ELTIF Reform: A Milestone in the Development of an EU Private Fund Structure for Accessing Wholesale Markets | Goodwin

The European Long-Term Investment Fund (ELTIF), a collective investment framework for both professional and retail investors looking to invest in long-term assets, has been available to EU managers since December 2015. However, the ELTIF’s uptake has been disappointing, with 84 ELTIFs launched to date, based in a small number of member states — Luxembourg, France, Spain, and Italy, and with relatively small net asset size (ESMA register, January 2023). In contrast, the Luxembourg Reserved Alternative Investment Fund (RAIF), an unregulated AIF, introduced a year after the ELTIF, and which number 1686 (according to ALFI), has been well received.

To respond to its critique as a complex, cumbersome, and expensive vehicle and to attempt to reduce barriers, improve flexibility, and make access simpler, the European Commission proposed a revised ELTIF framework in 2021. On 15 February 2023, the amending Regulation was adopted by the European Parliament. It will enter into force 20 days after being published in the Official Journal of the EU (expected imminently) and apply nine months later.

Although AIF structures are likely to continue to dominate the institutional investor segment of the private funds market, we expect the ELTIF to be a good fit for those EU managers (and fund of funds managers) prepared to accept increased compliance, detailed authorisation requirements, and regulatory risk in order to be able to target retail investor wealth, in particular for investment in infrastructure and green projects. This is an important further step towards the “retailisation” of investments that would otherwise only be available to professional investors.

ELTIFs are subject to AIFMD, although a highlight is the fact that the ELTIF marketing passport covers retail investors as well as professional investors. The Luxembourg Undertakings for Collective Investment (UCIs – Part II) is also available for retail investors and, for EU strategies, can be considered in conjunction with the ELTIF.

In this briefing we have picked out a few of the main changes in the amending Regulation which address some of the perceived shortcomings in the uptake of the ELTIF to date.

Better Calibration of Key ELTIF Rules

• An extended list of eligible assets to include those outside the EU and reduce the threshold of eligible investment assets from 70% to 55%. This will improve the liquidity profile of the ELTIF’s underlying portfolio and, combined with revised diversification requirements, allow asset managers to have more flexible portfolio composition.
• A broader and simpler definition of ‘real assets’ to include all assets that have intrinsic value due to their substance and properties. This captures a broader range of potential real asset investment strategies. Of note is the removal of both the requirement that real assets are owned directly or via ‘indirect holding via qualifying portfolio undertakings’ and a €10 million minimum investment value.
• Clear differentiation between ELTIFs to be marketed exclusively to professional investors and those that are marketed to retail investors. As set out below, provisions on diversification and concentration are disapplied for ELTIFs marketed only to professional investors. The rules applicable for ELTIFs targeting retail investors also provide more flexibility.
• ELTIFs solely marketed to institutional investors can borrow up to 100% of the net asset value of the ELTIF (and ELTIFs marketed to retail investors, up to 50%). There is a ramp up period of up to three years to comply with borrowing limits, and borrowing arrangements fully covered by investors’ capital commitments would not constitute borrowing. The rectification provisions also now apply to infringement of borrowing limits (as well as portfolio diversification and composition).
• ELTIFs can utilise master-feeder structures, where a feeder invests at least 85% of its assets in a master (provided sufficient investor protection is ensured). Both feeder and master structures must be ELTIFs. There is also a more flexible framework for fund-of-funds strategies, as target funds are no longer restricted only to other ELTIFs, EuSEFs, or EuVECAs.
• ELTIF managers and affiliated entities are permitted to co-invest in the ELTIF or co-invest with the ELTIF in the same asset; however managers must ensure organisational and administrative safeguards are in place to monitor and manage conflicts of interests (and that these are adequately disclosed).
• Investors can no longer require the winding down of an ELTIF where that ELTIF is unable to satisfy redemption requests within one year.
• The ELTIF manager must inform the national competent authority (NCA) when disposing of ELTIF assets for the redemption of investors (by one year before the date of the end of the ELTIF’s life), but only need to provide an itemised schedule for the orderly disposal of its assets on request by an NCA.

Enlarged Scope of Eligible Investment Assets

The prescriptive but broader list of eligible assets (comprising a 55% minimum of the ELTIF’s capital, as mentioned above) under the amending Regulation includes:

• Equity and quasi-equity investments issued by a ‘qualified portfolio undertaking’ (see below) and acquired by the ELTIF (or issued in exchange) from that qualifying portfolio undertaking or from a third party via the secondary market or held as a minority co-investment participation in a qualified portfolio undertaking;
• Debt instruments issued by a qualifying portfolio undertaking;
• Loans granted by the ELTIF to a qualified portfolio undertaking with a maturity of no longer than the life of the ELTIF;
• Shares/units in other ELTIFs, EuVECAs, EuSEFS, UCITS, and EU AIFs managed by EU AIFMs (provided that those underlying funds invest in ELTIF eligible assets and that none of them have more than 10% invested in any other collective investment undertaking). This limitation has been relaxed to allow fund of funds strategies beyond investments in EuVECAs and EuSEFS only, and does not apply to feeder ELTIFs;
• Real assets (as noted above, the €10 million minimum value is removed);
• Simple, transparent, and standardised securitisations (STS) under the EU Securitisation Regulation (this will include mortgage-backed securities, commercial, residential, and corporate loans, and trade receivables); and
• Green bonds.

