C-REITs Enter a New Stage of Normalized Issuance - Quick Review of "Guofa No. 1014 Document"

LABEL： Real estate ,

On July 26, 2024 (yes, another small weekend!), before the end of work, the new regulation "Notice of the National Development and Reform Commission on Fully Promoting the Normalization of Real Estate Investment Trust Fund (REITS) Projects in the Infrastructure Sector" (NDRC Investment [2024] No. 1014, hereinafter referred to as "No. 1014 Document") was implemented.

Document No. 1014 will be implemented from August 1, 2024. If there is any inconsistency between the relevant documents issued by the National Development and Reform Commission and this notice, this notice shall prevail.

Read this article in 10 minutes, and you can quickly grasp the latest key points of Document No. 1014:
1、 Pilot - Normalization

The original "pilot issuance" has been transformed into the current "regular issuance", and the original "pilot project application requirements" have now been adjusted to "project application requirements".
Author's Brief Review:

After four years of pilot testing, C-REITs have finally officially transformed into a comprehensive and normalized business.
2、 REITs assets can be further expanded

The newly added underlying asset categories include:

1. Energy category: Replace photovoltaic power generation with solar power generation in energy infrastructure projects, while adding energy storage facilities and clean, low-carbon, flexible and efficient coal-fired power generation (including cogeneration coal-fired power) projects. However, coal-fired power generation projects still need to meet specific conditions, namely one or more of the following conditions: the minimum power generation output under pure condensing conditions is 30% or less of the rated load; Co firing low-carbon fuels such as biomass, hydrogen, and ammonia, with a co firing heat ratio of not less than 10%; Equipped with large-scale carbon capture, utilization, and storage (CCUS) equipment.

2. Park category: Development zones that belong to the "park infrastructure" category after 2018 need to obtain approval documents from the State Council or provincial governments. Specifically, if the individual buildings included in the underlying assets of the park project include hotels and supporting ground businesses that are physically inseparable and belong to the same initiator (original equity holder) in terms of property rights, and account for no more than 30% of the same individual building area, they can be included in the underlying assets of the project.

3. Rental housing category: In addition to the original affordable rental housing, the "rental housing" category has added public rental housing projects, market-oriented rental housing projects (which need to be self owned by professional institutions, sold separately without splitting, and used for long-term rental), and rental housing projects that specifically provide supporting services for enterprises entering the park.

4. Cultural and tourism category: A 4A level tourist attraction project has been added to the "Cultural and Tourism Infrastructure"; And the supporting tourism hotels in the scenic area (within the planning scope of the scenic area and owned by the same initiator (original rights holder)) can be included in the pool together.

5. Consumer infrastructure category: The "Consumer Infrastructure" project has added various professional market projects such as home furnishings, building materials, textiles, etc; The supporting hotels and commercial office buildings of the consumer base (which are physically inseparable from the consumer infrastructure and belong to the same initiator (original equity holder) in terms of property rights) can be included in the underlying assets of the project. The total proportion of their building area to the total building area of the underlying assets should not exceed 30%, and in special circumstances, it should not exceed 50%.

6. Elderly care category: Add "elderly care facilities", which refer to elderly care projects registered in accordance with the law and filed with the civil affairs department.

7. Other: Other infrastructure projects that comply with national major strategies, development plans, industrial policies, and other requirements. This fallback clause reserves exploration space for emerging infrastructure projects that comply with policy guidance.
Author's Brief Review:

The expansion of the asset class of issuable REITs in this round responds to the urgent market demand.
(1) Park/consumer base/cultural and tourism assets

A certain proportion of hotel, commercial, and/or office assets are allowed to be pooled together in the park, consumer base, and cultural tourism REITs, but the requirements are also different. For example, regarding the infrastructure of the park and the consumption infrastructure, Document No. 1014 emphasizes that they are physically inseparable, and on this basis, the calculation of the proportion of composite formats for park infrastructure should be based on "individual buildings"; As for cultural and tourism infrastructure, due to the physical characteristics of hotels/guesthouses in cultural and tourism projects, which are separated into separate areas/buildings/rows, Document No. 1014 only requires tourism hotels to be "supporting" scenic spots when entering the pool, fully respecting the natural characteristics of different types of infrastructure in multi format design and mixed operation, and to some extent avoiding the situation where complete projects are restricted from entering the pool or need to be specially divided and reorganized due to the existence of hotel and office related (supporting) properties.
(2) Energy assets

