07/12336725_2 DEBT FUNDS - BANKING AND FINANCE BRIEFING ELTIF - EUROPEAN LONG-TERM INVESTMENT FUNDS – THE FIRST STEP IN THE POSSIBILITY FOR DEBT FUNDS TO GRANT LOANS IN FRANCE Following the publication of its guide on European long-term investment funds ("ELTIF") on 21 January 2016, on 1st April 2016 the French Autorité Des Marchés Financiers ("AMF") published the results on its public consultation launched in October 2015 regarding the possibility for investment funds to grant loans and its proposal to the French government. The EU Regulation 2015/760 of 29 April 2015 on European long-term investment funds (the "ELTIF Regulation") is in force since 9 December 2015 in all EU member states. ELTIF is a label for alternative investment funds ("AIF") whose purpose is, inter alia, to provide financing to companies investing in the real economy and businesses needing long term financing. ELTIFs can be marketed in the EU for both institutional investors and retails. French law n°2015-1786 of 29 December 2015 has echoed the possibility for ELTIFs to grant loans to French companies by exempting ELTIFs from the so-called French banking monopoly rules pursuant to which only duly licensed credit institutions or financial companies may grant loans on a regular basis. The provisions of the ELTIF Regulation have inspired the AMF. The next step is to now implement a consistent and efficient legislation in France allowing debt funds to grant loans in France alongside with the ELTIF Regulation. Other exemptions to the French banking monopoly rules are likely to follow. 1. ELTIF at a glance As emphasised by the EU Commission1 , ELTIF (or FEILT in French): • benefits from a European label for AIFs that are cumulatively subject to the ELTIF Regulation and the relevant AIF national applicable rules; • shall invest at least 70% of its capital in long term debt instruments, equity or quasi-equity instruments; • may only be managed by an asset manager who is authorised under the AIFM Directive (the "AIFMD"); • operates under the AIFMD regime as a category of authorised closed-ended funds; and 1 FAQ on ELTIF published by the Commission on 13 February 2015. APRIL 2016 Paris Table of Contents 1. ELTIF at a glance 1 2. Asset side 2 3. A wide audience: retail and professional investors 3 4. A close-ended fund 4 5. AMF Public Consultation outcome 4 6. Other forthcoming factors that will play a decisive role for the success of ELTIFS 5 LINK Herbert Smith Freehills DEBT FUNDS - BANKING AND FINANCE BRIEFING – APRIL 2016 HERBERTSMITHFREEHILLS 2 07/12336725_2 • is intended to operate cross border and benefits from a European passport to be marketed near both institutional and/or retail investors across Europe. ELTIF IS A NEW LABEL FOR ALTERNATIVE INVESTMENT FUNDS An ELTIF is not a 'new' category of fund but rather an attractive European "label" that some AIFs (and only AIFs) can request. Any ELTIF shall be managed by asset managers authorised under the AIFM Directive and established in the EU2 (by opposition to asset managers of AIF not located in the EU). As a reminder, the AIFM Directive puts in place a stringent set of rules for the managers of AIFs (such as requirements on custodians, valuation, mechanisms to deal with conflicts of interest and disclosure of information to investors). In practice, existing AIF asset managers that already comply with the AIFM Directive may, if they already have an appropriate team of loan analysts, request the ELTIF "label" for existing AIFs which today invest in loans to lend directly to companies rather than to acquire credit claims from credit institutions or other funds. ELTIFs shall comply at all times with (i) ELTIF Regulation, (ii) AIFMD and (iii) national rules applicable to its legal form. ELTIFs are prohibited from changing their form into a UCITS or any other collective investment undertaking not covered by ELTIF Regulation3 . In France, French AIFs that would be "ELTIF eligible" are Organismes de titrisation (OT), i.e. French securitisation vehicles, fonds professionnels de capital investissement (FPCI), fonds professionnels spécialisés (FPS), organismes de titrisation (OT), organismes professionnels de placement collectif immobilier (OPCI), Fonds d'Investissement de Proximité (FIP), Fonds Commun de Placement à Risques (FCPR), Fonds Communs de Placement dans l'Innovation (FCPI), sociétés civiles de placement immobilier (SCPI) and sociétés d’épargne forestière (SEF). French securitisation vehicles are particularly tailored for the ELTIF "label"4 . 2. Asset side ELIGIBLE INVESTMENT PORTFOLIO One of the main purposes of the ELTIFs is to invest in long-term assets that are by nature illiquid and difficult to value. ELTIFs shall invest at least 70% of their capital in the following eligible investment assets5 : • equity or quasi-equity instruments issued by a "qualifying portfolio undertaking", i.e. eligible companies mentioned in the ELTIF Regulation (see below); • all eligible assets in which UCITS may invest6 , such as transferable securities, money market instruments, financial derivative instruments, units of UCITS, etc…; • debt instruments issued by eligible companies; • loans granted to eligible companies with a maturity no longer than the life of the ELITF; • units or shares of another ELTIF, EuVECA (European Venture Capital Funds)7 , EuSEF (European Social Entrepreneurship Funds)8 , subject to concentration limits; and • individual "tangible" assets with a value of at least Euro 10.000.000 (or its equivalent in the relevant currency). 