through proactive acquisition strategies, improve liquidity and further attract potential sponsors and new investors.
In April 2020: (i) China's National Development and Reform Commission (NDRC) and CSRC published their joint notice ("Joint Notice"); and (ii) CSRC released its draft guidance ("Draft Guidance") on China REITs.1 On 3 August 2020, NDRC published a further notice elaborating on the application process for pilot China REIT projects ("NDRC Notice").
The Formal Rules published on 7 August 2020 officially established the China REIT regime, and we will discuss some of the key changes to the Draft Guidance in more detail below.
Key amendments to the Draft Guidance
The Formal Guidance contains various substantial and miscellaneous amendments to the Draft Guidance, with detailed explanations provided for the approach.
Structure of China REITs
It was prescribed under the Draft Guidance that each China REIT shall invest at least 80% of its assets into one single infrastructure asset-backed security plan, which will indirectly hold the underlying assets. In the Formal Guidance, each China REIT can invest at least 80% of its assets into one or more infrastructure asset-backed security plans, which would allow more flexibility for China REITs to make acquisitions.
The other features of the China REIT structure set out in the Draft Guidance remain unchanged.
In the NDRC Notice, the eligible classes of "infrastructure assets"2 are expanded to specifically also include:
- Data center, artificial intelligence, intelligent computing center projects.
- 5G, communication tower, internet of things, industrial internet, broadband network, cable TV network projects.
- Smart transportation, smart energy, smart city projects.
NDRC also specifies additional criteria for eligible underlying assets such as requiring the estimated net cash flow distribution rate for the underlying assets (calculated as follows: estimated annual distributable cash flow/net value of target asset) to exceed 4% in each of the next three years.
The Formal Guidance contains substantial amendments to the borrowing provisions stipulated in the Draft Guidance. Under the Formal Guidance, external borrowings existing prior to the formation of the China REIT have to be repaid from the IPO proceeds, unless such borrowings satisfy the following requirements:
- The purposes of loans are limited to the daily operation, maintenance and acquisition of infrastructure projects.
- The total assets of the China REIT do not exceed 140% of its net assets.
Under the new Formal Guidance, China REITs may now enter into post-IPO loans for the purposes of acquisitions, although such loans cannot exceed 20% of the net assets of the China REIT, among other requirements.
The Formal Guidance now clarifies that at least 90% of the consolidated annual "distributable amount" of the China REIT, instead of distributable profit as specified under the Draft Guidance, shall be distributed to the investors in cash.
The Formal Guidance defines the "distributable amount" as the net profit of the China REIT subject to reasonable adjustments such as changes to fair value through profit or loss, depreciation and amortization of underlying assets and operating cash flow. This clarification is consistent with the practice of Hong Kong and Singapore listed REITs.
The Formal Guidance clarifies that only 20% of the original owner's shareholding (rather than all of its shareholding, per the Draft Guidance) needs to be locked up for five years. The remainder of the original owner's shareholding (i.e., in excess of 20% interest) is locked up for three years. The revised lock-up period is still more onerous than those applicable to other international REIT regimes and PRC listed companies.
Application and operational clarifications
The Formal Guidance provides further details in relation to the application process and operational matters for China REITs including with respect to the matters requiring shareholder approvals, disclosure and reporting.
For example, acquisitions sized below 20% of the China REIT's net assets only require disclosure, while acquisitions sized between 20% and 50% require majority shareholder approval and those exceeding 50% require two-thirds shareholder approval.
The Formal Guidance also further elaborates on the roles and obligations of the fund manager, fund trustee, financial advisor and other external management and professional parties with respect to the China REIT. It has also clarified that some of the requisite experience including investment management and real estate research can be satisfied via outsourcing to affiliated parties of the fund manager. This potentially provides more flexibility for internal reorganization and strategic partnerships, including strategic joint ventures with experienced asset managers.