The pilot scope of Document No. 958 for energy projects related to power generation only includes clean energy projects. This time, coal-fired power generation projects and energy storage projects that meet specific conditions have been added, and solar power generation projects with different technological routes have been expanded. We understand that this is a practical need for new energy to gradually replace coal-fired power as the main power source in this important stage of energy transformation, which is in line with the development strategy of ecological civilization and the requirements of the "3060 dual carbon" target. Among them, "solar power generation" has multiple technological routes, no longer limited to photovoltaic power generation as a technical solution. The coal-fired power units proposed this time revolve around the technological transformation route of flexibility and low-carbon emissions. The coal-fired power units and independent energy storage projects transformed by the former will become important participants in the power auxiliary service market, expanding the regulation resources of the power system and playing a crucial role in deepening China's power marketization reform; The financial support for low-carbon emission transformation of coal-fired power units is also an important component of transitional finance in sustainable development, which can promote the upgrading of coal-fired power units, accelerate the development of new energy storage, and continuously strengthen the construction of power system regulation capacity. The addition of new types of assets into the pool responds to the practical needs of the "3060" strategy and electricity marketization reform, and is also a need to establish first and then break, and continue to deepen the adjustment of energy structure. However, the commercial rationality of the two types of coal-fired power assets and energy storage assets entering the pool still needs to be observed whether electricity marketization and electricity price reform can match the cost investment of coal-fired power unit technology route reform.
(3) Rental housing assets

This time, public rental housing and market-oriented rental housing projects have been explicitly added to the rental housing category. Among them, although the public rental housing projects were not listed within the scope of the original pilot projects, in practice, both Beijing's affordable housing and Zhaoshe's affordable housing projects have public rental housing assets. They were originally classified as "rental housing with a guarantee nature" and included in the pool. After the new regulations were introduced, public rental housing can return to its original name and be included in the pool. However, the low rate of return, aging age structure of tenants, and unstable income expectations caused by the strong public welfare nature of public rental housing still pose substantial obstacles to such asset based REITs; Marketized rental housing projects are more suitable for long-term and large-scale operation of houses originally planned for residential use as rental housing. However, for houses that are changed from non residential use to residential use as rental housing, it is still necessary to consider the specific situation of the project, especially from the perspective of project renovation compliance, whether they are operated and managed as affordable rental housing or market-oriented rental housing projects.
(4) Pension assets

The addition of elderly care projects in Document No. 1014 is in line with the national strategy of actively responding to population aging, promoting the coordinated development of the elderly care industry, building and improving a comprehensive, inclusive, and diversified elderly care service system, and continuously meeting the growing multi-level, high-quality, and healthy elderly care needs of the elderly. However, at present, elderly care products are still in the stage of cultivation and development in China. For insurance institutions that specialize in important operations, elderly care products are important asset allocation targets, and the separation of light and heavy assets needs to meet financial regulatory requirements. On the other hand, they are also a welfare scarce resource supply for insurance companies to provide targeted services to elderly care insurance recipients. Therefore, in addition to yield, issuers also need to pay attention to the balance of objectives between REITs issuance and their insurance main business, as well as frequent related party transactions during their existence period. In addition, for traditional centralized institutional elderly care projects and community elderly care projects transformed from various types of buildings in urban communities, attention should be paid to different compliance requirements such as investment and construction, major renovation and expansion.
3、 Emphasize the integrity of underlying assets

Further clarify the requirements for the integrity of underlying assets. The regulations on the integrity of underlying assets are no longer the original single line notification requirements, but have been incorporated into the basic requirements of REITs projects as a whole. In principle, all essential and inseparable components necessary for achieving asset functionality should be fully included in the scope of underlying assets; In special circumstances where it is not possible to include all underlying assets, effective measures should be taken to ensure the stability of underlying asset operation and management. There are specific quantitative indicators for infrastructure projects in the park: it is encouraged to include all buildings belonging to the same asset in the underlying assets. In special circumstances, the proportion of assets not included should not exceed 30% of the area of a single building, and the maximum should not exceed 50%.
Author's Brief Review:

The requirement for the integrity of underlying assets in Document No. 1014 is divided into two parts. The first half is the basic principle that applies universally to all types of assets, which means that the necessary and inseparable parts for realizing asset functions should be pooled together. In special circumstances where it is not possible to fully pool all assets, measures should be taken to ensure the stability of the operation and management of the pooled assets; The latter part is the specific quantitative indicator requirements for the proportion of pooled assets in the same building of special types of assets, namely park projects. This integrity requirement is beneficial for the long-term unified operation and management of assets in the pool, and to a certain extent, can prevent the situation of artificially splitting projects to avoid compliance issues with some assets; On the other hand, the universal requirement for complete inclusion in the pool, in principle, imposes higher explanatory requirements on some housing construction projects, especially those involving mixed use housing, where only a portion of the commercial assets are included in the pool.
4、 Government subsidies shall not exceed 15%

