By Xizhen Wang 

On August 3, 2012, the National Association of Financial Market Institutional Investors (the “NAFMII”) issued the Guidelines on Asset-backed Notes for Non-financial Enterprises on the Interbank Bond Market (“银行间债券市场非金融企业资产支持票据指引”, the “Guidelines”), which creates a new channel for non-financial enterprises to secure financing or finance their operations.

  • Overview of the Guidelines

The Guidelines provide considerable autonomy for non-financial enterprises to originate asset-backed notes (“ABN”) and issue ABN on the interbank market. Originators may adopt different transaction structures to issue ABN, provided that what is used will not cause adverse effects on the shareholder and the creditors of the originator. Also, there are no complex or regulatory or approval requirements and the ABN projects need only be registered with the NAFMII, an attractive factor of the ABN.

The originator may finance and obtain cash through the issuance of ABN, and the principal and interest of the ABN will be repaid to the investors with the cash flow generated from the underlying assets. Such underlying assets refer to, according to the Guidelines, property, property rights and portfolio of property and property rights [1] (i.e. receivables, revenues generated from infrastructure projects). Assets of all types must be unencumbered and able to provide predictable cash flow.

There are several other requirements to be followed in ABN issuances. Certain information disclosures are required in order to protect ABN investors, including the disclosure of detailed structure, assessment reports regarding the future cash flow, the risk of purchasing ABN and the ongoing operational reports on the underlying assets. The ABN may be issued privately or publicly both on the interbank market while the public issuance requires credit rating of the notes. And, the NAFMII encourages the originator to adopt the new investor-pay model credit rating method.

  • Rosy Prospect of ABN

So far, six ABN projects have been successfully launched since the Guidelines were promulgated in August 2012. The originators are mainly construction companies and infrastructure companies, and the assets are receivables and revenues from infrastructure projects. Those precedents reflect and confirm a common viewpoint that ABN is a complementary and alternative method of Quasi-municipal Bond. The latter experienced a growth spurt in 2008 and 2009 and has been criticized because of the lack of an effective credit risk control mechanism. According to the statistics, commercial banks provide most of the Quasi-municipal Bonds proceeds and those proceeds are mainly used to conduct infrastructure projects supported by local governments. With the increase of the total amount of the Quasi-municipal Bonds and the macroeconomic uncertainty, risk of default by those government-backed companies is rising and the financing cost is increasing. Local infrastructure and construction companies need a new way to finance and governments need to control credit risk. With regard to this, the ABN transaction is supposed to expand the financing channels of those companies and also help to control risk through compliance with requirements of the NAFMII.

Although the ABN is highly expected to be the third means of securitization, [2] the precedent transactions are quite different from typical securitization. There was no special purpose vehicle (“SPV”) established to hold the underlying assets and no asset transfers occurred. Instead, the originators pledge the receivables or the revenues to the ABN holders to ensure the repayment of the notes. In the case of default, the ABN holders will be regarded as secured creditors. In other words, the existing ABN structures do not provide the function of bankruptcy-remote.

According to the NAFMII, the structure of ABN transactions is still developing and NAFMII is quite open to initiatives on this regard. In fact, a wholly new ABN structure is under discussion, where a trust is to be used as SPV to hold the underlying assets and provide a bankruptcy-remote facility. Moreover, diversified credit enhancement mechanisms and credit rating methods are also encouraged by the NAFMII in prospective ABN transactions.

[1] See Article 2 of the Guidelines

[2] In the securitization market of China, the Asset-backed Securities projects, regulated by the China Banking Regulatory Commission, and the Corporate Assets Securitization projects, regulated by the China Securities Regulatory Commission, are regarded as two ways to conduct securitization.