The project sponsors are almost always the shareholders of the project company. Depending on the industry, the institutions acting as sponsors will be different, ranging from state-owned enterprises to private enterprises, and from domestic corporates to international corporates.
Lenders involved in project finance transactions in China are mainly banks. Previously, foreign banks were quite active in the market, but in recent years Chinese banks have played a more and more important role in project finance transactions, which includes state-owned banks and joint stock banks. Export credit agencies, such as the China Export & Credit Insurance Corporation (Sinosure), also play a significant role in the market, by providing guarantees and insurances. Sinosure provides insurance support and issues guarantees to counterparties of Chinese export-oriented companies.
Public-private partnership transactions are commonly seen in public service industries, such as energy, transport, environmental protection, agriculture, forestry, technology, government-subsidised housing, healthcare, education and culture, etc.
The legislation applicable to public-private partnership transactions includes (without limitation) the Civil Code, the Budget Law, the Government Procurement Law and the Bidding Law.
There are several main issues that need to be considered when structuring project finance transactions in China.
First, the parties need to carefully consider the basis on which the deal should be structured: non-recourse, limited recourse or otherwise. Sponsors normally prefer a non-recourse or limited recourse deal. However, in many project finance transactions, the lenders will require a guarantee or other security from the sponsors even though they take security over all the project assets.
Secondly, the capital ratio is regulated and determined based on the nature of the investment project under PRC laws. Generally, the minimum capital ratio is 25% but it varies depending on the nature of the investment project. Project sponsors need to structure their financial model carefully so that the capital ratio requirement does not affect the return on invested capital.
Industries/sectors relating to the so-called New Infrastructure – 5G, Data Centre, AI, Industrial Internet and IoT, etc – are expected to be more active in the coming year.
Under PRC laws, the following types of assets are typically available as collateral to lenders:
The forms that security typically takes in the market include guarantee, pledge and mortgage.
Under PRC laws, security created over certain types of assets needs to be registered at the relevant asset-based registry for perfection purposes. The security perfection requirements for these types of assets are as follows:
Security can be created in favour of a security agent in syndicated loan transactions, as the security agent concept is generally recognised in the PRC. A security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.
A Chinese company can create a floating mortgage over its machinery, equipment, raw materials and semi-manufactured products, as well as its finished products, both those currently owned and those to be owned in the future. However, under PRC laws, it is not generally possible to create a floating charge over all present and future assets of a company. Separate agreements are required to create a security over each type of asset.
Costs associated with registering collateral security interests in China are minimal, and the borrower usually pays these costs (if any) directly. For example, the registration fee for security over a land use right and buildings is CNY80 or CNY550 (depending on the types of land use right and buildings) for each registration; the registration fee for security over receivables is CNY30 per annum for each registration; and no registration fee is payable for security over shares.
To the extent practically possible, it is almost always necessary to identify each item of collateral in the security document individually in order to grant a valid security interest. It is noteworthy that it may not be possible to individually identify each item of collateral for certain types of security, such as a floating mortgage over machinery, equipment, raw materials and semi-manufactured products, as well as finished products (both currently owned and to be owned in the future). In this case, a general description of the collateral should be sufficient. It is also advisable to consult the relevant security registry in advance regarding whether the collateral needs to be individually identified for the purpose of security perfection.
Under PRC laws, there are two types of cross-border security that need to be registered with the State Administration of Foreign Exchange of the PRC (SAFE):
Other types of cross-border security are generally not required to be registered with the SAFE. For example, if foreign lenders lend into China and take security over assets located in China, the security is not required to be registered with the SAFE. In practice, cross-border security registration may need to have been completed prior to the application of security registration with the relevant asset-based registry, so it is advisable to check with the relevant authorities on a case-by-case basis.
Lenders usually conduct due diligence against the collateral over which they will take security. This due diligence normally assesses whether there are other liens or restrictions on the collateral, among other matters. Generally, liens are recorded with the relevant security registry and therefore are searchable following the prescribed procedures (eg, the authorisation of the collateral owner may be required).
Generally, the parties may choose the form of security release, as there is no restriction in this regard under PRC laws. It should be noted that, if a security release form is required to be submitted to the security registry for the purpose of deregistering the security, it is advisable to confirm with the security registry whether the release form is acceptable.
Under PRC laws, a secured lender can enforce its collateral if the debt secured by that collateral is not paid when due and payable, or if another event of default provided in the finance documents occurs. Generally, there are three methods by which to enforce collateral in China.