Restrictions on the inclusion of government subsidies in the operating income of PPP projects: (1) If the source of project income includes government subsidies, they should be subsidies provided in accordance with industry regulations and not special subsidies for specific projects. (2) The proportion of annual subsidy amount to the total annual income of the project in the past three years shall not exceed 15% in principle.
Author's Brief Review:

Although the first requirement mentioned above was not explicitly stipulated, it has always been based on this logic and standard in past project operations. The second requirement mentioned above is a quantitative standard that has been substantially increased this time, and the 15% indicator requirement has raised the threshold for issuing REITs for this type of PPP project. Throughout the years, local governments in China have provided significant special subsidies for the operation of urban public utilities based on considerations of benefiting and stabilizing people's livelihoods, while end-users/citizens have enjoyed better public services at lower payment prices. However, with the further reform of the pricing system for urban public utilities, the user payment standards are also being raised according to the level of marketization, returning to the price center that matches quality and price, thereby loosening the subsidy tilt of local governments. However, the 15% subsidy ratio limit is expected to have a significant impact on the scale of RETIs in China's urban public utility infrastructure in the short term.
5、 Shift from yield oriented to cash flow stability oriented

No longer impose mandatory requirements on project returns, that is, remove the original rule's mandatory requirement that the internal rate of return (IRR) during the fund's lifespan should not be less than 5% per year, and the net cash flow distribution rate should not be less than 3.8%; However, it is required that there are no risk factors that may have a significant impact on the long-term stable operation of the project in the future. A comprehensive analysis and full disclosure of major renovation and expansion, equipment updates, and other activities that may significantly affect normal operation within 3 years after the project is issued are needed. There is also a quantitative requirement for the proportion of EBITDA/operating net cash flow in the past 3 years to the expected EBITDA/operating net cash flow in the next 3 years (not less than 70%), emphasizing the stability of project (forecast) revenue. The prediction of future operating revenue of the project needs to transition from historical situations to future forecasts.
Author's Brief Review:

The project yield is now subject to market judgment. However, there have been further improvements in the stability and reliability of predicting cash flows, as well as the requirements for examining and referencing historical cash flows. The newly added requirement is that the ratio of EBITDA/operating net cash flow in the past 3 years to the expected EBITDA/operating net cash flow in the next 3 years should not be less than 70%. In essence, it imposes restrictions on future cash flow forecasts based on past cash flow situations, which may have an impact on the valuation of some projects, especially those that have experienced a decline in cash flow due to public health events in the past 3 years or are in the incubation period in the past 3 years.
6、 Moderately relax the size of alternative assets

For specific situations (such as projects that lack other expandable assets due to common industry reasons, and projects with an initial issuance scale exceeding 5 billion yuan), the requirements for the size of expandable assets should be appropriately relaxed.
Author's Brief Review:

After several years of practice, the regulatory authorities have once again optimized the requirements for the scale of potential fundraising assets based on the actual market situation. This provides a flexible path for original equity holders/initiators with strong operational capabilities to expand their asset pool through mergers and acquisitions after the initial public offering of REITs.
7、 Unified principle of not involving housing

The initiator (original equity holder) of projects such as rental housing, consumer infrastructure, and elderly care facilities is required to not be involved in the development of commercial residential properties.
Author's Brief Review:

The entities closely related to the development of commercial residential properties still need to meet the requirement of 'not involving housing'.
8、 Unified admission requirements for intermediary agencies

Treat all intermediary agencies equally, requiring law firms, accounting firms, asset appraisal agencies, tax consulting agencies, and securities firms serving as financial advisors to not be on the list of serious dishonest entities, not to be suspended from practice by industry regulatory authorities, and not to be suspended from securities or infrastructure REITs business by relevant regulatory agencies. No separate request has been made for law firms and accounting firms to have not engaged in any significant illegal or irregular activities in the past three years.
Author's Brief Review:

The compliance requirements for all intermediary institutions are treated equally, which is closer to the compliance essence of intermediary institutions' execution behavior than previous regulations. Intermediary institutions may participate in REITs business if they have not seriously breached their trust, are not required to suspend their practice, or are not required to suspend their corresponding business operations.
9、 Clarify the compliance requirements for collective land

There is no substantial adjustment to the project's compliance with macro management policies, investment management procedures, and legal compliance requirements for land use. Only additional information/document requirements have been added regarding the use of collective land for the project (if collective land is used, the relationship between the collective land owner and the project company should be explained, relevant agreement documents should be provided, and the agreement should be signed with the consent of the relevant parties. If there is external leased land, the lease term shall not exceed 20 years. If the remaining term of the land used by the project company is less than the duration of the fund, relevant information should be explained).
Author's Brief Review:

