European Long-Term Investment Funds (ELTIFs) were created by the EU to facilitate investment by both professional and retail investors into companies and projects which require long-term capital, such as SMEs, infrastructure, real estate, research and development. However, the uptake on ELTIFs has been lacklustre.
The EU is currently reviewing this regime with a focus on how to improve it and increase its popularity. Upon the UK's withdrawal from the EU, the ELTIF will exist in the UK in the form of a Long-Term Investment Fund (LTIF). This could also provide a welcome opportunity to revamp the regime. It will be interesting to see whether both the UK and the EU are successful in their quest, and how closely the two regimes resemble each other at the end of that journey.
When the Regulation on European Long-Term Investment Funds (the ELTIF Regulation) came into force on 8 June 2015, it aimed to improve non-bank investment in the European economy, fill a gap in the regulatory framework for long-term investment into "real assets" and consequently build the capital markets union, a key tenet of the EU's economic agenda.
To qualify as an ELTIF, an investment fund must:
- invest at least 70% of its capital in prescribed types of assets. An ELTIF is only able to invest in unlisted or small companies needing long-term capital, real assets that need long-term capital to develop them, and funds regulated under the EuVECA Regulation or the EuSEF Regulation;
- be subject to various diversification requirements and strict limits on gearing (at 30% of the value of its capital, in the same currency as the asset into which the borrowing is invested) and use of derivatives;
- be an EU-domiciled AIF offered by a manager who is authorised under the AIFM Directive (AIFMD). In addition, the fund itself needs to be authorised in its home member state. The ELTIF can be internally managed; and
- be closed-ended, with a specific "end of life" date (linked to the lifecycle of the assets of the fund) before which investors are generally not allowed to redeem their units or shares in the fund. However, to incentivise investment by retail investors, the ELTIF Regulation provides a limited exception to this rule, where redemption is permitted within a defined redemption policy which treats investors fairly and where the manager can demonstrate effective liquidity risk management.
Given the ELTIF's focus on retail investors, another key feature is that before the fund is marketed it is required to publish a prospectus complying with the Prospectus Regulation and content requirements set out in the ELTIF Regulation. Additional safeguards are required to be met before the fund can be marketed to retail investors. Finally, ELTIFs benefit from the EU marketing passport under AIFMD, meaning that a manager of an ELTIF can market the fund into host EU member states so long as the notification process in AIFMD has been followed.
Whilst well intentioned, since the adoption of the ELTIF regime only around 28 ELTIFs have been established with a low asset base of less than €2 billion.
On 19 October 2020, the European Commission (the Commission) launched a consultation on the ELTIF Regulation, which will close in January 2021. The preliminary feedback from the Commission's Inception Impact Assessment (theIIA) on the ELTIF Regulation raised three main focus areas:
- removing limitations on the supply side by improving the fund structuring and eligible assets related aspects of the ELTIF framework, with stakeholders calling for the inclusion of other asset types and investments in a wider range of funds;
- reducing the demand side barriers to investment (with a focus on retail investors, including the limited redemption rights, but also the institutional investor base); and
- introduction of incentives by member states to promote ELTIF investment, such as tax reliefs.
There have also been calls for the revised ELTIF regime to place stronger emphasis on environmental, social and governance (ESG) policies. It will be interesting to see how the strong ESG agenda is reflected in the improved ELTIF Regulation.
We await to see what developments will be made to the ELTIF Regulation but, as these will take place after the UK's withdrawal from the EU, the UK will have to make decisions as to how far to adopt those changes in its own equivalent regime, or whether any improvements the UK makes will serve to distinguish it from the EU regime.
The UK's Long-Term Investment Funds (Amendment) (EU Exit) Regulations 2019 (the LTIF Regulations) will come into force at the end of the transition period and will only apply to UK AIFMs and funds established in the UK, its purpose being to amend the ELTIF Regulation to ensure that it functions post Brexit.
Key points to note are that the LTIF will lose the benefit of the EU marketing passport that forms part of the ELTIF regime, and the LTIF Regulations remove provisions relating to co-operation and information sharing by UK supervisors with EU authorities as this was considered inappropriate with the UK not being a part of the single market. Furthermore, the LTIF will maintain the existing investment rules in the ELTIF regime, meaning that investments in EEA member states and investments in the rest of the world are distinguished, with EEA assets being given preferential treatment in certain circumstances.
Whilst the LTIF Regulations largely mirror the ELTIF Regulation at present, the UK government will soon publish a consultation on reforming the UK's funds regime to enhance the UK's attractiveness for the asset management sector. It is hoped that improvements in the LTIF Regulations will be included in this reform agenda.
Additionally, in light of the recent regulatory and media scrutiny on open-ended funds investing in illiquid assets following high-profile fund suspensions, a successful LTIF regime could provide retail investors with a welcome closed-ended alternative.
We await with interest the UK's response to the conclusions of the current ELTIF review and whether in its own review of the LTIF regime it proactively seeks to respond to some of the criticism of the current structure from stakeholders. It is clear that the UK, as the end of the Brexit transition period approaches, is seeking to balance the desire to achieve continuity for market participants with the opportunity Brexit gives for the UK to promote its investment management sector and its own agenda. A successful long-term investment fund, focused on sustainable growth in the UK (and EU) economy, allowing retail investors to participate in these investments, is a big prize.