2 See Article 4 of the AIFM Directive for the definition of an EU AIFM; Recital (9) about the EU dimension of the ELTIF. 3 Recital (11) and Article 4 of the ELTIF Regulation. 4 For a detailed description of French Securitisation Organisms, see our client briefing published in 2015 which can be found here. 5 Recital (14) and Article 9 of the ELTIF Regulation for more details on eligible investment portfolio. 6 The ELTIF Regulation cross refers to article 50(1) of the Directive 2009/65/EC in this respect. 7 Regulation (EU) 345/2013 of the European Parliament and the Council adopted on 17 April 2013 related to European Venture Capital Funds. An EuVECA (European Venture Capital Fund) is a European label created by the European Commission for all asset managers that manage venture capital funds (only AIF). To use the fund label, funds will have to prove that 70% of the capital received from investors) are spent in supporting young and innovative companies. 8 Regulation (EU) 346/2013 of the European Parliament and the Council adopted on 17 April 2013 related to European Social Entrepreneurship Funds. Asset managers of social entrepreneurship funds can use this label and market their funds across the whole EU if their funds prove that a high percentage of investments (70% of the capital received from investors) are spent in supporting social businesses. DEBT FUNDS - BANKING AND FINANCE BRIEFING – APRIL 2016 HERBERTSMITHFREEHILLS 3 07/12336725_2 As reminded by the AMF, an ELTIF shall not derogate to the rules applicable to its legal form and shall comply with the activity programme of its asset manager. If a special form of vehicle shall invest mainly in real estate assets, the obtaining of an "ELTIF label" will not allow such vehicle to invest mainly in non-real estate assets. Article 10 of the ELTIF Regulation specifies that an "eligible company" (other than a collective investment undertaking): • is not a financial company; • is a company that: o is not admitted for trading on a regulated market or a multilateral trading facility (unlisted companies); or o is admitted for trading on a regulated market or on a multilateral trading facility and its capitalisation shall not be more than Euro 500,000,000; • is a company that is located in a EU Member State or in a third country not listed by FAFT9 ; or • is a financial company that finances eligible companies or eligible assets of at least Euro 10,000,000. Eligible companies are, accordingly, not limited to EU companies. It should also be noted that the definition of "assets" in the ELTIF Regulation circumvents the possibility for ELTIFs to hold commercial property or housing if such assets are not linked with a long-term financing project. The rationale of this definition is to prevent ELTIFs from having a speculative activity in the real estate area for example. PORTFOLIO DIVERSIFICATION Article 13(2) of the ELTIF Regulation provides that an ELTIF shall not invest more than: • 10% of its capital in instruments issued by, or loans granted to, any single eligible company; • 10% of its capital in units or shares of any single ELTIF, EuVECA or EuSEF; and • 5% of its capital in eligible assets in which a UCITS may invest where those assets have been issued by any single body. INVESTMENT PROHIBITIONS Article 9(2) of the ELTIF Regulation provides that an ELTIF shall not undertake any of the following activities: • short selling assets; • taking direct or indirect exposure to commodities including via financial derivative instruments, certificates representing them, indices based on them or any other means or instrument that would give exposure to them; • entering into securities lending, securities borrowing and repo transactions or any other agreement which has an equivalent economic effect and poses similar risks if thereby more than 10% of its assets are affected; and • using financial derivative instruments except where it solely serves the purpose of hedging risks related to its other investments. 3. A wide audience: retail and professional investors There are no restrictions regarding the type of investors which may invest in ELTIFs. Both retail and professional investors are targeted by the ELTIF Regulation. Professional investors include professional clients10 such as credit institutions, investment firms, insurance companies, pension funds, management companies, etc, and clients who request to be considered as a professional investor11. 9 FATF (Financial Action Task Force: GAFI) intergovernmental body that promote guidelines to fight anti-money laundering and terrorist financing. 10 In accordance with the Annexe I of the MIFID 2 Directive 2014/65/EU. 11 In accordance with the Annexe II of the MIFID 2 Directive 2014/65/EU. DEBT FUNDS - BANKING AND FINANCE BRIEFING – APRIL 2016 HERBERTSMITHFREEHILLS 4 07/12336725_2 Retail investors will also have the opportunity to invest their savings in long-term strategic projects through ELTIFs. The ELTIF Regulation provides a "minimum entry ticket" of Euro 10,000 for retail investors investing in an ELTIF when the investment capabilities of such retail in financial instruments do not exceed Euro 500,000, and provided further that such investment does not exceed 10% of the financial portfolio of such retail. The ELTIF Regulation also provides additional requirements in respect of the marketing of ELTIFs with retails investors. In this respect, ELTIFs shall adopt the format of the Key Investor Information Document (KIID) and shall provide a comprehensive prospectus enabling investors to make an informed assessment of the locked-up principle of the ELTIF12. Asset managers shall also provide adapted investment advice to retail investors13. In addition, asset managers of ELTIFs shall provide a three-page Key Investor Information Document (a KIID which fulfils the PRIIPs Regulation14 requirements, as the European Commission considers the ELTIF as a Packaged Retail Investment Product (PRIIP)). 