Deregulations as recent as 2015
In April 2015 the People’s Bank of China (PBOC) relaxed its rules for the sale of mortgage and asset-backed securities, and these products may now be sold with limited approval from regulators.
Mortgage or asset-backed securities are securities which are based on pools of underlying assets. These assets are usually illiquid and long-term, and pooling and securitisation makes them available to a broad range of investors.
When assets are securitised, the future cash flows of the assets are passed through to investors in the form of an asset-backed security. The types of securities most relevant to Chinese asset owners include commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS) and asset-backed securities (ABS).
A trio of beneficiaries
Mortgage and asset-backed securities remain at an early stage of development in China, but the market has considerable potential for future growth. These structured products enable developers and banks to transform outstanding loans into tradable notes.
Banks no longer have to keep assets or mortgages on their balance sheets for the duration of the loans, and they can sell the stream of interest and capital payments to investors, freeing up capital for other investing activities – such as loaning to developers.
For investors, CMBS, RMBS and ABS offer some favourable characteristics, which include better yield potential compared to corporate bonds, a diversification of property types and location, and exposure to alternative assets that caters to different risk-return preferences.
From an owner’s perspective, the single biggest attraction of structured products is their ability to unlock asset values while allowing the owners to retain part of the asset’s future growth potential.
When assets are securitised in China, future cash flows and a portion of the asset appreciation are – for a specified time period – often bundled into the financial product. This allows asset owners to unlock the asset value and to use the proceeds to pay off debt or to seek out other investment opportunities.
Still a drop in the bucket compared to the US
With regulations on CMBS, RMBS and ABS issuance relaxed only in 2015, China’s market remains at an early stage. Its size is dwarfed by that of the US: according to Commercial Mortgage Alert, in 2016 the US accounted for 98 per cent of global CMBS issuance, and total US CMBS issuance reached US$76 billion.
While CMBS issuance in the US is subject to occasional sharp year-on-year changes, in recent years it has settled into a post-financial crisis range of between US$50 and US$100 billion each year.
China still has a way to go before it reaches US levels. That said, the sheer size of the country’s real estate market indicates that CMBS, RMBS and ABS products have the potential to gain popularity and achieve greater issuance in China.
In addition, with China’s property prices reaching record highs in 2016, the government could roll out more tightening measures that make financing difficult, which is why the market for structured products could grow significantly in the years to come.
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