On 10 March 2015, the European Parliament ratified the Regulation on European Long-Term Investment Funds (ELTIF Regulation). The ELTIF Regulation envisages a new category of collective investment vehicle, known as a European Long-Term Investment Fund (ELTIF). ELTIFs will facilitate investment in unlisted companies and projects that require long-term capital, such as infrastructure or transport projects, as well as private equity and intangible assets, such as research and development projects.
Long-term investment is regarded as important for economic growth, stability, and job creation and the policy intention is to open up the private sector as a funding source for the European real economy and address the lack of funding for these projects caused by banks' reluctance to lend. Currently, private investment into these asset classes is limited. This is thought to be due to the lack of a standard framework enabling and encouraging this type of investment and to the illiquidity of the underlying assets, which makes them unsuited to many existing fund structures. The ELTIF Regulation is designed to put in place such a standard framework across Member States.
ELTIFs are intended to attract a wider pool of private sector investors in longer-term asset classes. In particular, corporate and smaller pension funds are seen as likely to invest in ELTIFs. Although their investment mandates may currently rule out the use of Alternative Investment Funds (AIFs) (which may be seen as too high-risk) or preclude direct investment in such assets, the social aspect of the ELTIF together with the regulated structure of an ELTIF could provide a market for smaller scale funds and investors.
Fund managers should be aware that an ELTIF’s investment strategy will be restricted by the ELTIF Regulation.
ELTIFs will be subject to uniform rules on investment (Articles 9 -11 ELTIF Regulation), diversification (Article 13) and concentration (Article 15).
Specifically and in summary:
- an ELTIF will have up to five years to invest at least 70% of its capital in the principal class of eligible investment assets, with a maximum of 10% of its capital in any one eligible investment.
- Eligible investments are described in the ELTIF Regulation as including:
- equity or quasi-equity instruments, debt instruments, or loans in each case issued or granted by a “qualifying portfolio undertaking” (as defined in Article 11);
- certain direct (and prescribed indirect) holdings of individual real assets that require upfront capital expenditure of at least €10m;
- units or shares in other ELTIFs, EuVECAs and EuSEFs (subject to those second schemes having a restriction on the level of their capital investment in ELTIFs)
- Eligible investments are described in the ELTIF Regulation as including:
- if the full capital of the ELTIF has not been invested in eligible investment assets, the remaining 30% of capital may be invested in assets included in Article 50(1) of the UCITS IV Directive.
- This includes investment in transferable securities, units in other collective investment schemes, deposits and approved money markets.
- an ELTIF may only borrow up to 30% of its capital in cash (and subject to certain other conditions).
- an ELTIF may not:
- invest in speculative assets;
- undertake short selling of assets;
- enter into securities lending, securities borrowing or repos; or
- use financial derivative instruments except where it serves the purpose of hedging risks inherent to other investments of the ELTIF.
Redemption of Units or Shares
ELTIFs will generally not redeem units or shares before the end of their life-span, which will be determined by the life-span applicable to the assets of the ELTIF. However, an ELTIF's rules/instrument of incorporation may provide that units or shares are freely transferable. If permitted by the ELTIF's rules/instrument of incorporation and indeed its chosen structure, an ELTIF's shares may be listed on a regulated exchange to provide exits prior to the end of the life of the fund.
Primarily for the protection of retail investors the European Parliament and the Council of the European Union agreed on redemption rules that would allow an ELTIF with enough liquid assets to release funds back to investors at their request. The manager of an ELTIF has the discretion to decide whether to add redemption rights, in accordance with the investment strategy. When redemption rights are in place, those rights should be clearly disclosed in the instrument or rules of the ELTIF.
STRUCTURE AND MARKETING
ELTIFs will be closed-ended and may be listed or unlisted.
