Key Points in the SFC Consultation Paper on Proposed Amendments to the REIT Code

The Hong Kong Securities and Futures Commission (“SFC”) released a consultation paper on 9 June 2020, proposing amendments to the Hong Kong Code on Real Estate Investment Trusts (“REIT Code”), to invite market participants and interested parties to comment on the proposed amendments. Pádraig Walsh and Alan Wong from the Financial Services Regulation practice group of Tanner De Witt summarize the amendments to the REIT Code.

Real Estate Investment Trusts, commonly referred to as REITs, are investment vehicles incorporated to generate stable income by holding large scale properties. Investors of REITs will be able to profit from the rental income of the properties without the need to purchase any properties.

Minority holdings

At present, a REIT is required to hold a majority stake (50%) in each property. The SFC proposes relaxing the REIT Code to allow investment in properties in which the REIT does not have majority ownership and control if: (1) such arrangement is in the best interests of the unitholders; (2) an appropriate legal opinion is obtained; and (3) adequate disclosures have been made to investors in the offering documents, circulars or announcements. These properties are referred to as “Minority-Owned Properties” and can take the form of a joint venture entity. This is further sub-categorized by the SFC as “Qualified Minority-Owned Property” and “Non-Qualified Minority-Owned Property”.

A REIT can hold Non-Qualified Minority-Owned Properties provided the value of the REIT’s holding of:

1. Non-Qualified Minority-Owned Property does not exceed 10% of its gross asset value (“GAV”) (the Single Investment Cap); and
    
2. all Non-Qualified Minority-Owned Properties, along with Relevant Investments (further defined below), Property Development Costs (further defined below) and other ancillary investments of the scheme, does not exceed 25% of the GAV (the “Maximum Cap”).

The SFC has yet to make any further clarification on what “other ancillary investments” include.

A Qualified Minority-Owned Property is not subject to the Maximum Cap restriction and can be counted towards the core 75% requirement, provided that the following requirements are complied with:

• the REIT complies with the overarching principles. This is in addition to the general principles that apply to REITs;
 

• the REIT must have the right to receive and obtain financial and operational information of the property;
 

• board representation, if applicable, must be proportionate to reflect the REIT’s ownership;
 

• the constitutive documents of the joint venture entity must include:
  • a specified minimum percentage of annual distributable income and the REIT should be entitled to receive at least its pro rata share (which is generally expected to be no less than majority of the annual distributable income);
   
  
  • veto rights granted to the REIT over a list of key matters listed in the REIT Code; and
   
  
  • dispute resolution mechanism between the REIT and other joint owners; and
   
  
• there must be good governance and adequate measures in place to avoid conflicts of interests.

To keep the proposed amendments consistent, the SFC is also proposing to increase the limit for a REIT’s holding of Relevant Investments. Relevant Investments include: (1) securities listed on the Stock Exchange of Hong Kong Limited (“Exchange”) or other internationally recognized stock exchanges; (2) unlisted debt securities; (3) government and other public securities; and (4) local or overseas property funds. The limit for Relevant Investments issued by any single group of companies will be increased from 5% to 10% of the GAV. This makes Relevant Investments subject to the Single Investment Cap.

Property development

Since the last amendment to the REIT Code in 2014, REITs were allowed to invest in property development projects, provided that the aggregate investments in property developments undertaken by the REITs (“Property Development Costs”) is subject to a 10% GAV cap. In light of the general support and comments received by the SFC on the previous change, the SFC proposes to further adjust the limit. This will have the effect of allowing REITs with a smaller GAV to acquire properties at an earlier stage. The intention is that this should in turn enhance the breadth and depth of the Hong Kong REIT market.

The SFC propose that the 10% GAV cap on Property Development Cost will be increased to 25% of the REITs GAV if:

• unitholders’ of the REIT have given their consent to such increase by way of resolutions at a general meeting;
 

• it must be permitted and effected pursuant to the constitutive document of the REIT; and
 

• the trustee’s consent must be obtained.

Property Development Cost will be subject to the Maximum Cap.

