This article was first produced in partnership with the Financial Services practice module of Lexis PSL.
In June 2013, the European Commission (the Commission) proposed the creation of a new investment fund vehicle, namely the European Long-Term Investment Fund or ELTIF, designed to make longer term investment easier both for managers and investors. ELTIFs are to be created pursuant to the ELTIF Regulation, which will have direct effect and will not permit 'gold-plating' so that EEA member states will not be able to add or remove any of the requirements set out in the ELTIF Regulation.
On 11 March 2015, the European Parliament published a provisional edition of the text of the ELTIF Regulation adopted at the plenary session on 10 March 2015. The ELTIF Regulation now needs to be formally adopted by the Council of the European Union and then published in the Official Journal (OJ) of the EU. It will enter into force 20 days after publication in the OJ and is expected to apply six months after it has entered into force. This means it is likely to apply at the end of 2015/early 2016.
WHAT IS AN ELTIF?
An ELTIF will be an Alternative Investment Fund (AIF) for the purposes of the Alternative Investment Fund Managers Directive (AIFMD). Only EU AIFs, that is AIFs that are established in a member state of the EEA, are eligible to apply for and be granted authorisation as an ELTIF. As an AIF, they must have an authorised manager who will be a full scope EU AIFM (that is subject to the full requirements of the AIFMD). The ELTIF Regulation also permits the establishment of a self-managed ELTIF, which would apply to its home state regulator simultaneously for authorisation as an ELTIF and as an AIFM under the AIFMD. As an EU AIF subject to the AIFMD, an EU AIF must have a depositary.
Thus ELTIFs are subject to two tiers of regulation; the ELTIF itself is authorised under the Regulation and the AIFM (and so indirectly the ELTIF) is authorised under the AIFMD.
An ELTIF may consist of several compartments (an umbrella fund) with each compartment being regarded as a separate ELTIF.
WHY DID THE COMMISSION PROPOSE ELTIFS?
The ELTIF is an important part of the Commission's Capital Markets Union initiative.
ELTIFs are designed to increase the amount of non-bank finance available for companies investing in the real economy of the European Union with the Commission saying that action is needed at European level as there is no consistency among the funding vehicles in Member States. The Commission sees long-term finance as a crucial enabling tool for putting the European economy on a pathway for sustainable and inclusive growth. ELTIFs should provide finance to infrastructure projects, unlisted companies or listed small- and medium-sized enterprises, transport infrastructure, sustainable energy generation or distribution and social infrastructure (hospitals, schools and social housing).
WHAT DOES THE ELTIF REGULATION DO?
ELTIF Regulation creates a new type of authorised AIF to join the two other categories of authorised AIFs, European Serial Entrepreneurship Funds (EuSEFs) and European Venture Capital Funds (EuVECAs). ELTIFs are fixed-life vehicles that may take different legal forms but may only invest in certain types of assets and must invest at least 70% of their funds in such assets.
Unlike the AIFMD, the ELTIF Regulation permits cross-border marketing to retail investors as well as to professional investors but subject to additional specific requirements.
RELATIONSHIP WITH OTHER PIECES OF THE EU LEGISLATION
ELTIFs and their managers are subject to the AIFMD. In addition, the UCITS Directive is relevant as up to 30% of an ELTIF's assets that may be invested other than in ELTIF eligible investment assets may only be invested in assets that are eligible assets for a UCITS to invest in (eg listed securities, money market instruments and short-term deposits). ELTIFs are required to publish a prospectus when marketing their units or shares and the prospectus must contain the information required to be disclosed both under Article 23 of the AIFMD and under the Prospectus Directive and Regulation as applied to collective investment undertakings of the closed-end type. Where marketed to retail investors, the PRIIPS Regulation (Regulation on Key Information Documents for Packaged and Insurance-based Investment Products) will apply and so a Key Information Document (KID) is required. Marketing will also be subject to MiFID II and ELTIFs will be categorised as complex products. In addition, the ELTIF Regulation makes it a condition for marketing ELTIFs to retail investors that retail investors are provided with 'appropriate investment advice' from the manager or distributor of the ELTIF.