They will be AIFs under the EU Alternative Investment Fund Managers Directive (AIFMD) and must be both incorporated in the EEA and managed by an authorised EEA AIFM. Managers will also need to comply with rules relating to marketing, typically those applicable to a listed product, and transparency rules equivalent to those contained in AIFMD. A prospectus, under the Prospectus Directive including Annex XV of the Prospectus Regulation, will be required. Those used to dealing with listed funds will be familiar with the disclosure requirements applicable to closed-ended funds and this expertise will now be potentially transferable to other products. As stated in Article 24(1) of the ELTIF Regulation, the prospectus must be sent to the competent authority. The rules and instrument of incorporation form an integral part of the prospectus, and are to be included in the prospectus as an annex.
ELTIFs may be marketed on a pan-European basis by an EU AIFM under an AIFMD marketing passport to both professional and retail investors. This is more permissive than the AIFMD passporting regime, which provides for a marketing passport in respect of professional investors only.
Marketing to Retail Investors
The rules permitting marketing to retail investors are heavily restricted by a minimum investment threshold and suitability requirements. A retail investor with a portfolio of up to €500,000 may not invest an aggregate amount exceeding 10% of their portfolio in ELTIFs, subject to an initial minimum amount invested in one or more ELTIFs being not less than €10,000. Furthermore, the ELTIF manager or distributor will be required to undertake suitability tests for retail investors and to provide the investors with "appropriate investment advice". At debate, the European Parliament inserted specific provisions into the ELTIF Regulation to ensure that retail investors putting their money into a fund are properly informed of the implications of their investment and are afforded additional protections.
If marketed to a retail investor, an ELTIF would be presented as a Packaged Retail and Insurance-based Investment Product (PRIIP) and will be required to have a Key Information Document (KID), setting out the features and the risks. The primary risk for retail investors is the length of time their investment could be locked away in the ELTIF, which may potentially be inaccessible until the end of the ELTIF's life.
NEXT STEPS AND COMMENTS
Following its ratification in the European Parliament, the ELTIF Regulation now must be officially endorsed by the Council, and the rules will apply 6 months after their entry into force.
ESMA will be issuing rules on subscription and redemption and more stringent requirements applicable to ELTIFs which are marketed to retail investors. Much of this detail is expected from ESMA within the next year as the legislative process progresses.
From a UK perspective, there is no guarantee that an ELTIF could be marketed meaningfully to retail investors in the UK. The primary issue is that there is no obvious structure for the ELTIF to adopt. A limited partnership would currently be most likely classed as a collective investment scheme and subject to significant restrictions on marketing to retail investors, whilst a body corporate, even a listed investment trust, would likely fail to provide a tax efficient structure. In order to address some of these issues, both HM Treasury and the FCA may be expected to consult on legislative and regulatory amendments. The outcome of such a consultation will be dependent on industry engagement and support for ELTIFs. While one might expect government support, given the desire to promote the UK as an asset management centre, without the support of the industry, ELTIFs may not receive significant UK Government attention and resource, particularly given the possibly significant changes to the political landscape this year.
The level of industry support will depend on how successfully the industry anticipates ELTIFs operating in the market. ELTIFs may appeal to managers experienced in infrastructure and regeneration projects and investors, such as smaller pension schemes, who ordinarily cannot invest directly in such projects due to the high level of project commitment. The key feature of the ELTIF scheme is that it is intended to appeal to retail investors seeking a route to invest in projects requiring long term funding. The European Parliament demonstrated that they anticipate uptake by retail investors by adding protections for retail investors at debate on 10 March 2015. However, due to the minimum investment requirements, many retail investors with an interest in this area of investment are likely to have already found a route into such an investment. In practice, the group of investors who would be thought likely to invest may not be as large as predicted.
The tax status of ELTIFs, hopefully tax transparent or exempt, is still to be confirmed, and will be dependent on the structure decided upon. The EU Commission has indicated that in order to ensure the ELTIF’s proper functioning, it will assess any potential barriers that may restrict the raising of long-term capital across borders, including barriers that arise from the tax treatment of such investments.
Fund managers should monitor this legislative progress and any opportunity to contribute towards a consultation, and bear in mind that ELTIFs may be an attractive form of investment for their investors looking for long-term investment returns generated by certain alternative sectors, as well as being a scheme open to retail investors.