4. A close-ended fund Unlike UCITS (open-ended funds) rules that allow shareholders or unitholders to get their money back at any time during the UCITS life, an ELTIF is dedicated to long-term projects and shall cover the lifecycle of assets in which such ELTIF invests. The ELTIF Regulation therefore provides that investors in an ELTIF shall not be able to request redemption of their units or shares before the contractual maturity of the ELTIF15, except in limited cases. Article 21 of the ELTIF Regulation provides that any ELTIF shall specify in a schedule the orderly disposal of its assets in order to redeem investors' units or shares at maturity. Such schedule shall provide valuation rules (which are important for non-liquid assets). A consultation on draft regulatory technical standards made by ESMA (in order to complete such valuation rules) has been made but no regulatory technical standards have yet been taken further to such consultation. 5. The AMF Public Consultation outcome The AMF released on 1st April 2016 the results of its public consultation launched in October 2015 to which 26 market participants (including us) have answered (the "AMF Public Consultation"). The AMF has made some proposals to the French government. According to the AMF publication, the AMF will use these proposals to constitute its own doctrine on ELTIF. The proposals are: (i) as a general rule, the AMF wishes that rules allowing investment funds to grant loans provide equivalent principles between different lenders through a clear and secured legal framework, taking into account the economic models of each entity involved; (ii) only AIF management companies could manage funds that would be able to grant loans, provided further that such management companies have a specific activity programme for such purpose that the AMF shall approve (having regard, on a case by case basis, to the means that such AIF management companies will dedicate to the activity of granting loans); (iii) non-French management companies that manage French funds for which the granting of loans is envisaged shall obtain prior authorisation from their national regulator; (iv) the fonds professionnels spécialisés (FPS), the organismes de titrisation (OT) and the fonds professionnels de capital investissement (FPCI) would be the only type of funds that could grant loans (all of the above mentioned funds could also obtain the ELTIF label); (v) when loans granted by a fund represent more than 10% of the net assets of the fund, the following requirements shall apply : - loans shall only be granted to non-financial companies and shall have a maturity inferior to the life of the fund; - the use of leverage to lend shall be prohibited, i.e. the borrowing for the funds shall not be used to finance loans granted by the funds; - no use by funds of short selling, repos or derivatives save for the hedging of exchange risks; and 12 Article 23 and 24 of the ELTIF Regulation. 13 Article 30 of the ELTIF Regulation. 14 (PRIIPs) Packaged Retail and Insurance-based Investment Products Regulation (EU) 1286/2014 adopted by the European Parliament and the Council on 26 November 2014. 15 Recital (34), (36) and Article 18 of the ELTIF Regulation. DEBT FUNDS - BANKING AND FINANCE BRIEFING – APRIL 2016 HERBERTSMITHFREEHILLS 5 07/12336725_2 - loans shall be granted with view to be kept by the funds, i.e. the transfer of loans shall be limited so as to avoid the "originate to distribute" model; (vi) management companies that manage funds granting or acquiring loans shall be able to directly recover the credit claims from obligors; and (vii) management companies that manage funds granting loans shall make a statement on a quarterly basis to the AMF and the Banque de France on all loans that have been granted (for follow up purposes by French authorities). The position of the AMF described above is largely inspired by the ELTIF Regulation. However, the AMF has required some elements that are not in the ELTIF Regulation such as (i) the limitation to lend only to non-financial companies when loans granted represent more than 10% of the net assets of the fund, and (ii) the restriction to transfer loans once originated when loans granted represent more than 10% of the net assets of the fund. Practitioners have emphasised that the AMF shall not add burdensome local regulation to the ELTIF Regulation that would make the Paris marketplace unattractive. The AMF mentioned in the AMF Public Consultation that it is aware of practitioners' requirements but the requirement of the quarterly statements of loans made by funds mentioned in (vi) above is an indication that the French authorities do not wish for the emergence of an alternative banking activity by funds without any supervision. 