It is noteworthy that, under PRC laws, the parties can have a debt instrument notarised by a notary office and obtain a notarial certificate when signing the instrument. Debt instruments that can be notarised include but are not limited to loan agreements, security documents, etc. Once notarised, the debt instruments will be granted enforceability by notarisation under PRC laws. In the event of default, the secured lender can request the notary office to issue an enforcement certificate regarding the notarised debt instrument (eg, a security document) and apply directly to the competent PRC court for enforcement of the collateral.
It is generally possible for security enforcement to be taken directly by a security agent, unless the security document provides otherwise. As mentioned, a security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.
For a foreign-related contract, PRC laws generally allow the parties to choose the governing law of that contract (PRC laws or a foreign law), except where the choice of foreign law violates mandatory PRC legal provisions or where any provision of the foreign law violates a public policy of the PRC in the determination of a particular issue, in which case PRC laws would be the applicable laws. Under PRC laws, contracts are considered to be foreign-related contracts when:
Based on this, for loan agreements entered into between a Chinese company and foreign lenders, PRC laws generally allow the parties to choose a foreign law as the governing law (in particular, English law), and PRC courts will give effect to the choice of foreign law. For security documents, however, as a matter of the lex situs doctrine, the security is typically governed by PRC laws, since the security asset is located in China.
Generally, the submission to a foreign jurisdiction should be upheld under PRC laws, provided that it does not contradict the mandatory legal requirements in China, such as the legal requirement regarding exclusive jurisdiction.
Under PRC laws and according to the international treaties concluded or acceded to by the PRC or based on the principle of reciprocity, PRC courts shall review an application or a pleading for the recognition and enforcement of a judgment rendered by a foreign court. If, upon review, the foreign judgment neither contradicts the fundamental principles of PRC laws nor violates state sovereignty, security or public interest, PRC courts shall rule to recognise and enforce the foreign judgment. China officially signed the Hague Convention on Choice of Court Agreements in September 2017, and is still going through the ratification procedure. To date, there is no other international treaty in respect of the recognition and enforcement of judgments between the PRC and the UK or USA.
China is a member of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (ie, the New York Arbitration Convention). Therefore, a foreign arbitral award against a Chinese company should be enforceable in China if the legal provisions of the Arbitration Law of the PRC are complied with.
Generally, there are no substantive restrictions on a foreign lender’s ability to enforce its rights under a loan or security agreement. However, as the official language in PRC courts is Chinese, a foreign lender would have to prepare and present a Chinese translation of documents filed with PRC courts. Moreover, PRC courts generally require a foreign lender to notarise and legalise its constitutional documents, as well as the power of attorney granted to its legal counsel in a judicial proceeding.
The following regulatory requirements when foreign lenders grant loans within the PRC are worth mentioning.
Foreign Debt Quota
Pursuant to the regulations of the PBOC, a foreign debt quota is required for a Chinese borrower to take out loans from foreign lenders. The risk-weighted outstanding amount of all foreign loans borrowed by the Chinese borrower shall not exceed its foreign debt quota. The foreign debt quota is calculated as follows: the borrower’s capital or net assets multiplied by the cross-border financing leverage ratio multiplied by the macro-prudential regulation parameter.
Depending on the type of borrower, the calculation of foreign debt quota is different:
Currently, the macro-prudential regulation parameter is 1.5 for both financial institutions and enterprise borrowers.
NDRC 56 Registration
For foreign loans with a tenor of more than one year, the borrower is required to apply for registration in advance with the National Development and Reform Commission of the PRC (NDRC). It is noteworthy that the NDRC 56 registration is required not only where the borrower is a Chinese enterprise but also, technically, where the borrower is an offshore subsidiary or an offshore branch controlled by a Chinese enterprise.
Foreign Debt Registration
After the signing of the loan agreement, the borrower is required to register the loan agreement with the SAFE.
Under PRC laws, there are two types of cross-border security that need to be registered with the SAFE: NBWD and WBND (see 2.5 Restrictions on the Grant of Security or Guarantees). Other types of cross-border security are generally not required to be registered with the SAFE. For example, if foreign lenders lend within China and take security over assets located in China, the security is not required to be registered with the SAFE.
In addition, security created over certain types of assets located in the PRC needs to be registered at the relevant asset-based registry for perfection purposes; see 2.1 Assets Available as Collateral to Lenders for details.
According to the Foreign Investment Law of the PRC, which was promulgated on 15 March 2019 and came into force on 1 January 2020, China applies the National Treatment Principle plus a negative list to foreign investment. This means that foreign investors and Chinese investors are generally treated equally, provided that:
In addition, China is a member of the World Trade Organization, and has entered into more than 130 bilateral investment treaties and more than 100 double tax treaties with other countries.
