VShina has experienced a constant stream of innovation in asset securitization products since the publication in 2014 of the Regulations for the administration of the asset securitization activities of subsidiaries of securities companies and fund management companies. Whichever structure is used, however, the primary focus should remain the authenticity of the underlying assets.

Croc Yan
Partner
DeHeng Law Firms

Regulators penalized intermediaries for failing to cautiously carry out mandatory checks and verifications regarding the authenticity of the underlying assets in securitization transactions. This question is a complex and key issue for the asset securitization industry.

The underlying assets (including their corresponding underlying assets) form the basis for the securitization of assets. According to regulations, due diligence on the legality of the underlying assets is required to include the authenticity and legality of the formation and existence of those assets.
In general, the types of underlying assets include real rights, receivables (accounts receivable, etc.), rights to income (rent, infrastructure charges, etc.), intellectual property, units of private funds and rights to benefit from a trust. Verifying the authenticity of assets means evaluating whether they exist objectively and really. Particular attention should be paid to the following points:

The existence of a real context or a possibility of transaction. The parties to the transaction have a real demand for the transaction in the underlying assets to occur, such as: The main activity being upstream or downstream, or the existence of a supply-demand relationship; the supplier or recipient of the transaction having the qualifications or the license necessary to engage in the activity concerned; the supplier or recipient of the transaction owning the establishment, assets or equipment necessary to carry out the activity concerned; and audit reports (financial statements) reflecting the assets concerned.

There is information supporting the process of forming the underlying assets. Underlying asset formation is the process of acquiring rights to the underlying assets and requires verification of the entity holding the rights, registration status, scope of rights, enforcement of the corresponding contract and the completeness of the procedures involved, if the valid consideration has been paid in full and the validity period has been exceeded.

Evidence showing the actual execution of the transaction. The actual performance of the transaction is mainly reflected in the authenticity of the flow of goods (including transaction forms such as project construction and services) and cash.

This requires the transaction provider to provide records of: records of receipt of goods by the transaction recipient (including, but not limited to, receipt of orders, acceptance notes, documents third-party institutions confirming the inspection and quarantine of goods, and the use of documents attesting to the results of the service at various stages); emails, WeChat and other records from the parties to the transaction confirming the purpose of the transaction; documents of the parties to the transaction confirming the execution of the transactions (including, but not limited to, account statements, proof of delivery of goods at different stages and evidence confirming the final settlement of prices); history of similar transactions, issuance of invoices and verification of their authenticity; and pay attention to the intimate relationship between business and amounts in different performance materials.

Intermediaries mainly perform due diligence through means such as review of written documents, on-site visits to places of business related to the underlying assets, interviews with relevant persons, random on-site reviews of original documents and looking at publicly available information (if applicable) to get a full audit.

In practice, the risk of non-genuine underlying assets increases if the proportion of linked transactions is relatively high, the concentration of suppliers or customers is high, certain players (such as factoring companies, trust companies and asset operating companies) involved in erecting the structure of the transaction lacks independence or for other reasons. Accordingly, when setting up an asset securitization product using underlying assets with the above-mentioned characteristics, attention is usually paid to the following three means of due diligence, in addition to setting conditions and restrictions in the structure of the transaction by setting fixed values ​​for the amounts.

Site visits and interviews. It is necessary to carry out on-site visits to entities related to the underlying assets, assets and counterparties to the transaction, as well as to interview middle managers with knowledge of the details of the activity. These interviews mainly focus on the details of the transaction, such as the procurement procedure, delivery times, billing period, delivery method and storage location.

Verification of the implementation of the company’s internal systems. It is mainly a question of sifting through the internal management systems, management procedures, operating specifications and management of operations of companies that have a link with the formation of the underlying assets, including more specifically: The system selection before an operation occurs, for example systems for supplier management and tendering and submission of offers; the contract enforcement system, for example the enterprise process and approval system for contract enforcement; the performance / acceptance management system, eg the authority and procedural requirements system for performance and acceptance; and the payment approval system, eg invoice management systems, approval authority and approval of material requirements.

Internet search. A comprehensive online search for relevant reports and advertising relating to the parties to the transaction can be performed with search engines and on websites such as China Judgments Online and www.creditchina.gov.cn. The transaction involving the underlying assets should also be analyzed to confirm whether the transaction conforms to business logic and whether the entities involved present a major risk of breach of trust, litigation, etc.

Although asset securitization product offerings still rely to some extent on trust in the entities involved, the underlying assets remain the prerequisite for securitization, and only by focusing on the authenticity of assets that securitization can be sustainable.

Fang Yan is a partner at DeHeng Law Offices. She can be contacted on +86 755 8828 6447 or by email at [email protected]