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April 24, 2017

In April 2015 the People’s Bank of China (PBOC) relaxed its rules for the sale of mortgage and asset-backed securities – securities which are based on pools of underlying assets – allowing these products to be sold with limited approval from regulators. These assets are usually illiquid and long term, and pooling and securitization makes them available to a broad range of investors. When assets are securitized, the future cash flows of the assets are passed through to investors in the form of an asset-backed security and the 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 favorable 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 securitized 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 ocean compared to the U.S.
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 U.S.: according to Commercial Mortgage Alert, in 2016 the US accounted for 98 percent of global CMBS issuance, and total US CMBS issuance reached USD 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 USD 50 and 100 billion each year.

China still has a way to go before it reaches the same level as the U.S.. That said, the sheer size of the country’s real estate market indicates that CMBS, RMBS and ABS products have the potential to gain more 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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Dave Chiou

Head of Capital Markets Research, JLL China

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