Generally, there are no restrictions on payments abroad or the repatriation of capital by foreign investors. According to PRC laws, a foreign investor may freely remit into or out of China its capital contributions, profits, capital gains, proceeds from the disposition of assets and proceeds from liquidation, whether in CNY or in a foreign currency.
Typically, a project company will maintain its CNY account(s) and/or foreign currency account(s) onshore with Chinese banks. In several circumstances (such as for the purpose of collecting offshore revenue proceeds, or making payment of expenditures outside China), PRC laws allow a project company to maintain offshore foreign currency accounts, provided that the project company applies for and obtains approval from the SAFE in advance.
The following registration/filing requirements apply to financing agreements.
NDRC 56 Registration
For foreign loans with a tenor of more than one year, the borrower is required to apply for registration in advance with the NDRC. It is noteworthy that the NDRC 56 registration is required not only where the borrower is a Chinese enterprise but also, technically, where the borrower is an offshore subsidiary or an offshore branch controlled by a Chinese enterprise.
Foreign Debt Registration
After the signing of the loan agreement, the borrower is required to register the loan agreement with the SAFE.
Cross-Border Security Registration
Under PRC laws, there are two types of cross-border security that need to be registered with the SAFE: NBWD and WBND (see 2.5 Restrictions on the Grant of Security or Guarantees).
In addition, security created over certain types of assets located in the PRC needs to be registered in the relevant asset-based registry for perfection purposes; see 2.1 Assets Available as Collateral to Lenders for details.
In China, land and natural resources are generally owned by the state. Individuals or enterprises can be granted the usufruct in order to use or operate such assets; a licence or a certificate (such as a land-use certificate) will be required in this respect. However, foreign entities are restricted from holding the usufruct of land or natural resources directly. As required by the principle of commercial presence, foreign entities need to establish a foreign investment enterprise in China in order to undertake relevant business or operate such assets.
The security agent concept is generally recognised in the PRC and a security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.
Where security interests compete with each other, priority will be determined based on the time when the security interest is perfected: the security interest that is perfected earlier will have priority over that which is perfected later.
Where a sponsor injects equity by way of subordinated debt, the project finance lenders usually procure a subordination undertaking from that sponsor. This kind of contractual subordination provision should generally be upheld by the PRC court, even in the case of the insolvency of the borrower, provided that the contractual subordination provisions do not violate the rules governing the priority of competing security interests under PRC laws.
PRC laws do not generally require a project company to be organised under the laws of China. However, in practice, the competent governmental authority usually requires the project company to be a company incorporated under the laws of China.
As a matter of fact, it is extremely rare for a project company to be a foreign company incorporated outside China, and the typical legal form of a project company is a limited liability company.
The Enterprise Bankruptcy Law of the PRC provides for three types of insolvency proceedings: reorganisation, conciliation and bankruptcy liquidation. An insolvency proceeding is commenced by filing an application with the competent PRC court.
A debtor can file an application for reorganisation, conciliation or bankruptcy liquidation with the competent PRC court if the debtor is insolvent (ie, it is unable to pay off its due debt and/or its assets are not sufficient to pay off all its debts). A creditor can also apply for the reorganisation or bankruptcy liquidation of a debtor from the competent PRC court if the debtor is unable to pay off its due debt. If the court accepts the application, it shall appoint an administrator. Once appointed, the administrator will take over all the debtor’s assets, as well as the management of the debtor. The administrator shall report to the court and be supervised by the creditors’ meeting and the creditors’ committee.
During the reorganisation proceedings, the debtor or the administrator shall prepare and submit a draft reorganisation plan to the court and the creditors’ meeting within six months (unless otherwise extended) after the court accepts the reorganisation application. The creditors will discuss the draft reorganisation plan in the creditors’ meeting, and will be divided into groups based on the categories of debts for voting on the draft reorganisation plan. If all groups of creditors pass the draft reorganisation plan, it will be submitted to the court for approval. The reorganisation proceedings shall be terminated upon approval of the reorganisation plan by the court. If the reorganisation plan is not passed by the creditors’ meeting or in other circumstances prescribed by the Enterprise Bankruptcy Law, the court will terminate the reorganisation proceedings and declare the bankruptcy of the debtor.
A debtor can apply for conciliation with the court directly; it can also apply for conciliation after the court accepts a bankruptcy application made by a creditor, but before the declaration of bankruptcy of the debtor. In applying for conciliation, the debtor shall submit a draft conciliation agreement. The creditors’ meeting will discuss and vote on the draft conciliation agreement. If it is passed by the creditors’ meeting, the court shall rule to acknowledge the draft conciliation agreement and terminate the conciliation proceedings. If the draft conciliation agreement is not passed by the creditors’ meeting or in other circumstances prescribed by the Enterprise Bankruptcy Law, the court will terminate the conciliation proceedings and declare the bankruptcy of the debtor.
