Could the ELTIF become more popular?
The ELTIF Regulation took effect in 2015. While there have been successful fund launches under the existing regime, the number of ELTIFs in the market remains below expectations (at the time of writing there are 67 authorised ELTIFs in the EU and none in the UK). The ELTIF review is required by the ELTIF Regulation, but the impetus to make the ELTIF more attractive is due to external factors.
Alternative asset managers are keen to grow their investor base and their assets under management, and many are interested in tapping the substantial pool of ‘mass affluent’ capital in the EU, very little of which has historically been invested in private assets. Policymakers also see opportunities to direct private capital to growth-producing projects that might also help with the recovery from the pandemic, as well as the transition to sustainable sources of energy.
The UK has also undertaken a review of its own fund regime and has launched the Long Term Asset Fund (LTAF), a flexible UK alternative to the more prescriptive ELTIF regime.
The ELTIF review forms part of the EU’s wider Capital Markets Union initiative that aims to develop the EU’s capital markets and reduce the economy’s reliance on bank financing channels.
What is happening?
The ELTIF review was preceded by preparatory work, including a consultation which closed in January 2021 and ESMA’s public expression of its recommendations for reform. The European Commission published draft legislative proposals on 25 November 2021 and the reforms are now being debated by the EU’s co-legislators, the European Council, and the European Parliament.
The legislative reforms might be agreed by early 2023. Member States will have 24 months to implement the reforms from the publication of the changes in the EU’s Official Journal, and so early 2025 is the indicative implementation date. The current, unreformed ELTIF Regulation continues to apply in the meantime.
What are the proposed reforms?
The European Commission proposed the following key reforms in its draft legislation.
1. Broadening the scope of investment and risk management
- Permitting master-feeder and fund of funds strategies, with investment allowed in a broader array of other (although EU-only) fund structures, subject to concentration limits although these would not apply to ELTIFs marketed solely to professional investors.
- A broader definition of real assets and relaxed rules for the ELTIF’s holding of those assets.
- Raising the market capitalisation threshold for portfolio companies from €500m to €1bn at the time of initial investment and reducing the market value of eligible real assets from €10m to €1m .
- Reducing the minimum holding of long-term assets from 70% to 60%.
- Removing the reference to “European long-term investments” from the objective of the regime, implicitly acknowledging the ELTIF’s global investment scope. However, this is somewhat misleading because ELTIFs may still invest only in other EU funds and local regulators may still take the view that a minimum portion of an ELTIF’s assets must still be invested into the EU.
- Allowing ELTIFs to borrow cash subject to limits relative to the overall size of the fund (50% for retail funds and 100% for professional-only funds).
- Clarifying the conflict of interest rules to enable market practices of co-investment (namely, allowing AIFMs managing ELTIFs and other funds to co-invest so long as conflicts are identified and managed).
2. Making the ELTIF more accessible to retail investors
- Removing the €10,000 initial minimum investment requirement.
- Removing the 10% cap on a portfolio’s exposure to the ELTIF for investors with a total portfolio smaller than €50,000.
- Aligning the point-of-sale suitability test with MiFID II’s requirements.
- Removing the requirement for the provision of local facilities.
3. A “Liquidity Window Mechanism”
- A mechanism to allow investors to dispose of their shares in a (closed-ended) ELTIF before the end of the fund’s life, on a ‘matched’ secondary market basis.
4. Changes to regulatory permissions and notifications
- Clarifying that the relevant national regulator is only responsible in the authorisation process for authorising the ELTIF and not the associated EU AIFM, meaning that the AIFM does not need to be domiciled in or delegate to the same Member State as the ELTIF.
- Obliging national regulators to report changes in ELTIF-related regulatory permissions, such as authorisation and deauthorisation, to ESMA monthly.
How will these changes make a difference?
The reforms to the ELTIF’s investment rules would be a significant improvement. In particular, the options to create fund of fund and feeder structures are likely to be particularly welcomed by managers, and the loosening of the other eligible assets restrictions is similarly likely to be helpful.
A greater distinction between professional and retail ELTIFs has given policymakers license to scale back some of the more onerous requirements on managers of ELTIFs marketed solely to professional investors; however, it remains to be seen whether professional investors will view the ELTIF "badge" as attractive or whether professional investor-only ELTIFs may be viewed as unnecessary, given the AIFMD professional investor marketing passport is available to EU AIFs managed by EU AIFMs without the additional burdens of the ELTIF wrapper.
The lower thresholds for investment by retail investors, while potentially administratively helpful, seem unlikely to open substantially greater pools of capital as managers and distributors have largely focused on the intermediated, private wealth, market for potential ELTIF investors, and few seem keen to expand further into the wider retail market.
The European Commission has also declined to permit substantial further redemption mechanisms, making clear that it views ELTIFs as primarily closed-ended vehicles, subject to limited investor liquidity only (in contrast to the UK LTAF regime, where managers may design their own investor liquidity opportunities, subject to demonstrating to the FCA that the LTAF will be able to honour its liquidity commitments). It is not immediately clear how the proposed "matched" secondary market mechanism would work in practice, in a retail investor concept; although potentially distributors could have a role to play in generating this sort of secondary market. However, a committee of the European Council has stated that it is amenable to a “partially open-ended” ELTIF, permitting redemptions during the life of the fund but subject to a notice period (somewhat comparable to the UK LTAF which requires a minimum 90-day notice period). This would be a positive development, but it remains to be seen whether the co-legislators will pursue this proposal.
Overall, while not perfect, the reforms should make the ELTIF a more attractive fund vehicle and we anticipate seeing ELTIF feeders being set up over the next few years to invest into investment managers’ private fund vehicles, as well as a growth in ELTIF infrastructure funds, in particular, as the European energy transition accelerates.