What’s the story so far? (ELTIF 1.0)
Regulation (EU) 2015/760 on European long-term investment funds (ELTIF Regulation) first came into force on 9 December 2015. Its main objective was to foster long-term investments and strengthen the European capital market by channelling non-bank capital towards European long-term projects to the benefit of the European economy. Initially, the ELTIF Regulation was designed to streamline the process of raising capital, in particular with regard to specific types of alternative investment such as unlisted companies, debt instruments for which a buyer cannot be easily identified, real assets that require significant initial investment as well as small and medium sized enterprises (SMEs) with capitalisations of up to EUR 500 million that have been admitted to trade on a regulated market. ELTIFs were conceived as a financial instrument to address the lack of late-stage venture capital financing.
In general, the ELTIF Regulation supplemented the provisions set out in Directive 2011/61/EU on Alternative Investment Funds Managers (AIFMD) and therefore provided separate, harmonised regulation for a specific category of alternative investment funds offered to both professional and retail investors. Compared to AIF structures, the ELTIF regime provides certain advantages. In particular, it is a fully harmonised European label for financial products, which allows for EU-wide passport-based marketing to both professional and retail investors. In comparison, AIFs under the AIFMD can only be passported to professional investors and marketing to retail investors is subject to national rules.
Despite the ambitious legislative goals, the commercial success of the ELTIF Regulation has remained rather limited, especially in Germany. According to an Impact Assessment Report (SWD(2021) 342 final) accompanying the proposal for a revised ELTIF Regulation, published by the European Commission on 25 November 2021, only a relatively small number of ELTIFs had been launched by the end of 2021, namely a total of 57 ELTIFs in just four jurisdictions (Luxembourg, Italy, France and Spain) – none in Germany – amounting to only around EUR 2.4 billion in 2021. As of June 2023 the number of authorised ELTIFs had increased to 89. However, the Commission’s originally anticipated success did not materialise.
Necessity for an upgrade (ELTIF 2.0)
As part of the Impact Assessment Report, the Commission identified that the attractiveness of ELTIFs could be significantly improved by readjusting the restrictions for fund managers and reducing the obstacles to entry for small investors. In particular, the “one size fits all” approach, whereby the ELTIF Regulation applies the same fund rules to both professional and retail investors, including restrictions on leverage, diversification and portfolio composition requirements, concentration rules and limits on eligible assets and investments, has affected the attractiveness of ELTIF vehicles. The Impact Assessment Report outlined that – among other factors – overly restrictive fund rules, limitations on the scope of eligible assets and investments, regulatory barriers and diverging or difficult to understand national requirements and practices are among the factors limiting the uptake of ELTIFs.
In light of this, the European Commission aimed to address the ELTIF Regulation’s lack of commercial success by revising its content.
The revision of the ELTIF Regulation resulted in the following key enhancements:
- Wider range of eligible assets: The original ELTIF Regulation imposed limitations on investments, particularly in real assets and other eligible investment funds. However, the Revised ELTIF Regulation significantly broadens the range of eligible assets. It now includes fund of funds investment strategies, investments in STS securitisations, and direct investments in real assets. Previously, investments in real assets had to be held either directly or through indirect holdings in qualifying portfolio companies. Notably, the Revised Regulation eliminates the minimum threshold of EUR 10 million concerning investments in real assets, enhancing accessibility to a wider array of investment opportunities.
- Composition and diversification of an ELTIF’s portfolio: The Revised ELTIF Regulation simplifies rules relating to the composition and diversification of an ELTIF’s portfolio. Regarding the ELTIF’s diversification requirements, the EU legislator has taken the criticism of the original ELTIF Regulation for being too rigid seriously and introduced significant relaxations with the Revised ELTIF Regulation. Instead of the previous minimum of 70%, only 55% of the ELTIF’s capital must be invested in eligible assets. ELTIF’s that are only distributed to professional investors now benefit from certain simplifications in terms of diversification requirements, concentration limits and borrowing.