Once the court declares the bankruptcy of the debtor, it shall notify the debtor, the administrator and the creditors, and make a public announcement. The administrator shall prepare a conversion plan and a distribution plan for the bankruptcy estate, and submit that plan to the creditors’ meeting for discussion. Once the plan has been passed by the creditors’ meeting and approved by the court, the administrator shall be responsible for selling off the bankruptcy estate (usually through auction) and carrying out the distribution plan. Following the final distribution of the bankruptcy estate, the administrator will submit a distribution report to the court, based on which the court will decide whether to conclude the bankruptcy proceedings.
As a matter of principle, upon the debtor’s insolvency a secured lender shall still enjoy priority over the security assets and can enforce the security in accordance with the provisions of PRC laws.
The Enterprise Bankruptcy Law of the PRC provides that, after the court accepts the insolvency application, the preservation measures concerning the debtor’s property shall be released and the execution procedures shall be suspended. Similar to unsecured creditors, a secured lender shall file its claim (specifying the claim amount as well as whether the claim is secured) with the administrator and participate in the insolvency proceedings. In particular, a secured lender shall suspend the enforcement of security during the reorganisation proceedings. However, if there is a possibility that the collateral may be damaged or the collateral value may decrease dramatically so that it will prejudice the rights of the secured lender, the lender may apply to the court for resumption of the enforcement of security.
In the case of bankruptcy liquidation proceedings, secured creditors may recover their outstanding loans from the enforcement proceeds of the collateral, and also from the debtor’s general assets to the extent that those secured creditors cannot fully recover their loans from the enforcement proceeds of the collaterals. Subject to the credits mandatorily preferred by PRC laws (such as wages, social insurance premiums and taxes), proceeds from the disposition of the debtor’s general assets are distributed to creditors on a pro rata basis.
In the case of a reorganisation proceeding, all the creditors, including secured creditors, will recover their outstanding loans in accordance with the approved reorganisation plan.
Lenders should be aware of the following risks associated with a borrower, security provider or guarantor becoming insolvent (this is not an exhaustive list).
First, PRC laws provide that, after the court accepts the insolvency application, the preservation measures concerning the debtor’s property shall be released and the execution procedures shall be suspended. Similar to unsecured creditors, a secured lender shall file its claim (specifying the claim amount as well as whether the claim is secured) with the administrator and participate in the insolvency proceedings. In particular, a secured lender shall suspend the enforcement of security during the reorganisation proceedings. However, if there is a possibility that the collateral may be damaged or the collateral value may decrease dramatically so that it will prejudice the rights of the secured lender, the lender may apply to the court for resumption of the enforcement of security.
Secondly, the following transactions are voidable upon insolvency:
Thirdly, mutual debts can be set off in insolvency proceedings, but with limitations. The debts to be set off must arise before the court accepts the bankruptcy application. If the creditor knows that the debtor is insolvent when it acquires the debt to be set off, set off is not permitted, because this will procure an advantage for the creditor to the prejudice of the debtor’s assets. In addition, a debt of unpaid capital contributions to the debtor is generally not permitted to be set off.
No entities are excluded from bankruptcy proceedings in China.
Insurance can only be provided by licensed Chinese insurance companies, which are heavily regulated.
Insurance policies over project assets should be payable to foreign creditors, provided that the creditor in question is named as a beneficiary under the relevant insurance policies.
Domestic lenders must pay enterprise income tax (EIT) in respect of interest originating both within and outside China.
PRC EIT will also arise in respect of interest payable to foreign lenders if:
Such EIT shall be subject to withholding at source. The payer (eg, the borrower) will be the withholding agent, and the EIT will be withheld from the interest amount paid to the foreign lenders.
China has signed double taxation treaties with many countries. Tax relief and exemption may be available from the payment of interest according to provisions of the double taxation treaty between China and the country of the foreign lender.
There is no specific tax provision under PRC laws regarding the proceeds of enforcing security or claiming under a guarantee. However, it is generally believed that similar tax treatment should apply to the extent the proceeds of enforcing security or claiming under a guarantee (or part of them) constitute the payment of interest.
Other taxes may also be applicable (eg, value-added tax). Domestic lenders shall pay value-added tax in respect of the payment of interest. For foreign lenders receiving the payment of interest from China but having no establishment in China, value-added tax will be deducted from the payment by the payer (eg, the borrower).
As a result of the market-oriented interest rate reform, there are currently no usury laws or regulations generally limiting the amount of interest charged by lenders.