Borrowing Limit

A REIT may borrow, but is currently subject to an aggregate borrowing limit of 45%. The SFC noted requests from the market to increase this borrowing limit to allow REITs make more acquisitions to grow portfolios. After balancing the need for relaxation on the borrowing limit and the nature of a REIT as a relatively low risk, income-generating investment vehicle, the SFC proposes to increase the borrowing limit slightly from 45% to 50%.

In addition, the SFC proposes granting further flexibility to REITs. In circumstances where the borrowing limit is exceeded solely as a result of a decline in property values or other reasons beyond the control of the management company, the REIT would not be required to dispose of assets to pay off part of the borrowings. However, no further borrowing is permitted.

Connected party transactions and notifiable transactions

At present, the SFC regulates REITs in the same manner as listed companies, including granting waivers to certain connected party transactions involving REITs on the same bases as those applicable to listed companies under the Rules Governing the Listing of Securities on the Exchange (“Listing Rules”). The SFC is proposing to amend the REIT Code so that all connected party transactions will be regulated by reference to the Listing Rules. Changes include:

• amending the definition of “connected persons” to incorporate language similar to the Listing Rules;
 

• amending the definition of “transaction”;
 

• introducing provisions that allow the SFC to regulate the following matters by applying Chapter 14A of the Listing Rules:
  • whether a transaction is a connected party transaction;
   
  
  • whether certain connected party transactions are continuing connected party transactions;
   
  
  • whether an exemption is available for the type of connected party transaction and the conditions for any such exemption;
   
  
  • the unitholders’ approval, disclosure, reporting and other requirements for a connected party transaction; 
   
  
  • the content requirements that apply to announcements, circulars and annual reports issued in relation to connected party transactions; and
   
  
  • where a transaction is a continuing connected party transaction, the annual review and other additional requirements;
   
  
• requiring announcements by REITs to be made on the Exchange’s website in accordance with the Listing Rules; and
 

• adjusting the information required to be included in announcements, circulars and annual reports.

A REIT’s trustee is also required to state his view on the transaction in the announcements and circulars relating to the connected party transaction. This includes:

• whether the trustee has any objection to entering into the transaction;
 

• whether the transaction is consistent with the scheme’s investment policy and in compliance with the REIT Code and the REIT’s constitutive documents;
 

• whether the transaction is on normal commercial terms, fair and reasonable and in the interests of the holders as a whole; and
 

• where holders’ approval of the transaction is not being sought, the trustee’s confirmation that such approval is not required under the REIT Code or the REIT’s constitutive document.

Notifiable transactions will also be regulated so the requirements applicable to listed companies under the Listing Rules will also apply to REITs.

Miscellaneous amendments

SFC also proposed several miscellaneous adjustments to the REIT Code, including:

• requiring REITs to maintain a “public float”, which is at least 25% but subject to SFC’s authorization to fall below the requirement, in a similar manner as listed companies;
 

• allowing REITs to upload documents on the REIT’s website for inspection by the public in Hong Kong, in addition to inspecting at the management company’s place of business; and
 

• removing the need to use two layers of special purpose vehicles.

Concluding comments

The amendments to the REIT Code proposed by the SFC are to be welcomed. The changes, if adopted, will allow REITs to have more flexibility. This holds the prospect of allowing smaller REITs to grow or new REITs to be launched in Hong Kong, which may lead to the expansion of the Hong Kong REIT market.  These changes will also bring Hong Kong’s regulations closer to requirements imposed by other comparable jurisdictions. Nonetheless, the changes do not alter the overall character of REITs as a stable, relatively low risk investment. It is unlikely the proposed amendments will adversely affect investor protection or market integrity.

The deadline to submit comments to the SFC on the consultation paper is 10 August 2020.

Pádraig Walsh and Alan Wong

If you would like to discuss any of the matters raised in this article, please contact:

Pádraig Walsh Partner | E-mail

Eddie Look Partner | E-mail

Tim Drew Partner | E-mail

Edmond Leung Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.