Brussels signs off on new rules to make ELTIFs more attractive

What's happened?

On 7 March 2023, the Council of the EU formally adopted the text of a new Regulation which will introduce amendments to the ELTIF Regulation.

This followed trilogue negotiations between the Council, the European Commission and the European Parliament, which led to a political agreement on the text of the amending Regulation in October 2022.

This was then formally approved by the European Parliament in February and, with the Council's adoption, the text will now proceed to be published in the Official Journal (OJ) in due course.

What happens next?

On the twentieth day after publication in the OJ, its provisions will 'enter into force' - this is a timetabling technicality the new amendments will not, in fact, become effective until nine months after their 'entry into force'.

If publication follows, as expected, in the next few weeks, this means that the provisions will most likely go 'live' in the very early part of 2024.

Grandfathering provisions mean that

• ELTIFs authorised before the date of application of the amending Regulation will be deemed compliant for five years following the date of application

• ELTIFs authorised before the date of application of the amending Regulation, which do not raise additional capital, will be deemed compliant full stop.

Key changes made under ELTIF 2.0

The ELTIF Regulation came into effect in December 2015. At the time, it was hailed as a new investment vehicle which would channel capital towards long-term investments in the real economy and which could be marketed to all types of investors - including retail - across the EU. However, for a number of reasons it failed to take off as anticipated and relatively few ELTIFs have been launched (and only in a very limited number of Member States).

These drawbacks were recognised by the Commission as it undertook its five year review of the Regulation. The changes which have now resulted from that work have been seen by some as insufficiently bold or wide ranging but they do, at least, increase the chances that the ELTIF will become a more popular brand. In welcoming the European Parliament's vote in February, for example, EFAMA, the European trade association, saw the revamped regime as having "the potential to become an attractive "go-to" fund structure for long-term investments, with particularly beneficial improvements for retail investors".

Among the various changes to the existing rules that the amendments will bring about, we would highlight the following:  

Broadening the scope of eligible assets

• a simplified definition of "real assets" and the removal of the existing EUR 10 million threshold to qualify as a "real asset"

• an increase to the market capitalisation threshold for listed portfolio undertakings (from EUR 500 million to EUR 1.5 billion)

• removal of the prohibition on investing in an authorised or registered financial undertaking (other than a financial holding company or mixed-activity holding company) where the undertaking is less than five years old as at the date of the investment.

Portfolio Composition & Diversification restrictions

• lowering the percentage of an ELTIF's capital that must be invested in eligible investments from 70% to 55%
• increasing the percentage of an ELTIF’s capital that can be invested in any single qualifying portfolio undertaking from 10% to 20%
• increasing the percentage of an ELTIF’s capital that can be invested in any single real asset from 10% to 20%
• maintaining the limit whereby no more than 20% of an ELTIF’s capital can be invested in aggregate in ELTIFs, EuSEFs and EuVECAs
• introducing a new limit whereby no more than 20% of an ELTIF’s capital can be invested in STS securitisations
• increasing the aggregate risk exposure to a counterparty of the ELTIF arising from OTC derivative transactions, repo agreements, or reverse repos from 5% to 10% of the ELTIF’s capital

Note that the restrictions in the second to fifth bullet points above are disapplied where the ELTIF is marketed solely to professional investors

Fund-of-funds / Master-Feeder structures

• an increase of the maximum limit that ELTIFs will be able to invest in other EU AIFs other than ELTIFs and UCITS to 100% allows - finally - for fund-of-funds structures for retail ELTIFs

• this key development will allow retail investors indirect exposure to funds which, until now, have been available to professional investors only

• on the other hand, although master-feeder structures will be allowed, these will be limited to both the master and the feeder having to be ELTIFs.

Open-ended ELTIFs

• It will be possible for ELTIFs to be structured as essentially open-ended as the amendments have eased the redemption provisions in the original ELTIF Regulation

• the revised redemption provisions, though, still remain fairly tough and the market may take the view that an ELTIF is better suited to a closed-ended than an open-ended fund structure

• ELTIFs may now allow redemption of units during the life time of the fund provided a number of conditions are met, including the ELTIF having an appropriate redemption policy and liquidity management tools

• the provision whereby investors could request the winding down of an ELTIF if their redemption requests have not been satisfied within one year has been removed

• ESMA will be mandated to develop regulatory technical standards to specify ELTIF redemption policies in greater detail

• for closed-ended ELTIFs, investors will be able to dispose of their shares before the end of the fund's life on a new "matched" secondary market basis, perhaps creating a form of liquidity for what are potentially highly illiquid assets.

Professional investors

• the new amendments to the ELTIF Regulation set out specific rules for ELTIFs that are to be marketed to professional investors only. These include disapplication of requirements covering portfolio diversification and composition; the minimum threshold for eligible assets; concentration limits; cash borrowing; the single asset limitation; the aggregate percentage limit on shares in other ELTIFs, EuSEFs or EuVECAs and the percentage limit on investments in STS securitisations

• the borrowing limit (which was originally 30% of the fund's capital) is raised to 50% where the ELTIF is marketed to retail investors but to 100% where it is marketed only to professional investors

Retail investors

• the new Regulation will include an explicit requirement to carry out a suitability assessment in all circumstances, regardless of how the retail investor acquires shares or units of the ELTIF (i.e., directly or via the secondary market)
• the retail investor's explicit consent will be required, confirming that he or she understands the risks of investing in an ELTIF,  where (a) the suitability assessment is not provided in the context of investment advice, (b) the assessment concludes that the ELTIF is not suitable for that investor and (c) the investor wishes to proceed despite that conclusion
• the original requirement for the ELTIF manager or distributor to give the retail investor 'appropriate investment advice' has been removed
• however, the manager of the ELTIF or its distributor must issue a clear written warning informing the retail investor that:
  • where the ELTIF's life exceeds 10 years, it may not be suitable for retail investors that are unable to sustain such a long-term and illiquid commitment and
  • where the ELTIF's rules provide for the matching of units on a secondary market, this does not guarantee that the retail investor will be able to to exit or redeem its units or shares of the ELTIF concerned.

• Finally, the existing ELTIF Regulation contains the restriction whereby, if a retail investor's portfolio does not exceed EUR 500,000, (a) he or she cannot not invest more than 10% of that portfolio in ELTIFs and (b) the minimum amount that investor can invest in one or more ELTIFs is EUR 10,000. The amendments remove both of these restrictions.

Conclusion

The changes being made will undoubtedly help make the ELTIF a more attractive fund vehicle. But whether they go far enough to change the ELTIF into a significant player in an increasingly crowded long-term investment market, only time will tell.