According to the Supreme People’s Court’s latest judicial interpretation, the interest rate for private lending shall not exceed four times the Loan Prime Rate (which is the benchmark rate published on a monthly basis by the National Interbank Funding Centre authorised by the PBOC) for a one-year loan when the loan agreement is concluded. Generally, private lending refers to lending transactions between natural persons, companies or other organisations, but excludes loans provided by regulated financial institutions (such as banks). The Supreme People’s Court’s latest judicial interpretation clearly provides that it shall not apply to loans provided by regulated financial institutions. However, in practice, the PRC courts may apply the above interest rate limit to loans provided by other lenders (including by foreign lenders).
For a foreign-related contract, PRC laws generally allow the parties to choose the governing law of that contract (PRC laws or a foreign law), except where the choice of foreign law violates mandatory PRC legal provisions or any provision of the foreign law violates a public policy of the PRC in the determination of a particular issue, in which case PRC laws would be the applicable laws. Under PRC laws, contracts are considered to be foreign-related contracts when:
Based on this, if all parties to a project agreement are Chinese companies and no other foreign factors are involved, the project agreement shall be governed by PRC laws. However, if one of the parties to a project agreement is a foreign company, then, in most cases, that project agreement could be governed by a foreign law, provided that this does not violate the mandatory provisions under PRC laws.
For loan agreements entered into between a Chinese company and foreign lenders, PRC laws generally allow the parties to choose a foreign law as the governing law (in particular, English law), and PRC courts will give effect to the choice of foreign law.
For security documents, however, as a matter of the lex situs doctrine, the security is typically governed by PRC laws, since the security asset is located in China.
As a matter of the lex situs doctrine, a security document is typically governed by PRC laws, since the security asset is located in China.
Current Status and Growing Trends of Project Finance in China's Real Estate Sector
Changes in regulatory policies
Since November 2022, with regulation relaxed on project financing in China, a series of policies to support the financing of real estate enterprises have been put in place, forming a “three-arrow” pattern. The framework of supply-side support policies has basically taken shape, and other positive policies are gradually being introduced.
On 8 November 2022, National Association of Financial Market Institutional Investors (NAFMII) and China Bond Insurance Co., Ltd. implemented credit enhancement measures to support private enterprises in raising money by means of bond sales.
On 12 November 2022, a circular announced that commercial banks will grant property developers letters of guarantee, which will allow them to withdraw money from their presale supervision funds, according to the China Banking and Insurance Regulatory Commission (CBIRC), the Ministry of Housing and Urban-Rural Development and the People's Bank of China. This aims to support qualified property developers' “appropriate use” of presale supervision funds and prevent and resolve their liquidity risks.
On 11 November 2022, the People's Bank of China and the former CBIRC jointly released a 16-point set of financial measures to maintain stable and orderly real estate financing, ensure timely deliveries of presold homes, co-operate with the risk disposal of distressed assets, and increase financial support for housing leasing.
On 28 November 2022, the China Securities Regulatory Commission (CSRC) decided to adjust and optimise five measures in terms of equity financing, including resuming the refinancing of listed real estate enterprises and companies, improving the IPO policies of overseas property markets, and further leveraging the role of REITs and private equity investment funds.
According to a notice released by the People's Bank of China and the National Administration of Financial Regulation in July 2023, China will extend two financial policies supporting the stable and healthy development of the real estate market to the end of 2024. The purpose of the move is to guide financial institutions to continue deferring loan payments for real estate enterprises, while propping up financial support for the real estate enterprises to ensure the delivery of housing projects. On 27 August, the CSRC formulated regulatory arrangements to co-ordinate the primary and secondary markets, in order to balance and optimise IPOs and refinancing. The combination of central and local policies has contributed to the stable development of the real estate market.
Despite the slight rebound after the release of positive financing policies in August and November, the financing situation in the second half of 2022 was still less stable than in the first half of the year. In the first half of 2023, the margin of support policy improved, and the scale of non-bank financing was still declining; the financing scale of bank credit increased, but overseas bonds and trust continued to shrink. The scale of new financing instruments such as trade acceptance, factoring and asset securitisation increased relatively. The following is a brief introduction to the status quo and development trends of the seven major financing instruments in China’s real estate sector.
Bank loans mainly include development loans, M&A loans, land reserve loans, working capital loans, commercial property loans, policy-based lending, etc. According to the People's Bank of China's Statistical Report on Loans to Financial Institutions in the fourth quarter of 2022, the balance of loans for real estate development was CNY12.69 trillion by the end of 2022, an increase of 3.7% year-on-year, 1.5 percentage points higher than the end of the third quarter, and 2.8 percentage points higher than the end of the previous year. The balance of loans for real estate development at the end of the second quarter of 2023 was CNY13.1 trillion, with a year-on-year growth of 5.3% and a growth rate of 1.6 percentage points higher than that at the end of the previous year.
