The ELTIF Regulation is being substantially overhauled and for the first-time private equity, real estate or other private market investments may be distributed to retail investors throughout the EU under the AIFMD marketing passport. Conor Durkin, Investment Funds Partner examines how the amendments to ELTIF Regulation undermines the distinction between retail and professional investor funds.
The European Council recently adopted an amending regulation (Amending Regulation) to the European Long-Term Investment Funds Regulation (ELTIF Regulation). In this article, our Investment Funds team outlines the changes the Amending Regulation introduces for ELTIFs that will be distributed to retail investors. We also consider the impact the Amending Regulation will have for retail investors in the EU.
Background
The ELTIF is a specialised investment fund that provides investors with access to long-term investments in private equity or real assets. ELTIFs are a type of alternative investment fund that are subject to the EU's Alternative Investments Fund Managers Directive (AIFMD). Only authorised fund managers can manage ELTIFs, and unlike traditional AIFs, ELTIFs have the benefit of an EU marketing passport for marketing to both retail and professional investors.
The aim of the ELTIF Regulation is to encourage long-term investments in the real economy, which includes listed and unlisted private companies, infrastructure projects, and real estate which may require long-term capital investment. Additionally, ELTIFs have the potential to address financing required for environmentally sustainable investments. The Amending Regulation provides retail investors in the EU an opportunity to invest in private market investments and infrastructure funds, which have not been available to the retail market.
Market uptake
To date, the adoption of ELTIFs has been sluggish; ELTIFs have not been established in most Member States and the total assets under management by ELTIFs is a modest €2.4 billion at the end of 2021. As a result, the European Commission (Commission) initiated a review of the ELTIF Regulation in 2020. The Commission concluded that the rules governing ELTIFs, and in particular ELTIFs that are distributed to retail investors, are overly restrictive, making it challenging for retail investors to access them, resulting in reduced effectiveness and limited appeal of these funds.
Key changes for retail ELTIFs
The Commission adopted a package of legislative proposals to address the commitments of the 2020 Capital Markets Union action plan in November 2021. The amendments to the ELTIF Regulation are aimed at making ELTIFs more appealing to investors as a fund available for long-term investments in the real economy. The key changes include:
- Much broader scope of eligible investments
- Less prescriptive diversification requirements, and
- Simplified distribution rules
Much broader scope of eligible investments
Qualifying Portfolio Undertakings: The Amending Regulation permits ELTIFs to invest in a much broader category of qualifying portfolio undertakings, meaning private companies, or listed companies whose market capitalisation is no more than €1.5 billion. Previously the market capitalisation was set at €500 million. Importantly, the Amending Regulation clarifies that ELTIFs may invest in qualifying portfolio undertakings established in third countries (being countries outside of the EU) provided the third country in question is not identified as high-risk third country under EU money laundering legislation.
Real assets: The definition of "real assets” has been broadened in scope to cover any assets that have intrinsic value due to their substance and properties. The original ELTIF Regulation stipulated that the minimum investment in real assets was €10 million has been removed.
Co-investments: Rather than be required to invest in vehicles that the ELTIF is the majority owner, an ELTIF will be able to make minority co-investments, which is anticipated to attract more promoters for these funds. In addition, the AIFM to an ELTIF (and its affiliated entities and staff) may invest in an ELTIF and in its assets, provided adequate administration arrangements are put in place to identify, manage and monitor conflicts of interest.
Fund of fund rules: ELTIFs will be allowed to invest in AIFs that invest in eligible assets on a “look through basis”. This will allow ELTIFs to pursue fund-of-funds investment strategies and invest in AIFs, as well as other types of EU funds, provided those funds invest in eligible investments.
Master-Feeder Structures: ELTIFs can be established as master-feeder structures, where a feeder ELTIF invests at least 85% of its assets in a master fund (provided sufficient investor protection is ensured). Both feeder and master funds must be ELTIFs.
Less prescriptive diversification requirements
ELTIFs will be required to invest at least 55% of their capital - meaning capital contributions and uncalled capital commitments - in eligible investments such as qualifying portfolio undertakings or real assets. At present, the minimum threshold for investment in eligible investments is 70%.