- Concessions for retail investors: The original ELTIF Regulation imposed a dual requirement on retail investors: a minimum initial investment of EUR 10,000 and a 10% cap on ELTIF investments within portfolios not exceeding EUR 500,000. This framework created significant barriers for retail investors, diverging from the goal of positioning ELTIFs as accessible retail investment options. Recognizing this challenge, the Revised ELTIF Regulation eliminates both the EUR 10,000 minimum initial investment and the 10% aggregate investment limitation, fostering greater inclusivity and flexibility for retail investors seeking to invest in ELTIFs. Moreover, the Revised ELTIF Regulation simplifies the requirement for ELTIF managers or distributors to conduct suitability assessments. Instead of a separate suitability assessment, the regulation now aligns with the provisions of Directive 2014/65/EU (MiFID II), stipulating that ELTIF managers and distributors must conduct suitability assessments in accordance with the MiFID II regime when directly offering or placing ELTIFs. This streamlining enhances clarity and coherence in the regulatory framework, benefiting both investors and asset management companies.
- Liquidity: The Revised ELTIF Regulation introduces the possibility of redemptions of shares before the end of a fund’s term. The European Securities and Markets Authority (ESMA) will develop regulatory technical standards (RTS) which will further specify the conditions for redemptions.
German regulatory approach
On 1 February 2024, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin’s ) published FAQs on the Revised ELTIF Regulation to provide clarity on BaFin’s regulatory approach. This publication emphasizes the regulation’s significance within the German fund and investment industry. Here are some key points worth noting:
- No licence extension required: BaFin clarifies that an extension of the licence of asset management companies is not required for the management of an ELTIF. However, the licence must cover the assets that the ELTIFs can acquire according to their investment requirements/articles of incorporation, the fund structure (open/closed) and the group of investors to whom the ELTIFs are to be marketed (retail or professional investors). If this is the case, no licence amendment is required but the asset management company must adapt the corporate purpose of its to reflect its ELTIF management activity .
- Distribution of ELTIFs via financial investment brokers: BaFin points out that financial investment brokers are also authorised to sell ELTIFs to retail investors in accordance with Section 34f of the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung – GewO). As ELTIFs can be either open-ended or closed-ended domestic or EU investment funds, the reference in Section 338a of the German Investment Code (Kapitalanlagegesetzbuch – KAGB) to the provisions of the ELTIF Regulation also allows the units of an ELTIF to be marketed in accordance with the KAGB, i.e. the requirements of Section 34f(1) nos. 1 and 2 GewO are met.
- Legal forms of an ELTIF: As the legal forms permitted for an ELTIF are not defined in the ELTIF Regulation, BaFin clarifies that the permitted legal forms are determined by the KAGB. This means that all legal forms permitted under the KAGB are possible for ELTIFs and the corresponding provisions of the KAGB apply. However, this only applies to areas that are not already regulated by the ELTIF Regulation, which takes precedence. This is particularly relevant to the product and distribution rules; these provisions are exhaustive and may not be further restricted by national law.
- Term of an ELTIF: The Revised ELTIF Regulation does not contain any specific requirements for the term of ELTIFs. A specific end date should be specified in the contractual terms and conditions or in the articles of association. The FAQ also includes a clarification regarding the maximum term of an ELTIF, which BaFin considers to be 30 years for closed-ended funds.
Draft RTS under the Revised ELTIF Regulation
On 23 May 2023, ESMA published a consultation paper on proposed draft RTS under the Revised ELTIF Regulation. The final report was published on 19 December 2023 and sets out the draft RTS which cover the following:
- The circumstances in which the life of an ELTIF is considered to be compatible with the life cycles of the individual assets and the different features of the redemption policy of the ELTIF;
- The circumstances for the application of the matching mechanism, i.e. the possibility to match transfer requests of units or shares of the ELTIF from exiting ELTIF investors with transfer requests from potential investors in whole or in part (before the end of the life of the ELTIF); and
- The disclosure of costs.
ESMA has submitted the draft RTS to the European Commission for adoption and is now awaiting final approval.
What’s next?
With the Revised ELTIF Regulation, the European legislator has addressed previous criticism and provided the foundation for a more flexible set of rules. For Germany in particular, this offers significant potential. The regulation can be viewed as generally favourable, especially when compared to competing fund types such as the RAIF in Luxembourg. Additionally, retail investors are now – for the first time – being offered a harmonised set of rules across Europe, fundamentally enabling a more flexible range of options than the fund categories of the KAGB. Particularly in light of the “European Passport”, the ELTIF is an attractive new option if the intention is to market the product throughout Europe.
So far, the amendment has been met with a largely positive response in the market. However, it remains to be seen to what extent it will achieve the desired increase in uptake of the ELTIF in the European domestic market.