Overall, the proportion of real estate credit resources has been significantly reduced, and it is more difficult for real estate projects to obtain funds through bank loans. However, with the introduction of positive policies at the end of 2022, the scale of bank loans gradually rose.
The confrontation between the buyer's right to claim the transfer of the house and the mortgagee is a dispute most relevant to the livelihoods of people in China. According to the relevant Chinese laws, if the house purchased is for residential use and the sale and purchase contract is signed before the property is seized by the court, and the price paid exceeds 50% of the total price, the buyer's right to claim the transfer shall take precedence and the bank cannot enforce its mortgagee right. Such dispute resolution is an exception made for the protection of consumers in response to irregular presales of commercial housing and other practices existing in China.
Debenture bonds are issued by entities other than the government, and stipulate certain cash flow from principal and interest payments. Real estate enterprises can issue enterprise bonds, corporate bonds, short-term financing bonds, medium-term notes, private placement notes and other debenture bonds for project construction.
Overall, there was little change in the scale of credit debt issuance by Chinese real estate enterprises in the first half of 2023, and the scale of overseas debt issuance declined. According to China Index Research Institute statistics, from January to August 2023, credit debt financing in the real estate industry amounted to CNY331.93 billion, down 0.1% year-on-year, and overseas debt issuance amounted to CNY13.55 billion, down 23.1% year-on-year.
According to data from financial information service agency Wind Information Co., Ltd., by the beginning of 2023 the stock of US bonds in China’s real estate sector amounted to USD175 billion, and the maturity of overseas US dollar bonds of real estate enterprises in 2023 is nearly USD45 billion, second only to the USD49 billion in 2022, and the maturity of 2024 and 2025 exceed USD30 billion.
In August 2023, real estate enterprises issued eight overseas bonds, with a total scale of CNY5.828 billion (compared to CNY417 million issued in the same period last year), maturing at CNY14.644 billion (CNY31.740 billion in the same period last year), with net financing of -CNY8.816 billion (-CNY31.323 billion in the same period last year). The overseas financing channels of real estate enterprises are still in the contraction stage, and the net financing amount in each month this year is in the negative range, facing greater net repayment pressure. Most real estate enterprises are finding it difficult to repay the stock of overseas debt by issuing new overseas bonds, operating only through other channels of financing.
The number of real estate enterprise bond defaults also increased in 2022. According to the White Paper on the Credit Status of Chinese Real Estate Development Enterprises in 2022 released by China Real Estate Association, as of 31 December 2022 a total of 32 real estate bond issuers nationwide confirmed substantial defaults or triggered cross-clauses on domestic bonds in 2022, involving 92 bonds (excluding rollovers), representing an increase of 109.09% from 2021, and involving a total issuance amount of USD52.105 billion, an increase of 15.10% over 2021.
In terms of overseas bonds, there were 39 real estate development enterprises with substantial defaults on foreign debt (excluding rollovers) in 2022, involving 166 bonds, representing an increase of 124.32% over the defaults of 74 bond by 12 enterprises in 2021. The amount involved in defaults totalled approximately USD11.623 billion, an increase of 214.13% over the USD3.7 billion in 2021, and the balance of debt involved totalled USD49.531 billion, an increase of approximately 9.6% from USD45,197 billion in 2021. Overall, real estate enterprises continue to be under the pressure of capital debt defaults, in which the debt defaults of private real estate enterprises have been concentrated, and the scale of debt defaults is huge.
From the perspective of resolution measures for bond defaults, enterprises usually prevent and deal with the risky events by making active efforts to communicate with creditors to seek rollover, initiate USD bond exchange offers, reorganise after the event, etc. Different measures can be taken for different market entities. First, real estate enterprises that have tighter liquidity and more evident default signals but are not yet in default may pay interest within the grace period, communicate with creditors to reach a rollover agreement or initiate USD bond exchange offers before default to avoid substantial default occurring. Enterprises that have already experienced substantial defaults, such as failure to pay principal and interest on time and cross-defaults due to rating downgrades, may adopt debt reorganisation as a solution.
Real estate trusts
Real estate trust loans are funds provided by the trustor to the trust company (trustee). As the trustee under the trust plan, the trust company shall provide trust loans to financing parties such as real estate developers or project companies, according to the trust documents and contracts. Meanwhile, the financing parties shall provide guarantee measures such as asset mortgage, equity pledge and third-party guarantee to the trust company, and repay the principal and interest on time. After the trust expires, the trust company shall distribute the principal and income to the trustor.