It is worth noting that, in its consultation paper on the review of the Prospectus Directive published on 18 February 2015, the European Commission acknowledges that these multiple layers of disclosure requirements may create overlaps between the various information to be disclosed to investors under each of them and asks for views as to the extent to which the disclosure regime is appropriate and contributes to the achievement of 'the goal of channelling capital into long-term assets and projects and small- and medium-sized enterprise provides investors with little additional benefit'.
APPLICATION FOR AUTHORISATION AS AN ELTIF
An AIF can only use the designation 'ELTIF' when it has been authorised in accordance with the ELTIF Regulation. An application for authorisation as an ELTIF must be made to the competent authority in the jurisdiction in which the AIF is established and must include:
- the fund rules or instruments of incorporation
- information on the identity of the proposed manager (which must be an authorised full scope EEA AIFM) and its fund management experience and history
- information on the depositary; and
- a description of the information to be made available to investors
The competent authority must inform the applicant within two months from the date of submission of a complete application whether authorisation as an ELTIF, including approval for the proposed EU AIFM to manage the ELTIF, has been granted. Separately, the EEA AIFM must apply to the ELTIF's competent authority for approval to manage the relevant ELTIF. The AIFM's application must include the written agreement with the depositary and information on delegation arrangements regarding portfolio and risk management and administration. A self-managed ELTIF must apply simultaneously for authorisation as an ELTIF and as an AIFM under the AIFMD. The timeframe for authorisation of a self-managed ELTIF is three months from the date of submission of a complete application.
INVESTMENT POLICIES AND RESTRICTIONS
At least 70% of an ELTIF's capital must be invested in eligible investment assets, that is:
- equity or quasi-equity instruments issued by a qualifying portfolio undertaking
- debt instruments issued by a qualifying portfolio undertaking
- loans granted by the ELTIF to a qualifying portfolio undertaking with a maturity no longer than the life of the ELTIF
- units or shares of one or several other ELTIFs, EuVECAs and/or EuSEFs provided they have not themselves invested more than 10% of their capital in ELTIFs; and
- direct or indirect holdings via qualifying portfolio undertakings of individual real assets with a value of at least EUR 10m or its equivalent
Real asset for this purpose is defined as 'an asset that has value due to its substance and properties and may provide returns, including infrastructure and other assets that give rise to economic or social benefit, such as education, counselling, research and development, and including commercial property or housing only where they are integral to, or an ancillary element of, a long-term investment project that contributes to the Union objective of smart, sustainable and inclusive growth'.
A QUALIFYING PORTFOLIO UNDERTAKING IS:
- an undertaking other than a collective investment undertaking that is not a financial undertaking; investment in a financial undertaking is permitted provided it exclusively finances qualifying portfolio undertakings or real assets with a value of EUR 10m or more
- either: (i) not admitted to trading on a regulated market or on a multilateral trading facility; or (ii) is admitted to trading and has a market capitalisation of no more than EUR 500m
- established in an EEA member state or in a third country that is not a high risk and non-cooperative jurisdiction identified by Financial Action Task Force (FATF) and has signed an exchange of tax information with the member state of the ELTIF's AIFM and every member state in which the ELTIF will be marketed
The balance of the ELTIF's capital may only be invested in assets which are eligible assets under the UCITS Directive.
The investment limits do not have to be complied with until the date set out in the rules or instruments of incorporation but in any event five years after the date of authorisation or half the life of the ELTIF, whichever is earlier. They may also be temporary suspended when the ELTIF raises additional capital or reduces its capital, with the suspension lasting no longer than twelve months.
The ELTIF Regulation prohibits an ELTIF from undertaking any of the following:
- short selling of assets
- taking direct or indirect exposure to commodities, including via derivatives instruments, certificates or indices or by any other means or instrument that would give an exposure to commodities
- securities lending; securities borrowing; repurchase transactions or any other agreement which has an equivalent economic effect and poses similar risks, if this affects more than 10% of the ELTIF's assets
- using financial derivative instruments except for the sole purpose of hedging the risks inherent in the ELTIF's investments. The European Securities and Markets Authority (ESMA) is to draft regulatory technical standards specifying criteria for the use of financial derivative to hedge risks.
