REITs products have been brewing in China for nearly 20 years. Ten years ago, when the author discussed the REITs he had served with the industry elites in the infrastructure field who worked at the Red Circle Institute at that time, he exclaimed, "Without the tax policy and related supporting support for the balance sheet, what I did was actually only REITs.". However, ten years later, a strong wind blew in: In April 2020, the National Development and Reform Commission and the Securities Regulatory Commission issued the "Notice on Promoting the Pilot Work of Real Estate Investment Trusts (REITs) in the Infrastructure Sector" and the "Guidelines for Public Offering of Infrastructure Securities Investment Funds (Trial Implementation)" (hereinafter referred to as the "Guidelines for Infrastructure Funds"), marking the final implementation of relevant policies for REITs. After more than a year of deliberation, in July 2021, the first batch of 9 publicly offered REITs funds received approval from the CSRC for listing, raising more than 31.4 billion yuan. Based on national conditions, the main goal of the first batch of REITs products is to effectively activate existing assets and stimulate new investment. Therefore, strict restrictions are imposed on pilot areas and industries, focusing on economic infrastructure areas such as warehousing and logistics, transportation facilities, municipal engineering, and other areas where government investment is large, business cycles are long, and it is relatively difficult to realize. Since then, the National Development and Reform Commission has issued the "Notice on Further Improving the Pilot Work of Real Estate Investment Trusts (REITs) in the Infrastructure Sector" to expand the scope of the pilot project from specific regions to the whole country, and also significantly expand the capacity in the industry, including energy infrastructure such as wind power and photovoltaic. At the end of December 2022, both AVIC Jingneng Photovoltaic REITs and CITIC Construction Investment National Power Investment Offshore Wind Power REITs products had received unanimous approval letters from the Shanghai Stock Exchange, and a breakthrough in new energy REITs was imminent, triggering widespread attention in the industry.

New energy projects, as basic assets, have a strong compatibility with REITs. The on-grid electricity price of new energy units adopts benchmark electricity prices, and as clean energy in terms of scheduling, it is well absorbed based on our project experience. Therefore, new energy power stations typically have stable and excellent cash flow. From the perspective of the project financial model, fixed costs such as depreciation and amortization account for a relatively high proportion of the cost of power stations, with stable profits. Overall, new energy power stations meet the requirements of the CSRC, the National Development and Reform Commission, and fund managers for sustained and stable cash flow base assets.

In December 2022, Han Zhifeng, Deputy Director of the Investment Department of the National Development and Reform Commission, publicly stated that by the end of 2023, we would strive to issue 60 REITs products with a scale of 200 billion yuan. We expect that the issuance of REITs will enter the fast lane in 2023. Considering the rapid development of the new energy track in China over the past two decades, we are optimistic that the new energy REITS will be an important area in the issuance of REITS in the future. For new energy projects, REITs products have also become an important and fixed exit path. At the current stage of readiness, it is timely to sort out the key points of compliance review for new energy REITS through understanding the new energy industry.

1、 Legal Defects in Project Assets

New energy projects are prone to legal flaws in terms of development, project approval, land, and lines. According to the application materials for two new energy REITs projects, this problem also exists. The Binhai North H1 Project and Binhai North H2 Project, both of which are held by China CITIC State Power Investment Offshore Wind Power REITs, have not obtained approval documents for submarine cable construction. In response to this situation, the Binhai Workstation of Yancheng Maritime Police Bureau has issued an Administrative Penalty Decision, imposing an administrative penalty of 150000 yuan on the project company. The current solution is consistent with the general securities issuance method: the original equity holder issues a "commitment letter" promising to cover the relevant penalties or risks.

Among the underlying assets of AVIC Jingneng Photovoltaic REITs, there have been cases where the project company has built and delivered projects independently of photovoltaic power stations, but failed to obtain construction permit documents such as construction land planning permit, construction project planning permit, and construction project construction permit. For this reason, the fund will peel off the defective assets from the project company before issuance and transfer them to the original equity owner with compensation. However, after the divestiture, the original owner will charge route rent for the delivery services provided by the project company for the delivery project. Currently, the fairness of the rental level for the delivery route is demonstrated through depreciation of the original book value.

In addition to the more common legal flaws in basic assets mentioned above, it is necessary to mention the long-standing reselling practices in the new energy industry. In accordance with the relevant provisions of the "Notice of the National Energy Administration on Carrying out Special Supervision on the Investment and Development Order of New Power Supply Projects" and the "Notice of the National Energy Administration on Printing and Distributing the Supervision Report on the Investment and Development Order of New Power Supply Projects (New Energy Part) and Work Requirements", we will resolutely stop speculation before new power supply projects are put into production. Therefore, it is also important to focus on equity changes in underlying assets before they are put into production.

