Background
To this date, only 57 alternative investment funds (“AIFs”) with relatively modest assets under management have been authorized as European long-term investment funds (“ELTIF”) across four jurisdictions, namely Italy, France, Spain and Luxembourg. However, there has been a growing interest for this structure in recent times and the revised regime could unlock the full potential of ELTIFs, which has been hindered by overly complex and restrictive rules, notably in terms of portfolio composition and distribution.
Primary change
The proposed regulation crystallizes political objectives linked to the Capital Markets Union, the Sustainable Finance Strategy and COVID-19 recovery plan with the ambition to enhance attractiveness of ELTIFs as go-to vehicles for infrastructure, real estate and SMEs1 financing in a context of growing appetite for private equity/debt investments from both institutional and retail investors.
The European Commission unveiled its proposal for a Regulation amending Regulation 2015/760 on 25 November 2021 which greatly improves the flexibility of the vehicle in terms of eligible assets, portfolio composition, distribution and authorization.
Practical considerations
The current ELTIF regime already comes with some distinctive advantages which have not been yet fully leveraged by sponsors. ELTIFs can provide access to private wealth investors searching for yield through a regulated vehicle tailor-made for long-term, illiquid and real assets. ELTIFs can represent a safer pathway for investors interested in private equity investments but present a lower risk profile than pure private equity funds.
Compared to AIFs, ELTIFs can be distributed across the EU with a passport to both professional and retail investors without being subject to national rules. Their default closed-end nature and long-term orientation can withstand market volatility and provide a good diversification tool and higher returns though exposure to non-traditional asset classes.
While tax treatment depends on the regulatory regime applicable to the AIF set-up, as an ELTIF and tax structuring determines eligibility to double tax treaties, certain jurisdictions such as Italy already provide tax incentives for ELTIF investors.
Insurance wrappers’ national investment compliance rules also enable investment in ELTIFs under certain conditions. For example, French retail investors can already invest up to 10% of units of their contract in an ELTIF while professional investors can invest up to 50% of their contract, within the limit of 10% of their wealth.
Following an amendment to Solvency II by Commission Delegated Regulation 2016/467, ELTIFs can also benefit from the same capital charges as equities traded on regulated markets which is lower than other equities.
The additional flexibility provided for in the overhaul proposal has the potential to alleviate most of the pain points for sponsors and should enhance the attractiveness of the vehicle in a context of COVID-19 recovery with many investment opportunities and growing appetite for alternative and sustainable strategies, both in the institutional and retail space.
Key points
1. Authorization and public register
Few changes have been incorporated to facilitate the authorization of the ELTIF and streamline the separation of those provisions that address the authorization of the ELTIF and that of the AIF manager (“AIFM”). The National Competent Authority (“NCA”) responsible for authorizing the ELTIF will be solely responsible for the authorization of an ELTIF and will not be involved in the additional authorization or ‘approval’ of the EU AIFM. The proposed regulation also clarifies that the authorization of an ELTIF should not be subject either to a requirement that the ELTIF be managed by an AIFM having its registered office in the ELTIF home Member State or that the AIFM pursues or delegates any activities in the ELTIF Home Member State. NCAs will be required to report information to the European Securities and Markets Authority (“ESMA”) on authorizations granted or withdrawn about ELTIF on a monthly basis – and not quarterly. Reporting granularity will also be increased to facilitate identification of the ELTIF, its units or shares and managers and enhance accessibility of ELTIF’s documents.
2. Investment rules
Eligible investment assets
Definition clarifications
The proposed ELTIF framework now explicitly allows eligible assets and investments to be located in third countries. Allocation strategies may include investments in environmental preservation or sustainability projects in third countries, research and development facilities or energy infrastructure, which have the potential of benefiting ELTIF investors and EU long-term growth and contribute to the ELTIF’s objectives.
Real Assets
The definition of real assets has been revised to capture any assets that have intrinsic value due to their substance and properties. This definition significantly broadens the scope of eligible assets, including those assets that cannot be easily quantified, for instance, those based on a discounted cash flow or comparison valuation method. Under the revised provisions, ELTIFs can invest in real assets if the minimum investment value of such assets is at least EUR 1,000,000 instead of EUR 10,000,000. This should enable asset managers to capture a broad range of potential real assets investment strategies irrespective of the values of the individual real assets, contribute to diversification and consequently reduce risks.
It is also no longer required that real assets are owned directly or via indirect holding via qualifying portfolio undertakings.
Co-investment
ELTIFs will be able to make minority co-investments in investment opportunities rather than be required to invest via or in majority owned subsidiaries.The AIFM managing an ELTIF and undertakings that belong to the same group with an AIFM managing an ELTIF, and their staff may co-invest in that ELTIF and co-invest with the ELTIF in the same asset, provided that the ELTIF manager has put in place organizational and administrative arrangements to identify, prevent, manage and monitor conflicts of interest and provided that such conflicts of interest are adequately disclosed.