- No more than 10% of an ELTIF's capital may be invested in:
- instruments issued by or loans granted to a single qualifying portfolio undertaking
- directly or indirectly in a single real asset
- a single ELTIF, EuVECA or EuSEF (and an ELTIF may not acquire more than 25% of the units or shares of a single ELTIF, EuVECA or EuSEF)
- The aggregate value of units or shares of ELTIFs, EuVECAs and EuSEFs that the ELTIF invests in must not exceed 20% of the ELTIF's capital.
- No more than 5% of an ElTIF's capital may be invested in a UCITS eligible asset issued by a single body.
In a variation of the UCITS 5:10:40 Rule, the 10% limit may be increased to 20% provided that the aggregate value of the assets in which the ELTIF invests more than 10% does not exceed 40% of the capital of the ELTIF.
If there is a breach of the diversification requirements for reasons beyond the control of the AIFM, the AIFM must take such measures as are necessary to rectify the position within a appropriate period of time '... taking account of the interest of the ELTIF's investors'.
Borrowing is permitted if it is for investing in eligible investment assets (but not for making loans to qualifying portfolio undertakings); has a maturity no longer than the life of the ELTIF and encumbers assets that represent no more than 30% of the capital of the ELTIF. The prospectus must state whether or not the ELTIF intends to borrow.
CONFLICTS OF INTEREST
As ELTIF must not invest in an eligible investment asset in which the manager of the ELTIF has a direct or indirect interest other than by holding units or shares of the ELTIFs, EuSEFs or EuVECAs that it manages.
This would appear to prevent co-investment by different funds managed by the same AIFM. The recent extension of the original draft wording to include EuSEFs and EuVECAs is surprising as only sub-threshold AIFMs are eligible to manage EuSEFs or EuVECAs (although once eligible, they do not cease to be eligible once they become full scope AIFMs).
An ELTIF may offer new issues of units or shares in accordance with its constitution but shall not issue new units or shares at price below their net asset value without a prior offering of those units or shares at that lower price to existing investors in the ELTIF.
ELTIF must have a fixed-life with a termination date set out in its constitutional documents, which may provide for the right to extend temporarily the life of the ELTIF and the conditions for exercising such a right. The life must be consistent with the long-term nature of the ELTIF and should be sufficient in length to cover the lifecycle of each of the individual assets of the ELTIF, measured according to the illiquidity profile and the economic lifecycle of the asset and the stated investment objectives of the ELTIF. The ESMA is to develop draft regulatory technical standards specifying the circumstances in which the life of an ELTIF is considered sufficient in length to cover the lifecycle of each of the individual assets.
An ELTIF may regularly distribute to investors income generated from its assets and capital realised after the disposal of an asset. Income distributions may not be made where revenue is required for future commitments of the ELTIF. An ELTIF may reduce its capital by distributions on a pro-rata basis in the event of disposal of an asset before the end of the ELTIF's life provided such disposal is considered by the AIFM to be in the investor's interests.
Investors in ELTIFs are not permitted to request redemption of their units or shares until the day following the date of the end of the life of the ELTIF. However, by way of derogation, earlier redemption may be permitted if:
- at least five years have elapsed since incorporation or, if shorter, one half of the ELTIF's fixed-life
- the AIFM is able to demonstrate an appropriate liquidity management system and effective procedures for monitoring the liquidity risk
- the AIFM sets out a defined redemption policy
- the redemption policy ensures that the overall amount of redemptions within any given period is limited to a percentage of the ELTIF's non-eligible investment assets; and
- the redemption policy ensures that investors are treated fairly with redemptions granted on a pro-rata basis if the redemption requests exceed that percentage
Investors must always have the option to be repaid in cash even if the constitution permits repayment in kind.
An ELTIF must adopt an itemised schedule for the orderly disposal of its assets in order to redeem investors' units or shares after the end of the life of the ELTIF and must disclose this to its competent authority no later than one year before the ELTIF's termination date.