Based on the actual situation of projects in recent years, compliance requirements for collective land have been increased, mainly from the principle of obtaining the consent of collective land rights holders.
10、 Narrowing the scope of transferability review

Regarding the transferability of the project, the National Development and Reform Commission no longer focuses on internal decision-making, state-owned asset transfer, spin off listing, financing restrictions and other matters. These matters are handled by the initiator (original equity holder) in accordance with regulations, regulatory requirements, company articles of association, etc.
Author's Brief Review:

For financing restrictions, given that the financing situation may be constantly changing, if detailed attention is paid to the financing restrictions and their lifting from the application stage of the development and reform, it may increase the workload of larger group companies. After simplifying these requirements, internal management, contract performance, state-owned asset transfer, spin off listing and other matters can be handled by the company according to project progress.
11、 Reclassify PPP project compliance timeline

For the compliance requirements of PPP projects, three time periods have been redefined (including franchise projects implemented before September 2014; government and social capital cooperation projects that have completed the bidding and procurement procedures from September 2014 to February 2023; and projects that have not completed the bidding and procurement procedures before February 2023), and different compliance procedures have been proposed for PPP projects in different time periods. And PPP projects must obtain a non objection letter issued by the signing institution of the franchise agreement and the industry regulatory department (except for those newly implemented after February 2023 and whose franchise agreement explicitly supports the issuance of REITs in the future).
Author's Brief Review:

The original document No. 958 divided the time period for PPP projects based on June 2015, which is the implementation time of the "Measures for the Administration of Infrastructure and Public Utility Franchise Operations" (Order No. 25 of the National Development and Reform Commission and other six ministries and commissions, implemented from June 1, 2015); The new time period is divided based on September 2014 (the time when the Ministry of Finance issued a series of PPP related regulations such as the "Notice on Promoting the Use of Government and Social Capital Cooperation Models"), February 2023 (the time when the government and social capital cooperation projects that have not completed the bidding and procurement procedures before the "2023 February" government and social capital cooperation project clean-up and verification stipulated in the newly issued "Infrastructure and Public Utility Franchise Management Measures" in 2024, as well as subsequent newly implemented franchise projects, shall be subject to the PPP project clean-up and verification referenced in this Measures).

Meanwhile, according to the laws, regulations, and policies of different periods, projects before September 2014 are clearly classified as "franchise projects", while projects after September 2014 are classified as PPP and/or franchise projects based on their applicable rules.
12、 Adjust the limit on recycling funds

The restrictions on the use of net recovered funds have been substantially lifted: the proportion of net recovered funds used to supplement the working capital of initiators (original equity holders) and other purposes has increased from 10% to the latest not exceeding 15%; No less than 85% of the recovered funds can be used for ongoing projects, newly built (including renovated and expanded) projects with mature preliminary work, and the acquisition of existing assets.
Author's Brief Review:

The adjustment of this rule is a substantial positive news for the entire market, which can mobilize the enthusiasm of heavy asset holders in the entire market to participate in C-REITs, and is conducive to building a REITs product system that is in line with mature markets.
13、 Implement a new audit process

Cancel the blind review system, and the main process for applying and recommending the initial issuance of the project is shown in the following figure:

 

When a newly purchased project is issued, the project application materials should be submitted to the provincial development and reform commission where the newly purchased project is located after the fund manager first releases a temporary announcement disclosing relevant information.
Author's Brief Review:

Reiterating the application process starting from the provincial development and reform commission, and consolidating the review responsibility of the provincial development and reform commission, effectively reducing the review burden of REITs projects, is conducive to improving the time efficiency of the development and reform review stage.
14、 Financial data needs to maintain a validity of 6 months

It is explicitly required that before recommending the project to the China Securities Regulatory Commission, financial data should be continuously updated and the benchmark date should be kept within 6 months prior to the recommendation.
Author's Brief Review:

There were corresponding requirements in the original practice, and this time they have been officially clarified in the rules.
15、 Consolidate the responsibilities of all parties involved

Clearly define the initiator (original equity holder) and fund manager as the "first responsible persons" for the project, responsible for the preparation and application materials in the early stage of the project. In order to consolidate the responsibilities of all parties, corresponding disciplinary measures will be taken against project parties, intermediary agencies, provincial development and reform agencies, and consulting and evaluation agencies with poor project quality.
Author's Brief Review:

Further clarify the joint responsibility of the initiator (original equity holder) and fund manager in the first priority, and strengthen the responsibilities of each participant and clarify corresponding disciplinary measures. This move is conducive to urging the initiators (original equity holders) to cooperate with the fund manager and various intermediary agencies to handle various declaration work carefully.