In May 2019, the CBIRC began to strengthen the supervision of trust financing in the real estate sector. Although the “16-point set of financial measures” was introduced in November 2022 to maintain the stability of financing for trusts and other asset management products, the overall improvement was not outstanding, and the scale of real estate trust financing continued to decline. According to the China Trustee Association, as of the first quarter of 2023, the balance of trust funds invested in the real estate sector amounted to CNY1.13 trillion, down CNY0.44 trillion or 28.21% year-on-year, and down 7.88% quarter-on-quarter, with the ratio dropping to 7.38%, down 3.26 percentage points year-on-year, and down 0.76 percentage points quarter-on-quarter. According to the China Index Research report, trust financing for real estate enterprises in January to August 2023 amounted to CNY25.44 billion, down 65.6% year-on-year.
Meanwhile, trust defaults in the real estate sector are relatively significant. According to the statistics in the research report of Hwabao Securities, a total of more than 200 projects with trust default risk were disclosed in 2022, involving about CNY120 billion, approximately CNY91.7 billion of which was involved in projects with trust default risk in the real estate sector, accounting for 75.3% of the total default amount, becoming the “hardest hit area” for default in the industry.
With the introduction of the “16-point set of financial measures”, the capital chain tension of real estate enterprises has been eased, and the default risk may be gradually released. Although the trust industry currently has a large stock of real estate trust projects, it still needs time to digest, and may face a relatively high risk of default in the short term. Nevertheless, there has been a marginal change in the policy tone, which fully demonstrates the importance of stabilising the real estate market. Stabilising real estate under the principle that “housing is for living in, not for speculation” is the main tone for the coming period, to promote the healthy development of the real estate market, and it is expected that the subsequent default situation of REITs will improve.
A large number of real estate trust projects in default are no longer disposed of by a combination of mortgage security, notarised debt instrument and enforcement. Instead, the trust company sets up new trust schemes in which the debtor entrusts the equity of the project company as trust property to be held by the trust company in order to divest the project company from the debtor's assets, thus achieving effective risk segregation. This has become an emerging trend in the disposal of real estate trust projects in default in China.
Commercial paper (trade acceptance) refers to the bill issued by the drawer and accepted by a drawee other than the bank, and it entrusts the drawee to unconditionally pay a certain amount to the payee or the bill holder on a specified date, which is an instrument for deferred payment in corporate transactions.
In the past three years, due to the liquidity problems of some enterprises, the problem of overdue commercial bills has also begun to emerge. According to the statistics of Piaofeng Information Network, the number of real estate project companies with persistently overdue commercial paper climbed sharply in 2022, from 128 in January to 1,469 in May, and the percentage of all persistently overdue commercial paper enterprises disclosed by the Shanghai Bills Exchange also rose from 22.8% in January to 57.5% in May.
According to China Real Estate Information Corp. (CRIC), the number of real estate project companies in the overdue list of trade acceptance in August 2022 was as high as 2,801, up nearly 40% from the previous month. As of the end of June 2023, there were 1,608 real estate project companies in the overdue list of trade acceptance, while the number of real estate enterprise subjects corresponding to project companies with overdue bills decreased by 4.3% to 200, and the number of overdue subjects was relatively stable.
It can be concluded that, after 2021, commercial paper financing received the following two restrictions. On the one hand, the People's Bank of China included commercial paper into the debt of real estate enterprises for supervision at the end of June 2021, which regulated the issuance and commercial paper of real estate enterprises; on the other hand, there was an increase in defaults of commercial paper of real estate enterprises and a decrease in acceptance by suppliers, which limited the development of commercial paper financing to a certain extent.
Factoring refers to a comprehensive financial service method in which the seller (creditor) transfers its current or future accounts receivable arising from the goods sales and service contract with the buyer (debtor) to the factor, and the factor provides the seller (creditor) with financing, credit evaluation of the buyer (debtor), sales account management, credit risk guarantee, collection of accounts, etc, and the buyer (debtor) directly reimburses the factor when the accounts are due. The bank factoring shall be the factoring business carried out by banking financial institutions, while the commercial factoring is the factoring business carried out by commercial factoring companies.
Since 2020, the development trend of factoring financing instruments in China has been positive. Pursuant to the China Factoring Industry Development Report (2020–2021) released by the China Banking Association, the bank factoring business volume of the members of the Professional Factoring Committee amounted to CNY3.56 trillion in 2021, an increase of 42.97%. Of that, the international factoring business volume was USD48.177 billion, an increase of 32.52% year-on-year, and the volume of domestic factoring business was CNY3.25 trillion, an increase of 44.44% year-on-year. In accordance with the China Commercial Factoring Industry Development Report 2021 released by the Professional Committee on Commercial Factoring of China Association of Trade in Services and its estimation, the commercial factoring business grew by 34.7% year-on-year to CNY2.02 trillion in 2021.