6. Other forthcoming factors that will play a decisive role in the success of ELTIFS PROFESIONNAL INVESTORS: SOLVENCY II CAPITAL REQUIREMENTS Insurance companies are major investors in infrastructure financing: the capital requirements rules that apply to them have a major influence on whether or not they will invest in long term investments16. The EU Commission has accordingly decided to change the rules under Solvency II to give insurance companies better incentives to invest in infrastructure projects. It is currently contemplated to amend the Solvency II Delegated Regulation17 in order to allow investments by insurance companies in ELTIFs to benefit from lower capital charges under Solvency II. RETAIL INVESTORS: EXTRA INCENTIVES? ELTIFs are AIFs that will benefit from the European passport for retail investors. This is a material feature of ELTIFs. Tax incentives and more flexible redemption policy will certainly be needed to definitely make ELTIFs attractive for retail investors. This has been clearly raised by several participants of the AMF Public Consultation. A good balance shall be found between the protection of retail investors and the long-term nature of investments in this respect. NEXT STEPS French law n°2015-1786 of 29 December 2015 has expressly exempted ELTIFs from the so-called 'French banking monopoly rules' pursuant to which only duly licensed credit institutions or financial companies may grant loans on a regular basis. The AMF has also stated that the French Règlement Général de l'AMF will be updated to be consistent with the ELTIF Regulation. However, French law still needs to be updated to give the means to ELTIFs to really act as an original lender/originator in practice as described in the AMF Public Consultation. In this respect, the AMF is in discussions with the French government which is expected to publish a decree that shall establish a revised legal framework allowing investment funds to originate loans in France in the coming weeks. This forthcoming decree is anticipated by practitioners to give debt funds real means to finance the socalled real economy alongside with credit institutions and not only to refinance it. 16 See the Fact Sheet of the European Commission n 30 September 2015, "New EU Rules to promote investments in infrastructure projects". 17 Commission Delegated regulation (EU) 2015/35 of 10 October 2014 on the taking-up and pursuit of the business of Insurance and Reinsurance. DEBT FUNDS - BANKING AND FINANCE BRIEFING – APRIL 2016 HERBERTSMITHFREEHILLS 6 07/12336725_2 Similarly to French fonds de prêt à l'économie18, the most appropriate vehicle in France for ELTIFs will probably be French securitisation vehicles19. French securitisation vehicles already have common features with the ELTIF Regulation (such as investors in the securitisation vehicles not being able to request the repayment of their units/notes). In addition, French legislation on securitisation vehicles already provides a great flexibility for French securitisation vehicles to acquire a wide type of assets20. Discussions amongst organisations in charge of promoting and developing the Paris financial marketplace are taking place to, inter alia, amend French securitisation law so as to allow the possibility for securitisation vehicles to: (i) apply for the ELTIF regime and grant loans in addition to their capacity to acquire credit claims that have been already originated by credit institutions; (ii) recover themselves the receivables they acquire or originate (i.e. without the need for its management company to appoint a servicer)21; (iii) benefit from security interests that may be only granted to credit institutions for the time being (in particular the assignment of receivables by way of security under the "Dailly law" regime set forth in articles L. 323-13 et seq. of the French Code monétaire et financier); and (iv) allow fonds commun de titrisation to opt for a legal personality (personnalité juridique) to benefit, inter alia, from double tax treaties or own physical assets in all jurisdictions in order to promote FCTs for cross border financings22. 7. Contacts Vincent Hatton, Partner T +33 1 53 57 70 85 M +33 6 78 77 97 72 firstname.lastname@example.org Vincent Danton, Senior Associate +33 1 53 57 74 14 +33 6 31 83 27 14 email@example.com 18 See our client briefing which can be found at the following link: http://herbertsmithfreehills.com/insights/legal-briefings/fonds-de-prets-aleconomie 19 See our client briefing which can be found here. 20 Even on at European level, securitisation vehicles appear as an innovative financial tool to collect capital for lending. On 31 March 2016, the European Commission, the European Investment Fund and the European Investment Bank launched the SME Initiative Securitisation Instrument (SISI) which will allow SMEs to access to finance at favourable pricing and will contribute to stimulate economic growth in the whole internal market. 21 As explained above, the AMF made an equivalent proposal on 1st April 2016. 22 French securitisation companies are not as flexible as French FCTs can be and their tax regime remains unfortunately uncertain. 07/12336725_2 7 If you would like to receive more copies of this briefing, or would like to receive Herbert Smith Freehills briefings from other practice areas, or would like to be taken off the distribution lists for such briefings, please email firstname.lastname@example.org. © Herbert Smith Freehills LLP 2016 The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on the information provided herein.