The European long-term investment fund regulation[1] (the ELTIF Regulation) was introduced in 2015. The aim of the ELTIF framework was to increase European long-term investments in the real economy. This includes infrastructure projects, real estate and listed and unlisted SMEs, which may require long-term capital investment. ELTIFs also have the potential to address financing required for environmental sustainability. The ELTIF provides an opportunity for investors looking for private equity investments with a lower risk profile than pure private equity funds. Given the long-term nature of ELTIFs and the fact that the ELTIF is closed-ended means that the ELTIF has the capacity to withstand market volatility.
What are ELTIFs?
ELTIFs are a sub-category of EU alternative investment funds. Only managers who are authorised under the Alternative Investments Fund Managers Directive (AIFMD) can offer an ELTIF. ELTIFs can avail of an EU marketing passport for marketing to retail and professional investors. By comparison, AIFs can only be marketed to professional investors, with national rules applying for marketing to retail investors.
However, even with the benefits offered by the ELTIF Regulation, the take-up of ELTIFs has been slow with total assets under management estimated at approximately €2.4 billion in 2021. In addition, most of the Member States have none yet established. For this reason, in 2020, the European Commission (EC) launched a review of the ELTIF Regulation. The EC concluded that the ELTIF rules are too restrictive and retail investors have difficulty accessing them thereby reducing the funds’ utility, effectiveness, and attractiveness.
Legislative proposal to amend the ELTIF Regulation
In November 2021, the EC adopted a package of legislative proposals to address the commitments of the 2020 Capital Markets Union action plan (CMU). The CMU itself aims to enable EU companies to access more stable and long-term financing and to tackle the climate crisis, as well as other environmental and social challenges. The CMU package includes a proposal to review the ELTIF Regulation (the Proposal). The Proposal reiterates the objective of the ELTIF Regulation to ‘facilitate the raising and channelling of capital towards long-term investments in the real economy’.
The proposed 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:
- Differentiating between ELTIF’s marketed to professional investors and retail investors
- Removing barriers to retail investor access, and
- Establishing an optional liquidity window mechanism for redemptions, where investors need to exit early
The Proposal is also aligned with the EU’s climate and environmental goals.
Proposed amendments
The proposed amendments to the ELTIF Regulation include:
Broader scope of eligible assets and investments:
- The regulation no longer references EU projects, explicitly allowing eligible assets and investments to be located outside of the EU, and
- The definition of ‘real assets’ has been broadened in scope to now capture any assets that have intrinsic value due to their substance and properties
Flexible fund rules:
- ELTIFs will be allowed to invest in AIFs who themselves 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.
- The minimum investment in a real asset threshold has been reduced from €10 million to €1 million, which aims to make real asset investments much more accessible. It also no longer requires that real assets are owned directly or via indirect holding via qualifying portfolio undertakings.
- The maximum market capitalisation threshold defining an eligible small and medium-sized enterprise equity or debt issuer has been raised from €500 million to €1 billion.
- ELTIFs will be able to make minority co-investments, which is hoped will attract more modest promoters of investment projects, rather than be required to invest via or in majority owned subsidiaries as is currently the case. The ELTIF manager, 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.
- The threshold for eligible investment assets of ELTIFs has been lowered to 60% from 70%. The remainder of the capital should be invested in UCITS eligible assets.
Borrowing:
- The borrowing limits of ELTIFs, which are marketed to retail investors, have been increased. This amendment seeks to allow the borrowing of up to 50% of the ELTIF value, instead of 30% under the current regime. This limit increases to 100% of the value of the ELTIF when the fund is marketed to professional investors. This is aimed at providing additional flexibility in the currency-related rules. It extends the possibility of ELTIFs to contract in a currency other than the base currency where currency exposures have been hedged or where it can be otherwise demonstrated that the borrowing in another currency does not expose the ELTIF to any material currency risks[2].
- Borrowing limits have also been increased to 100% of the value of the ELTIF where the fund is marketed to professional investors. However, additional investing safeguards have been introduced to counterbalance this increase.
Diversification requirements:
- The maximum retail ELTIF exposure to instruments issued by, or loans granted to, any single qualifying portfolio undertaking has been raised from 10% to 20% of the value of the capital of the ELTIF.
- The current threshold of 5% for UCITS eligible assets has increased to 10%. This limit can be raised to 25% whereby bonds are issued by a credit institution which has its registered office in a Member State and is subject by law to special public supervision designed to protect bondholders. The aggregate risk exposure to a counterparty of the ELTIF stemming from OTC derivative transactions, repurchase agreements, or reverse repurchase agreements will also be increased from 5% to 10% of the value of the capital of the ELTIF.
Concentration Limits:
- The concentration limit applicable to investments in a single eligible ELTIF, EuVECA, EuSEF, UCITS or of an EU AIF management by an EU AIFM has been raised from 25% of its units or shares to 30%. This concentration limit is not appliable where ELTIFs are marketed solely to professional investors.
Redemptions:
- Optional liquidity window mechanism introduced to provide full or partial matching of transfer requests of units or shares by existing ELTIF investors with subscription requests by new investors.
Accessibility to retail investors:
- Removal of the €10,000 initial investment requirement.
- Removal of the maximum 10% aggregate threshold requirement for those retail investors whose portfolios are below €500,000.
- Carry out suitability assessments in line with MiFID II provisions to remove the duplication of suitability tests and collection of information on retail investors’ knowledge, experience, financial situation and objectives provided for in the current regime.
Next steps
The Proposal will follow the EU’s standard legislative procedure and will likely be published in the Official Journal of the European Union in late 2023 or early 2024. The amending ELTIF Regulation would then apply six months after coming into force.
Conclusion
The proposed amendments to the ELTIF Regulation have the potential to make the ELTIF a sought-after investment vehicle.
The proposed amendments enable, among other reforms, more diverse investment opportunities, the creation of fund of fund structures and the removal of the minimum investment amounts for retail investors.
There is an expectation that amending the ELTIF 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. It has the potential to provide an attractive solution for infrastructure, real estate, as well as listed and unlisted SME financing for both institutional and retail investors.
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.
