Real estate financing under financial regulation and real estate control
By 王霁虹 汤宏伟
In recent years, in order to prevent systemic financial risks, various regulators have introduced the most stringent financial regulatory policies. Controls in the real estate market are also gradually escalating. The real estate industry involves the most numerous financial products. It is highly dependent on finance. It can even be said that the essence of real estate is finance. However, the current financial regulatory policies and real estate control situation are simply “double kill” to real estate enterprises.
Various regulators have put considerable and determined efforts into financial regulation. Real estate enterprises are facing all-round containment of financing. “Financing difficulties” and “cash shortage” are the predicaments that real estate enterprises are confronting in recent years, mainly due to the comprehensive containment from the regulators. National Development and Reform Commission suspended the issuance of corporate bonds by real estate enterprises for financing commercial real estate projects. China Banking Regulatory Commission issued several documents to rectify the chaos in the banking and trust industries, and severely punished a large number of banks and trust institutions in violation of the regulations for “transfusing blood” to real estate enterprises.
The Asset Management Association of China suspended registration and filing of private equity funds for lending activities. It also refused registration and filing of ordinary residential real estate projects in 16 hotspot cities invested by private equity asset management plans that securities and futures operating institutions set up. Moreover, China Insurance Regulatory Commission further rectified the misuse of insurance funds.
So far, except for standard loans for real estate development, other financing channels of real estate enterprises such as bond issuance, banking, trust, asset management, funds, insurance and so on have almost been completely blocked.
Asset securitization, the way out for real estate financing. While real estate financing is fully tightened, we should also pay attention to other options given by the policies. The State Council issued the Opinions on Actively and Firmly Reducing the Leverage Ratio of Enterprises on 22 September 2016 to encourage orderly development of corporate asset securitization. Moreover, the Guiding Opinions on Regulating Asset Management Business of Financial Institutions also clearly gave a green light to the asset securitization business.
Asset securitization refers to the business activities of issuing asset-backed securities based on the cash flow generated from underlying assets as repayment support and the credit enhancement achieved through structuring and other methods. Simply put, asset securitization is the financing through sale of the future cash flow of underlying assets. For the purpose of financing, original equity holders sell their legally held underlying assets that can generate sustained and stable cash flow to special asset-backed programs established by asset managers. Such programs acquire the underlying assets with the funds raised from investors and distribute the proceeds from the underlying assets to investors.
Corporate asset securitization involve numerous participants and complicated legal relationships. Original equity holders are the owners of underlying assets, usually the financing party, or maybe the affiliate or the bridge party of the financing party (common in the asset securitization with the dual SPV structure). They assist the parties with actual funding needs in financing. Asset managers are the subjects, usually securities companies, subsidiaries of fund management companies and other financial institutions recognized by China Securities Regulatory Commission, that establish and manage special programs for the benefit of investors, and sign relevant agreements and fulfill statutory and agreed obligations on behalf of the special programs. Investors refer to qualified investors who subscribe for the beneficiary certificates (asset-backed securities) of special programs and meet the requirements of the Interim Measures for Supervision and Administration of Private Equity Funds. Asset-backed securities shall be issued only to not more than 200 qualified investors.
Investors sign a Subscription Agreement with an asset manager and hands over the subscribed fund to the manager to set up a special program, so that investors obtain the asset-backed securities and become holders of the asset-backed securities. The manager signs an Agreement on Sale and Purchase of Underlying Assets with the original equity holder on behalf of the special program, and purchases the underlying assets from the original equity holder with the funds paid by investors for purchase of asset-backed securities. After the underlying assets are transferred to the special program, the cash flow generated by the underlying assets also flows into the special program for the manager to distribute to investors. In most cases, because the original equity holder is more familiar with the underlying assets, or has ongoing responsibilities and obligations to specific users in the underlying assets, the manager usually entrusts the original equity holder to be an asset service agency to take the responsibility of collecting cash flow of the underlying assets. Original equity holders, managers and investors are the core trading subjects in asset securitization. In addition, managers will also entrust law firms, accounting firms, rating agencies, custodian banks, guarantee institutions and underwriters to provide legal, financial, rating, custody, credit enhancement and underwriting services and other services.
Although the transaction structure of corporate asset securitization is complex, the stock assets can be used for financing in asset securitization, which is in line with the current policies of controlling incremental debts in the financial sector, and can convert non-standard assets into standard assets not subject to the current financial policies on limiting financing with non-standard assets. At the same time, off-balance-sheet assets are acceptable, which helps optimization of the financial statements of original equity holders. Therefore, real estate enterprises, in the context of current financial regulation and real estate control, should focus on the financing methods of asset securitization, such as asset securitization of house-purchase balance payments, asset securitization of property management fees, CMBS (commercial mortgage-based securities) and REITs (Real Estate Investment Trusts) etc., while making good use of stock assets for financing to further expand financing channels.