The problems and suggestions in the issuance of managerial assets in ABS or REITs

Recently, a client engaged in smart parking asset management encountered a “nerve-wracking” problem, that is, when assets such as municipal and scenic parking lots are revitalized and declared to issue asset-backed securities or infrastructure REITs, how should they view the access of these underlying assets and the equity transfer of the project company involved? The following author tries to sort out and put forward suggestions.

Key requirements for (franchise) projects

(1) The difference and relationship between the right of operation and the right of franchise

Franchise here only refers to the franchise in the field of infrastructure and public utilities as stipulated in the newly revised “Infrastructure and Public Utilities Franchise Management Measures” (hereinafter referred to as the “Management Measures”) in 2024, excluding commercial franchises, and clearly requires a “public-private partnership (PPP) model based on user fees”. Franchise operators need to go through fair competition procedures such as “recruitment, auction and suspension” to be granted.

The “right to operate” alone is not within the framework of the “Management Measures”, and mostly exists in projects where local governments directly authorize state-owned enterprises at the same level to invest in construction, but it is necessary to apply for approval, approval or filing in accordance with the “Regulations on Government Investment” and “Regulations on the Administration of the approval and filing of Enterprise Investment Projects”, and it is necessary to pay attention to whether there is a local government hidden debt risk.

The requirements for the issuance of ABS or REITs do not exclude the right to operate alone. In the “Notice on Comprehensively Promoting the Regular Issuance of Real Estate Investment Trust (REITs) projects in the field of Infrastructure” (hereinafter referred to as “No. 1014”), it is also clear that “operating income rights (including franchise rights)” are two categories of projects alongside project ownership. The “right of management income” here is a kind of broad management right.

In short, the broad sense of “management right” covers not only “franchise right”, but also the right of direct authorization without “bidding” procedures; The “management right” in the “management Measures” refers to the franchise right, and it is a franchise with attributive and limited scope.

(2) The relationship between franchise rights and PPP

On November 8, 2023, The General Office of the State Council forwarded the “Guiding Opinions on Regulating the Implementation of the New Mechanism of Cooperation between the Government and Social Capital” (hereinafter referred to as the “115 Document”), the “Administrative Measures” are implemented on May 1, 2024, and the 1014 document is implemented on August 1, 2024. The three documents were promulgated successively and took care of each other.

In addition to commercial franchises and public construction and private enterprises that do not involve the transfer of property rights, franchise projects in the field of infrastructure and public utilities belong to the scope of PPP and should be subject to the norms of document 115, and there is no franchise project in the field of infrastructure and public utilities that is not subject to the constraints and norms of Document 115.

Although the essence of the “new PPP mechanism” under the framework of document No. 115 is still the purchase of services by the government, it focuses on the “user pay” and clearly stipulates that: “Government payments can only subsidize operation and cannot subsidize construction costs in accordance with regulations,” and “financial funds shall not be used to cover project construction and operation costs through any means such as feasibility gap subsidies, promised minimum return rates, and availability payments.” In short, it is the definition of Article 4 of the Administrative Measures - infrastructure and public utility franchising is a PPP model based on user pay.

Therefore, Document No. 1014 puts forward specific requirements for PPP projects in the “Third part (V) of the declaration requirements”, including that where the source of project income is based on user fees and there are local government subsidies, the annual subsidy amount in the past three years shall not exceed 15% of the total annual income of the project in principle.

In addition, the three documents all take “February 2023” as the node of the new and old demarcated, and the projects that have not completed the bidding and procurement procedures before February 2023, as well as all the newly implemented PPP projects should be promoted in accordance with the requirements of the new mechanism. If the franchise agreement does not explicitly support the subsequent issuance of infrastructure REITs, a no-objection letter issued by the implementing agency of the franchise project and the competent authority of the industry should be obtained.

(3) The possible impact of the new changes in the “Administrative Measures” on the issuance of franchise projects

Article 21 of the Administrative Measures adds that the selected franchise operator and its investment, financing and construction responsibilities shall not be adjusted. If adjustments are necessary, the franchisee selection process will need to be re-implemented.

This shows that in the “construction” stage, it is no longer feasible for investors to exit the project through equity change of the project company. This clause aims to eliminate potential risks and uncertainties caused by equity changes, investment and financing changes and other factors, so as to play a key role in ensuring the sound operation and long-term sustainable development of the project.

Combined with the provisions of Article 40 of the “franchise project involving substantial changes in operating entities, equity transfer and other major matters, shall promptly inform the relevant industry authorities in writing”, which means that if the “operation” responsibility changes, there is no need to re-perform the franchise selection procedure, but it should be reported to the competent authorities. This widens the franchisor's exit possibilities during the operation period.