Retail ELTIFs will be required to spread investment risk and therefore a retail ELTIF will be restricted to investing:
- Up to 20% of its capital in the equity or debt of a single qualifying portfolio undertaking
- Up to 20% of its capital in a single property investment
- Up to 20% of its capital in a single ELTIF, EuVECA, EuSEF, UCITS or EU AIF managed by an EU AIFM
- Up to 20% of its capital in simple, transparent and standardised securitisations
- Up to 10% of its capital in transferable securities and money market instruments
- Up to 10% of its capital may be exposed to a counterparty under OTC derivative transactions, repo or reverse repo agreements
- An ELTIF may acquire no more than 30% of the shares/units of an underlying eligible ELTIF, EuVECA, EuSEF, UCITS or of an EU AIF management by an EU AIFM
Borrowing: The borrowing limits for retail ELTIFs will be increased from 30% to 50% of the ELTIF’s net asset value[1]. Importantly, borrowing that is fully covered by investors’ capital commitments is disregarded for the purpose of the 50% limit. Furthermore, an ELTIF may borrow in a currency other than the ELTIF’s base currency, where appropriate currency hedging arrangements are in place.
At present ELTIFs are restricted to charging or encumbering up to 30% of an ELTIF’s capital to secure borrowings. The Amending Regulation clarifies that an ELTIF may encumber or charge all of its assets as security for borrowings. The removal of the restriction on the extent to which an ELTIF may charge its assets is expected to make lending to ELTIFs much easier.
Simplified distribution rules
The Amending Regulation introduces a number of significant changes that will make it easier to distribute to retail investors, which include the following:
Removal of local facilities agent: Under the Amending Regulation there is no longer a requirement to put in place local facilities in each EU Member State where the ELTIF is marketed. The removal of the requirement for a local facilities agent is expected to significantly reduce the costs of marketing to retail investors.
Removal of minimum investment requirement: Retail investors will not be subject to a minimum investment requirement i.e. the minimum investment requirement of €10,000 per retail investor and the requirement that no more than 10% of a retail investor’s investment portfolio be invested in any one ELTIF have been removed.
Simplified suitability assessment: ELTIFs are permitted to be distributed to retail investors provided the AIFM applies a product governance process to ensure that the ELTIF is distributed to the relevant target market and the AIFM carries out a suitability assessment and determines that the ELTIF is suitable for retail investors in accordance with Article 25(2) of MiFID II.
Importantly, the Amending Regulation clarifies that a suitability assessment may be overridden if the AIFM obtains the explicit consent from the investor that it understands the risk of the investment and it acknowledges that the investment may not be suitable for it. In addition, the Amending Regulation no longer requires the AIFM or relevant distributor to provide “investment advice” to retail investors, as required under the original ELTIF Regulation.
Implementation
The Amending Regulation was formally adopted by the Council on 7 March 2023. It is expected to be published in the Official Journal by the end of March 2023 and will take effect nine months thereafter, i.e. during the first quarter of 2024. ELTIFs that were established under the ELTIF Regulation will still be considered compliant for a period of five years after the Amending Regulation takes effect.
Outlook
The Amending Regulation should have a significant impact on the investment landscape; by lowering the investment threshold for retail investors, ELTIFs will become more accessible to a much wider range of investors, potentially leading to increased demand for long-term alternative investment funds.
The Amending Regulation facilitates a more diverse set of investment opportunities, including the creation of fund-of-fund structures, master-feeder structures and the removal of the minimum investment amounts for retail investors.
The ELTIF will significantly broaden the investment opportunities for retail investors in private market investments and has the potential to provide an attractive source of finance for listed and unlisted private companies, infrastructure, and real estate. It is expected that the Amending Regulation will achieve its aim of improving the attractiveness of the ELTIF as a fund structure for long-term investments and as a non-bank source of finance to the real economy.
Please contact a member of our Investment Funds team for further information.
The content of this article is provided for information purposes only and does not constitute legal or other advice.
[1] This limit increases to 100% of the value of the ELTIF when the fund is marketed to professional investors.
