As reported in the December issue of our Funds ezine the European Parliament has reached political agreement with the Council of the EU on the proposed Regulation on European Long-term Investment Funds (ELTIF Regulation).

We have set out below a summary of the agreed draft.

Introduction

ELTIFs are designed to boost non-bank investment in the real economy across Europe. They will help pension funds, insurance companies, professional and even retail investors (if they are willing to invest at least €10,000 for the long term, whether in one or more ELTIFs) to invest in: (a) SMEs (both listed and unlisted); and (b) infrastructure projects, based within or outside the EU, provided that such investment benefits the EU economy.

Only an EU alternative investment fund (AIF) is eligible to become an authorised ELTIF and only then if it is managed by an EU alternative investment fund manager (AIFM). There is no mechanism allowing for the conversion of a UCITS to an ELTIF. However, it will be possible for a UCITS to invest in shares or units issued by an ELTIF to the extent that the relevant ELTIF’s shares or units are eligible assets for the purposes of the UCITS Directive.

Marketing of ELTIFs to retail investors

The draft Regulation contains a list of conditions that will apply to ELTIFs marketed to retail investors. For example, the manager or distributor of any such ELTIF must obtain all necessary information regarding a retail investor’s knowledge and experience, financial situation, risk appetite, investment objectives and time horizon in order to assess whether the ELTIF is suitable for marketing to that retail investor, taking into account, inter alia, the lifecycle and the intended investment strategy of the ELTIF. In addition, the depositary of such an ELTIF must comply with the provisions of the UCITS V Directive as regards the eligible entities that are permitted to act as depositaries, the depositary liability regime and the conditions applicable to the reuse of assets.

Eligible investments

An asset shall be eligible for investment by an ELTIF only where it falls into one of the following categories:

  • Equity instruments issued by a qualifying portfolio undertaking (as defined below)
  • Quasi-equity instruments issued by a qualifying portfolio undertaking, such as subordinated loans, participating loans, profit participating rights, convertible bonds and bonds with warrants
  • Debt instruments issued by a qualifying portfolio undertaking
  • Loans granted by the ELTIF to a qualifying portfolio undertaking where the loan has a maturity no longer than the life of the ELTIF
  • Units or shares of one or several other ELTIFs, European Venture Capital Funds (EuVECAs) and European Social Entrepreneurship Funds (EuSEFs)
  • Direct holdings or indirect holdings via qualifying portfolio undertakings of individual “real assets” with a value of at least €10 million. The draft Regulation states that real assets include, but are not limited to, infrastructure, intellectual property, vessels, equipment, machinery, aircraft or rolling stock and commercial or residential property.

Qualifying portfolio undertaking

A qualifying portfolio undertaking is an entity that fulfils all of the following requirements:

  • It is not a credit institution, MiFID investment firm, insurance undertaking, financial holding or mixed activity company, UCITS management company or AIFM
  • It is not admitted to trading on a regulated market or multilateral trading facility (each as defined in MIFID II) or it is admitted to trading on a regulated market or multilateral trading facility but has a market capitalisation of less than €500 million

Companies in the same group for the purposes of consolidated accounts shall be regarded as a single qualifying portfolio undertaking.

Portfolio composition and diversification

An ELTIF may not short sell, invest directly or indirectly in commodities or invest more than 10% of its capital in securities lending, securities borrowing, repurchase agreements or reverse repurchase agreements. The aggregate risk exposure of an ELTIF to a repo counterparty shall not exceed 5% of its capital.

An ELTIF must invest at least 70% of its capital in the eligible investments listed above. However, the application of this requirement may be deferred to a date that is 5 years or half the life of the ELTIF (whichever is the earlier) after the date of authorisation of the ELTIF. In exceptional circumstances, the competent authority of the ELTIF may approve an extension of this time limit by an additional twelve months.

An ELTIF shall invest no more than:

  1. 10% of its capital in instruments issued by or loans granted to any single qualifying portfolio undertaking
  2. 10% of its capital directly or indirectly in a single real asset
  3. 10% of its capital in units or shares of any single ELTIF, EuVECA or EuSEF. The aggregate value of units or shares of ELTIFs, EuvECAs and EuSEFs in an ELTIF portfolio shall not exceed 20% of the value of the ELTIF’s capital. In addition, an ELTIF may acquire no more than 25% of the units or shares of a single ELTIF, EuVECA or EuSEF
  4. 5% of its capital in assets which may be invested in by a UCITS, as listed in Article 50(1) of the UCITS Directive, where those assets have been issued by a single issuing body. Companies in the same group for the purposes of consolidated accounts shall be regarded as a single issuing body. The UCITS diversification limits also apply in this context so that an ELTIF may acquire no more than: (i) 10% of the non-voting shares of a single issuing body; (ii) 10% of the debt securities of a single issuing body; or (iii) 10% of the money market instruments of a single issuing body

An ELTIF may raise the 10% limit referred to in (a) and (b) above to 20%, provided that the aggregate value of the assets held by the ELTIF in qualifying portfolio undertakings and in individual real assets in which it invests more than 10% of its capital does not exceed 40% of the value of its capital.

An ELTIF may raise the 5% limit referred to in (d) to 25% in the case of bonds issued by an EU credit institution.

Investment in derivatives

ELTIFs may only use derivatives for hedging purposes. The aggregate risk exposure to a counterparty of the ELTIF stemming from over the counter (OTC) derivative transactions shall not exceed 5% of its capital.

Borrowing

An ELTIF may borrow cash provided that such borrowing fulfils all of the following conditions:

  • It represents no more than 30% of the capital of the ELTIF
  • It serves the purpose of investing in eligible investments (with the exception of loans granted by the ELTIF to a qualifying portfolio undertaking) provided that the holdings in cash or cash equivalents of the ELTIF are not sufficient to acquire the eligible investment
  • The borrowed cash is denominated in the same currency as the assets to be acquired
  • It has a maturity no longer than the life of the ELTIF
  • It encumbers the assets that represent no more than 30% of the capital of the ELTIF

Redemption

Investors in the ELTIF may not redeem their units or shares before the end of life of the ELTIF unless all of the following conditions are fulfilled:

  • Redemptions are not granted before the date specified in the ELTIF’s constitutive document.
  • The investment manager of the ELTIF has put in place an appropriate liquidity management system, effective procedures for monitoring the liquidity risk of the ELTIF and a defined redemption policy.
  • The redemption policy of the ELTIF ensures that: (i) the overall amount of redemptions within any given period is limited to a specified percentage of the ELTIF’s assets; and (ii) investors are treated fairly and redemptions are granted on a pro rata basis where necessary.

Trading of ELTIFs on a secondary market

The draft Regulation provides that the shares or units of an ELTIF may be admitted to trading on a regulated market or multilateral trading facility, thus providing investors with an opportunity to sell their units or shares before the end of life of the ELTIF.

Next steps

The text of the ELTIF Regulation agreed between the Parliament and the Council still needs to be endorsed by the Parliament's Committee on Economic and Monetary Affairs and the full Parliament. However, it is anticipated that the agreed text will be immediately approved by the ECON Committee and the Parliament. The ELTIF Regulation shall then enter into force on the twentieth day following its publication in the Official Journal of the EU and shall apply from six months after its entry into force. The ELTIF Regulation shall be binding in its entirety and directly applicable in all Member States.