With the increase of factoring business volume, factoring disputes were also on the rise. From data released on its official website, the Beijing Arbitration Commission accepted 29 cases involving commercial factoring disputes in 2021, with a total bid amount of CNY430 million. Compared with 2020, the average bid amount of cases increased from CNY1.72 million to CNY15.08 million, representing an increase rate of 776%.
Asset-backed security (ABS) and REITs
Asset-backed security is supported by the future cash flows generated from the underlying assets. It achieves the redistribution of risks and benefits through credit enhancement on the structural design and combination of the cash flows in the underlying asset pool. As a matter of fact, it is to transform the illiquid underlying pool assets into ABS with different credit ratings.
The ABS of real estate enterprises mainly include ABS of house-purchase balance payment, ABS of supply chain, ABS of property fee, Commercial Mortgage Backed Securities (CMBS), Commercial Mortgage Backed Notes (CMBN), REITs, quasi-REITs, etc. The financing of ABS for real estate enterprises has obtained good results since 2022. According to monitoring by the China Index Academy (a research institution under China Index Holdings that specialises in the real estate sector), ABS financing accounted for 31.2% of the total non-bank financing of real estate enterprises from January to August 2022, up 8.9 percentage points year-on-year. From January to August 2023, ABS financing amounted to USD180.08 billion, up 1% year-on-year, accounting for 32.7% of total non-bank financing for real estate companies.
REITs are special financial products that collect funds from public investors. They are invested and operated by professional investment institutions in real estate and legal related businesses, and regularly distribute most of the investment income to investors. By the end of July 2022, the average gain of the first batch of REITs was higher than that of the SSE index for the same period by nearly 40 percentage points. As of 31 August 2022, the 17 listed REIT products raised a total of CNY57.9 billion, with strategic placement accounting for more than 50% of the total, and 16 of them maintained a positive return, with an average increase of 28.38%; the highest one was up 49%, which was highly sought after by the capital market.
Since then, China has further expanded the scope of the pilot to include publicly offered REITs in the government-subsidised rental housing sector. Publicly offered REITs are of great significance in broadening the social financing channels and reducing the level of corporate debt. At present, publicly offered REITs are still in the pilot stage, and there is great room for development in the future.
M&A and bankruptcy reorganisation
Real estate enterprises in trouble can also obtain financial support through mergers and acquisitions or bankruptcy reorganisation to tide them over through the difficulties. Mergers and acquisitions of real estate refer to the sale of troubled project assets or equity interests of the project company by real estate enterprises to obtain funds. After acquiring project assets or project equity, the investor shall continue to invest funds for development and construction. Real estate enterprises can choose M&A for projects whose assets are greater than liabilities. For insolvent projects or projects in which no one is involved, the “bankruptcy reorganisation” mode (including a pre-reorganisation mode in practice) may be adopted.
According to the statistics of Focus Research Institute (a market research institution in the real estate industry in China), the number of mergers and acquisitions of real estate enterprises is currently not high. In the first half of 2022, there were 42 M&A cases in the real estate sector, with an amount of CNY40.16 billion. This represents only about 25% of M&A in previous years. In this view, real estate enterprises using mergers and acquisitions to obtain financing effect is not ideal at present.
However, with the gradual implementation of central and local support policies, M&A in the real estate industry are starting to rise. China Index Research Institute monitoring data shows that, in May 2023, the domestic real estate industry disclosed a total of 45 M&A transactions, an increase of 14 over the previous month. The total transaction scale was about CNY24.42 billion, an increase of 165.6%; the average single transaction size of CNY980 million was an increase of 80.6% quarter-on-quarter.
To sum up, the project financing of real estate enterprises was still under great pressure in the first half of 2023. Influenced by the “Three Red Lines” regulations and other regulatory provisions, coupled with the high requirements and restrictions of traditional financing methods on real estate enterprises, financial institutions and investors are more cautious in providing financing support to real estate enterprises. It is usually private enterprises with good financial standing or central and state-owned enterprises with good reputations that can successfully issue bonds or trusts.
Compared with traditional financing instruments such as bank loans, debenture bonds and trusts, new instruments such as trade acceptance, factoring and REITs are increasingly favoured by real estate enterprises. REITs in particular, as a kind of equity financing, are not affected by the “Three Red Lines” regulations and other regulatory provisions, which will be helpful to reduce the level of corporate debt. That is why REITs will be a new highlight of future infrastructure project financing, which deserves close attention and study.