A ‘qualifying portfolio undertaking’ includes:

• An undertaking traded on a regulated market or multilateral trading facility that has a maximum market capitalisation of €1.5bn – raised from €500m – at the time of initial investment; and
• A financial undertaking (other than a financial holding company or a mixed activity holding company) that is a regulated entity authorised or registered more recently than 5 years before the date of the initial investment – to include FinTech businesses.

However, a ‘qualifying portfolio undertaking’ cannot be located in a third country identified as high-risk under EU legislation or that is deemed non-cooperative in tax matters (as set out in the periodically-updated Council of the EU’s list) – to align with current EU money laundering standards and requirements.

Removal of Barriers and More Flexibility for Retail Investors

There are several improvements that will allow more straightforward and efficient retail investor access (and apply irrespective of the investor’s size):

• Retail investors are no longer subject to the €10,000 initial investment requirement and maximum 10% aggregated threshold requirement (for those with portfolios below €500,000).
• ELTIF managers can market to retail investors where a MiFID II suitability assessment has been carried out (and the duplicate ELTIF suitability tests and investment advice provisions are removed).
• Burdensome requirements such as the local marketing facilities requirements for retail investors are removed.
• ELTIFs marketed to retail investors can leverage up to 50% of the NAV of the ELTIF (as mentioned above, there is a two-tier borrowing limitation to cater for professional investor-only ELTIFs).

ELTIFs marketed to retail investors are subject to diversification and concentration requirements. However, an extension of the thresholds is welcome, as is the fact that the thresholds do not apply to ELTIFs solely marketed to professional investors. We have set out an overview below.

• An ELTIF can invest no more than 20% of its capital in:
  • A single qualifying portfolio undertaking (whether instruments issued by or loans granted to such undertaking);
  • A single real asset; and
  • Units or shares of any single ELTIF, EuVECA, UCITS, or EU AIF managed by an EU AIFM (i.e., forming part of the underlying funds for ‘eligible assets’ outlined above) and comprising no more than 30% of the units or shares of that fund. This restriction does not apply to feeder ELTIFs;
• A 10% investment limit on UCITS funds in any individual issuer (increased to 25% where bonds are issued by a credit institution with its registered office in a member state and that is subject to public supervision);
• Aggregate risk exposure to STS is limited to 20% of the ELTIF’s capital; and
• Aggregate risk exposure to a counterparty from OTC derivative transactions, repurchase agreements, or reverse repurchase agreements limited to 10% of ELTIF’s capital.

In addition, ELTIF managers looking to retail investor wealth will be subject to differing depositary requirements, additional disclosures (e.g., on fees and charges and on master-feeder structures), a written alert (e.g., where the ELTIF life is more than 10 years, that it may not be fit for retail investors that cannot sustain a long-term and illiquid commitment), and the PRIIPS KID requirements. The MiFID investor protection and product governance rules apply regardless of how retail interests are acquired, so the suitability assessments, statements, and any consents are required for investors that are admitted via distributors, the ELTIF manager itself, or the secondary market. Retail investors also have a two week cooling off period following their subscription to the ELTIF.

Move Towards Semi Open-Ended ELTIFs

An ELTIF manager may provide for redemptions before the end of the life of the ELTIF, provided certain conditions are met. A lot of the detail on this is to follow when ESMA develops level 2 measures covering, for instance, manager requirements for an appropriate redemption policy and liquidity management tools; the criteria for determining the minimum holding period when redemptions cannot be granted; redemption limits (based on the ELTIF’s expected cashflows and liabilities); and how the life of an ELTIF is to be considered consistent with the long-term nature of an ELTIF and compatible with the life-cycles of each individual asset. Redemptions in kind are permitted in certain circumstances.

Managers of closed-ended ELTIFs have the possibility to introduce an optional liquidity window mechanism by way of a full or partial matching policy. This is aimed at transferring units or shares of an exiting ELTIF investor to new investors requesting transfers, before the end of the ELTIF’s life. If the ELTIF manager incorporates this mechanism, a defined policy with the necessary information should be in place. Again, ESMA is tasked with drafting level 2 measures specifying the circumstances for the use of matching and information to be disclosed to investors.

Policies and procedures for both these liquidity mechanisms are to ensure that investors are treated fairly and that redemptions and matchings respectively are granted or carried out on a pro rata basis.

Concluding Points of Interest

To conclude, we would point out three other points of interest:

1. There is a five year transitional period for pre-existing ELTIFs that are still raising capital and, for those ELTIF managers who want to opt into the revised rules, they can do so by notifying their member state NCA. For new ELTIF applications, there is a competitive two month approval window for NCA approval.
2. Two years after the amending Regulation is in force, the European Commission will assess whether or not a ‘green ELTIF’ label should be introduced and reserved for ELTIFs fulfilling certain sustainability criteria under SFDR.
3. From a UK standpoint, the EU legislation on the ELTIF is to be repealed (as part of the Edinburgh Reforms package of provisions to address retained EU law), given the recently-introduced option of the UK-specific open-ended authorized Long Term Asset Fund (LTAF).

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