Funds
The new regime should facilitate the possibility of ELTIFs pursuing fund-of-fund investment strategies and investing in EU AIFs - in addition to ELTIFs, EuVECAs2 and EuSEFs3 - managed by EU AIFMs, provided those ELTIFs, EuVECAs, EuSEFs ̧ UCITS and EU AIFs invest in eligible investments.
Securitizations
The scope of eligible assets for ELTIFs is also broadened to encompass:
- Residential mortgage-backed securities
- Commercial loans that are secured by one or more mortgages on commercial immovable property
- Corporate loans (including loans granted to small and medium enterprises)
- Trade receivables or other underlying exposures that the originator considers to form a distinct asset type, provided that the proceeds from securitizing these trade receivables or other underlying exposures are used for financing or refinancing long-term investments
Small caps
The maximum level of the market capitalization threshold defining an eligible small and medium-sized enterprise equity or debt issuer has been raised from EUR 500,000,000 to EUR 1,000,000,000. This capitalization threshold will only be applicable at the time of the initial investment.
Portfolio composition
The requirement for an ELTIF to invest 70% of its capital in long term eligible assets has been lowered to 60%.
The remainder of the capital should be invested in UCITS eligible assets.
Diversification requirements
The maximum retail ELTIF exposures 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 aggregate value of simple, transparent and standardized (STS) securitizations should not exceed 20% of the value of the capital of ELTIF. A similar 20% limit also applies to an investment in a single eligible ELTIF, EuVECA, EuSEF, UCITS or of an EU AIF managed by an EU AIFM while a combined limit is set at 40% for these investments in other UCIs.
The current threshold of 5% for eligible assets for UCITS eligible assets has increased to 10%. This limit can be raised to 25% where 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 investment in a single eligible ELTIF, EuVECA, EuSEF, UCITS or of an EU AIF managed by an EU AIFM has been raised from 25% of its units or shares to 30%. This concentration limit will not apply where ELTIFs are marketed solely to professional investors.
Borrowing
ELTIFs marketed to retail investors can increase the borrowing of cash up to 50% of the ELTIF value instead of 30% in the current regime. This limit increases to 100% of the value of the ELTIF when the fund is marketed to professional investors. ELTIF will be able to contract in a currency other than the base currency exposures that have been hedged. The ELTIF manager will be required to provide a detailed presentation of the ELTIF borrowing strategy and limits and outline how exactly the borrowing will help implement the ELTIF strategy and mitigate borrowing, currency and duration risks.
3. Liability side
Alleviation of barriers to retail investors
In order to remove duplication of suitability tests and collection of information on retail investor’s knowledge, experience, financial situation and objectives provided for in the current regime, the proposed regulation cross-refers to the obligation of ELTIF managers and distributors, when directly offering or placing ELTIFs, to carry out the suitability assessment in line with the MiFID II provisions. This ties with the deletion of the minimum entry ticket (EUR 10,000) and the 10% aggregate threshold for retail investors whose financial portfolios do not exceed EUR 500,000.
Under the new regime, retail investors should be able, during the subscription period and at least two weeks after the effective date of the commitment or subscription agreement of the units or shares of the ELTIF, to cancel their subscription and have the money returned without penalty. The provisions on investor facilities will be deleted to facilitate the marketing of ELTIFs and align with the new rules on cross-border distribution of funds.
Optional liquidity window mechanism
A possibility will be introduced for an ELTIF manager to include in the rules or instruments of incorporation of the ELTIF an optional liquidity window mechanism in order to provide extra liquidity investors with appropriate safeguards. This secondary market liquidity mechanism should provide, before the end of the ELTIF’s life, full or partial matching of transfer requests of units or shares of the ELTIF by exiting ELTIF investors with subscription requests by new investors. The ELTIF manager will be required to have a defined policy for the liquidity mechanism including information on the transfer process for both exiting and subscribing investors, the applicable time window, the execution price, the conditions for the pro-ration, disclosure requirements and the applicable fees, costs and charges. ESMA will be mandated to develop regulatory technical standards specifying further the circumstances in which the mechanism should apply, including the content of related investor’s disclosure.
Master-feeder disclosures
The proposed Regulation clarifies the content of feeder ELTIF prospectuses which should include:
- A declaration that the feeder ELTIF invests 85% or more of its assets in units of the master ELTIF
- Information on the ELTIF’s investment objective and policy
- A description of the master-feeder ELTIF
- A description of the tax implications for the feeder ELTIF of the investment into the master ELTIF
Link to the ELTIF proposal
1 Small and medium size enterprises
2 European Venture Capital Funds authorized pursuant to Regulation n°345/2013, as amended
3 European Social Entrepreneurship Funds authorized pursuant to Regulation n°346/2013, as amended