In addition, Article 20 of the Administrative Measures stipulates that “Where a project company needs to be established, the implementing agency shall sign a preliminary agreement with the lawfully selected franchise operator, stipulating that it shall register and establish the project company within the prescribed period of time, and sign a franchise agreement with the project company.” That is, the selected franchisor who established the project company is not the subject of the franchise agreement, which is very meaningful in the subsequent discussion of the subject change.

Transfer and disguised transfer of franchise rights

(1) Formalism

As mentioned above, Articles 21 and 40 of the “Administrative Measures” respectively provide for the adjustment and change of the “investment and financing, construction” link and the “operation” link.

Local regulations on the transfer of government franchise rights are scattered in their local laws and regulations, which are not the same. There are expressions such as “shall not be transferred without authorization” or “shall not be transferred without consent”, and there are also direct “shall not be transferred” or “shall not be transferred in disguised form”. Some regions have also clarified the post-reporting system of equity transfer, or require the bidder of the franchise to make corresponding commitments to the future equity transfer matters when bidding.

(2) Materialism

In the practice of judicial adjudication in various places, although the country has not yet formed a unified adjudication standard, the courts have conducted a comprehensive review of the contract terms, the performance of the parties, the specific situation of the subject matter in dispute and other aspects, and will not be “one-size fits-all”, its purpose is “substance over form”, to explore the true expression of intention and legal relationship between commercial subjects.

First of all, look at laws and regulations. The “Management Measures” does not prohibit, it is necessary to analyze the relevant local laws and regulations or policies of the project location to determine whether it is prohibited or the conditions or prerequisites for change and transfer.

Second, focus on the franchise agreement signed. Is the signing subject the concessionaire or the project company? What about the assignment of the project in the agreement? Are there any changes, such as equity transfers, that may be considered “disguised transfers”? Whether it is allowed or can be allowed after the performance of a particular procedure, etc. And pay attention to the corresponding legal consequences of the agreement and the corresponding liability for breach of contract.

Thirdly, through the analysis and review of laws, regulations and agreements, we can judge the following points:

What is the true intention of both parties and what is the true purpose of the equity transfer (whether the transfer price is fair or not);

Whether the business entity has substantially changed (whether the equity, actual controller, relevant assets and qualifications have changed);

After the change, whether it still meets the fundamental requirements and conditions of franchise (subject qualification, qualification, project construction and operation ability).

Judging from this, the transfer of equity by the project company constitutes a disguised transfer of the government franchise.

Therefore, the transfer of the equity of the project company is not equivalent to the change of the project management ownership, and it is not equivalent to the transfer of the government franchise. Need to combine subjective and objective comprehensive judgment.

The impact of franchise changes on the issuance of ABS or REITs and suggestions

Whether it is ABS or REITs, the regulatory authorities are highly concerned about whether the project ownership is clear, whether the underlying assets are complete, and whether the project operating income and cash flow returns are sustainable and stable in the future.

With reference to Document No. 1014 and “Shanghai Stock Exchange Asset-Backed Securities Listing Condition Confirmation Rules Applicable Guidelines No. 2: Major Basic Assets” (Shanghai Stock Exchange (2022) No. 165), the steps to operability are summarized as follows:

1. Franchise agreement, local policy implementation documents, meeting minutes of project implementation agencies and industry authorities, confirmation letter, no objection letter, etc., whether the PPP project contract makes a restrictive agreement on the transfer of project income rights of the project company, etc.;

2. In terms of user payment, it is necessary to have the full control of the corresponding cash flow return account, the commitment or legal document of the government department to pay for the purchase of services according to the agreement, and whether the government subsidies in the revenue of the PPP project are included in the government's annual financial budget and medium-term financial planning;

3. If there is equity transfer, whether the transfer has been approved by all parties, and whether formal and written consensus has been reached with the project implementing agency and the competent industry authority for the disguised transfer that does not constitute the franchise right.

Finally, in view of the subsequent impact of this problem, it is suggested that the original owner should be prepared at the beginning of the project, the establishment of the project company and the signing of the franchise contract, and pay attention to the formal communication with the implementing agency and the retention of relevant letters and drafts.

If the right of operation is not directly authorized under the Administrative Measures, it is more necessary to pay attention to the source of its ownership and the issue of government hidden debt, after all, the franchise under the new PPP mechanism is more standardized and more mainstream. In the declaration and issuance stage, it is recommended to maintain more communication with the issuance audit body on the issue of implementation caliber.