2、 Identification of the nature of state subsidies in infrastructure funds and countermeasures for their impact

The determination of cash flow for new energy power stations is actually quite clear: the amount of electricity generated by the power station entering the grid for consumption multiplied by the electricity price is the cash flow that the power station can generate. In the current electricity market-oriented trading system, consumption or power limitation (power abandonment) has not been clearly defined from the perspective of rights and obligations. We believe that consumption is not a legal issue, nor is it discussed within the scope of this article. Therefore, electricity prices have become the core factor in determining the value of new energy power stations as underlying assets. Currently, new energy tariffs are mainly composed of benchmark feed-in tariffs and renewable energy tariffs with additional funding subsidies (referred to as "national subsidies"). Therefore, the identification of national subsidies and mitigation measures after subsidies decline in new energy REITs projects have become the focus of regulatory attention.
1. Whether the national subsidy is market-oriented operating income and whether it is a third-party subsidy

According to the requirements of Article 8 (4) of the Guidelines for Infrastructure Funds, the sources of cash flow are reasonably dispersed, mainly generated by market-oriented operations, and do not rely on non recurring income such as third-party subsidies. Therefore, the assessment of new energy assets by state subsidies poses three challenges: the source of state subsidies is single, and it does not appear to be market-oriented operation, and in nature, it also appears to constitute third-party subsidies. Therefore, this issuance condition poses a direct challenge for new energy projects where national subsidies account for the majority of revenue. From the perspective of the application materials for the two funds, it is mainly discussed from the following three aspects:

● From the perspective of revenue sources, national subsidies are generated from normal business operations and constitute a component of the electricity sales consideration. Therefore, they should be recognized as operating income in nature, rather than non recurring profit and loss.

● From the perspective of distribution history, after entering the national subsidy catalog, the allocated national subsidy continues to be received every year. Therefore, it belongs to continuous income related to the main business, rather than occasional income, and does not belong to non recurring profit and loss.

● It can also be determined from the regulatory policy of the Securities Regulatory Commission on asset securitization that the cash flow comes from central financial subsidies (including price subsidies) issued in accordance with national uniform policy standards, which can be included in the underlying assets of asset securitization.

2. The dispersion of cash flow sources

The cash flow of centralized new energy power stations often has only one entity, that is, the power company that has signed a "Medium and Long Term Power Purchase and Sales Contract" with the project company. Based on the application materials for the two new energy REITs projects, both have adopted the method of penetrating the cash flow to the terminal: the benchmark feed-in electricity price for coal-fired power generation, and the electricity fee income ultimately comes from the end users of the power company, According to the "Interim Measures for the Administration of the Collection and Use of Renewable Energy Development Funds", the national subsidy penetrates the renewable energy development funds recognized and paid. Thereby demonstrating that the sources of cash flow are reasonable and dispersed.

As for how to identify the source of cash flow for distributed photovoltaic projects and integrated duty-source projects, we will wait and see the development of REITs practice.

3. The cycle and stability of receiving state subsidies

There is usually a relatively long accounting period for obtaining national subsidies for new energy projects, and there is great uncertainty about the length of the recovery period. Both new energy funds adopt factoring, which assists project companies in releasing the liquidity of national subsidy funds, smoothes the cash flow curve of the project, and avoids excessive fluctuations in the fund's net worth compared to the more common method of outright listing.

4. The adverse impact of national subsidy recession on asset cash flow

As for the impact of the national subsidy recession on the fund's cash flow, both funds have taken the green card trading income substitution and fund raising assets as mitigation measures. At the same time, it is worth noting that AVIC Jingneng Photovoltaic REITs will apply for a safety line measure to terminate the listing and liquidate fund assets if the operating income drops by 40% or more after setting up a national subsidy rebate.

3、 It's not a problem

In addition to the aforementioned related compliance issues, based on the financing experience accumulated in the energy industry, the author believes that there are still the following situations regarding the issuance of REITs for new energy assets:
1. Problems with project liabilities

Article 28 of the Guidelines for Infrastructure Funds stipulates that the total assets of the fund shall not exceed 140% of the net assets of the fund. However, as a heavily funded asset, new energy power stations usually use financing leverage before reaching the Final Investment Decision stage. As a result, the debt ratio of underlying assets often exceeds the prescribed range of guidelines. Therefore, it is often necessary to adjust the capital structure of projects.

2. The issue of capital expenditure (capex)

All energy projects have the problem of large capital expenditures during the development phase. For new energy projects, if the inclusion of REITs requires a mandatory allocation of 90% of the annual income (Item 4, Article 2 of the Infrastructure Fund), there is first the issue of the source of capital expenditure. CITIC Construction Investment, State Power Investment and Offshore Wind Power REITs adopt a cost based approach without special provision, while AVIC Jingneng Photovoltaic REITs adopts a method of withdrawing 6 million capital expenditure funds per year. Although the source problem has been solved, it is expected to have a certain impact on the return on investment of the fund.

3. Whether the IRR is stable

According to the application materials, the IRR of the two new energy REITs funds is within the range of 9% (before tax). When discounting future cash flows, forecasting cash flows is usually based on past operations. However, considering that new energy sources have been widely involved in electricity trading, there is a risk that electricity prices can maintain current levels. At the same time, the attenuation of the power station, the increase of operation and maintenance costs in the later period may lead to a decrease in IRR. If the Fund does not raise funds at a later stage, it will be difficult to maintain investor interest with a reduced IRR level.

4. Internal governance

REITs adopt the model of public funds nesting asset-backed securities to hold underlying project assets, which is quite complex in structure. Linking industrial capital and financial capital in terms of role, with a view to scaling up investment in the new energy field. How the division of rights and obligations among fund managers, original equity holders, investors, and entrusted managers evolves within the current framework and whether it can achieve a balance is the focus of attention in the industry.
epilogue

For the new energy industry, REITs provide new exit channels. We look forward to exploring this new approach with enterprises in the new energy industry to achieve the integration of industry and finance and achieve the national dual carbon goal.