The schedule must include an assessment of the market for potential buyers and an assessment and comparison of potential sells prices for the assets, together with their valuation. The ESMA is to develop draft regulatory technical standards specifying the criteria to be used for the assessment of the market and the valuation.
The Regulation permits the units or shares of an ELTIF to be admitted to trading on a regulated market (the London Stock Exchange Main Market or the Specialist Fund Market in the UK) or on a multilateral trading facility. ((AIM) in the UK). In addition, investors must be able to freely transfer their units or shares to third parties other than the ELTIF AIFM. Where the units or shares are listed, the ELTIF must publish in its periodical reports the market value of the listed securities along with the net asset value per unit or share.
A prospectus is required before marketing an ELTIF and in addition where it is marketed to retail investors a Key Information Document (KID). The prospectus must include:
- all the information required of a closed-ended fund under the Prospectus Directive and Prospectus Regulation and under the AIFMD
- a prominent indication of the categories of assets and jurisdictions in which the ELTIF is authorised to invest in
- a clear statement about the illiquid nature of the ELTIF
- clear risk warnings
- a description of the hedging policy
The rules for instruments of incorporation of an ELTIF must be annexed to the prospectus. The prospectus must be provided in a durable medium or by means of a website and a paper copy shall be delivered to retail investors upon request and free of charge.
The ELTIF Regulation requires that the 'essential elements' of the prospectus shall be kept up to date even if there is no continuous share or unit issuance or marketing. This requirement will be familiar to the managers of authorised open-ended funds.
The prospectus must include clear costs disclosure and an overall ratio of costs to the capital of the ELTIF. Costs must be grouped as to:
- establishment costs
- costs relating to acquisitions and assets
- management and performance related fees
- distribution costs
- other costs including administrative, regulatory, depositary, custodial, professional service and audit costs
MARKETING TO RETAIL INVESTORS
The marketing passport to retail investors sets an ELTIF apart from other EU AIFs, which only have a passport for professional investors. However, there are additional requirements, which may make this less attractive.
- the establishment of a specific internal process for the assessment of the suitability for retail investors of the ELTIF before it is marketed or distributed to them
- the depositary must be a credit institution or equivalent and is not permitted to discharge its liability in the event of a loss of financial instruments held in custody by a third party even if caused by events beyond its reasonable control
- the legal form of an ELTIF marketed to retail investors must not require any additional commitments apart from the original capital commitment and must permit a retail investor during the subscription period and at least two weeks after the date of their subscription to cancel their subscription and have the money returned without penalty
- there must be appropriate procedures and arrangements to deal with retail investor complaints.
Facilities must be put in place in each Member State in which shares are to be marketed to retail investors making subscriptions, making payments, repurchasing or redeeming units and making available information. Retail investors must be provided with appropriate investment advice from the manager of the ELTIF or the distributor.
REACTION TO THE ELTIF REGULATION
Some interest in ELTIFs have been expressed by some asset managers, although the recent amendments to the Regulation as adopted by the European Parliament regarding retail investors make the ELTIFs rather less attractive. For AIFMs that are already marketing to institutional investors, it is difficult to see what ELTIFs have to offer in addition as the diversification requirements and borrowing restrictions on an ELTIF make it significantly less flexible that private equity or real estate limited partnership for example. However, there will be political pressure to promote ELTIFs and the fact that the investment restrictions do not confine investment to EEA-based assets is potentially attractive.
It will be entirely voluntary for asset managers as to whether or not they wish to establish and manage an ELTIF. If they wish to do so, they will have to comply with the ELTIF Regulation.
However, as only full scope AIFMs are eligible to manage ELTIFs, they will not be available to those EU AIFMs who take advantage of the AIFMD exemption for AIFMs who manage closed-ended funds with aggregate assets below the EUR 500m threshold.
It is relevant that Recital 31 of the ELTIF Regulation states that ELTIFs are conceived as an investment vehicle through which the European Investment Bank (EIB) can channel its European infrastructure or SME-financing. The possibility of having the EIB as a cornerstone investor might be a sufficient incentive.