On 15 February 2023, the European Parliament adopted the regulatory reform of the European long-term investments funds (ELTIFs) regulation to make these ELTIFs more attractive to asset managers and retail investors by facilitating their investments in the real economy and encouraging private capital flows toward more environmentally sustainable investments.
Since coming into force in 2015, the existing ELTIF regulation has offered long-term investment opportunities for professional and retail investors across Europe.
However, due to significant constraints on the distribution process and stringent rules on portfolio composition, only a limited number of ELTIFs have been launched to date.
By expanding the scope of eligible investment assets, updating the definition of “real asset,” creating differentiated rules for professional and retail investors, simplifying the retail investor access to ELTIFs and facilitating the investor’s exit, the revamped regime should address the prior shortcomings and design a better future than ELTIF version 1.
The updated regulation is expected to start applying from Q1 2024.
For further information and to discuss what these new developments mean to you as an ELTIF manager, distributor or investor, please get in touch with your Baker McKenzie specialist.
New investment rules: scope of eligible investment assets expanded and definition of “real asset” broadened
Expanded asset eligibility
- Assets and investments located in non-EU countries
The updated regulation expands the scope of eligible assets and investments to include those located in non-EEA countries. This expansion will enable the capturing of non-EU investments, for example, in subsea fiber optic cables that connect Europe with other continents, the construction of liquefied natural gas terminals and related infrastructure, or cross-border investments in renewable energy installations and facilities.
However, that so-called “third country” from an EU perspective must not be identified as a high-risk third country listed in the delegated act adopted pursuant to the fourth AML directive, nor mentioned in Annex I to the Council conclusions on the revised EU list of non-cooperative jurisdictions for tax purposes.
- Securitized assets
The updated regulation further allows ELTIFs to invest in STS securitizations1 (simple, transparent and standardized) with specific underlying exposures. The underlying assets must consist of long-term exposures such as securitized residential loans secured by one or more mortgages on residential immovable property, commercial loans secured by one or more mortgages on commercial immovable property, corporate loans, including loans granted to small- and medium-sized enterprises, and trade receivables or other underlying exposures that the originator considers as forming a distinct asset type, provided that the proceeds from securitizing those trade receivables or other underlying exposures are used for financing or refinancing long-term investments.
The aggregate value of STS securitizations in an ELTIF portfolio must not exceed 20% of the value of the capital of the ELTIF if the ELTIF units are marketed to retail investors. There is no limit for ELTIFs restricted to professional investors.
- Green bonds
Green bonds issued pursuant to the EU regulation on European green bonds in preparation will qualify as eligible investment assets under the updated regulation.
- Investment in financial undertakings
The current regulation prevents investments by ELTIFs in credit institutions, investment firms, insurance undertakings and other financial undertakings.
The updated regulation will permit ELTIFs to invest in recently authorized innovative financial undertakings such as fintech companies.
- Eligible portfolio undertakings
The market capitalization threshold of the listed qualifying portfolio undertakings in which ELTIFs can invest will be increased from a maximum of EUR 500 million to a maximum of EUR 1.5 billion to provide ELTIFs with a better liquidity profile (the determination of the market capitalization threshold will only be made at the time of the initial investment).
- Other investment funds
ELTIFs will be allowed to invest in UCITS and Alternative Investment Funds (AIFs) managed by EU AIFMs, which themselves invest in eligible assets on a “look through basis.” Under the current regime, ELTIFs can only invest in other ELTIFs, European Venture Capital Funds (EuVECAs) or European Social Entrepreneurship Funds (EuSEFs) structures. The current restriction, according to which the ELTIF must not invest more than 10% of their assets in any other collective investment undertaking, will remain, except in the case of feeder ELTIFs.
- Minority co-investment now possible
The updated regulation specifies that the provisions on conflict of interest do not prevent an ELTIF manager or an undertaking that belongs to the same group from co-investing in that ELTIF or from co-investing with that ELTIF in the same asset. It further clarifies that the manager of the ELTIF must (i) put in place organizational and administrative arrangements designed to identify, prevent, manage and monitor conflicts of interest and (ii) disclose such conflicts of interest adequately.
This new possibility for ELTIFs to conduct minority co-investment in investment opportunities is aimed at providing ELTIFs with additional flexibility in implementing their indirect investment strategies to attract more promotors of investment projects and increase the range of possible eligible target assets.
- Portfolio composition
Under the current regime, ELTIFs are required to invest at least 70% of their capital in eligible investment assets. That threshold will be lowered to 55% under the updated regulation.
ELTIFs will be allowed to pool their assets and make use of master-feeder structures by investing in master ELTIFs.
“Real assets” definition expanded
Real assets now include immovable property, such as communication, environment, energy or transport infrastructure, social infrastructure, including retirement homes or hospitals, as well as infrastructure for education, health and welfare support or industrial facilities, installations, and other assets, including intellectual property, vessels, equipment, machinery, aircraft or rolling stock.
The requirement for a minimum value of individual real assets of EUR 10 million will be abolished. Requirements for direct ownership or via indirect holding via qualifying portfolio undertakings of the real assets will also be removed.
Differentiated rules for professional and retail investors
Fewer restrictions for professional investor ELTIFs
ELTIFs that are only marketed to professional investors will benefit from more attractive and specific rules with respect to the diversification and composition of the portfolio concerned, the concentration limits and the borrowing of cash.
- No concentration limit for professional investor ELTIFs
The concentration limit and the portfolio composition and diversification rules will no longer apply to ELTIFs that are marketed solely to professional investors (nor to a feeder ELTIF investing in its master ELTIF or where an ELTIF is a feeder ELTIF, as applicable).
- Limit of cash borrowing increased
The limit on borrowing of cash for ELTIFs that are marketed solely to professional investors will be extended to no more than 100% of the ELTIF’s net asset value (instead of 30% under the current regulation). Subject to appropriate hedging of currency exposure, the ELTIFs should also be able to borrow in the currency in which the manager of the ELTIF expects to acquire the asset.
Access to retail investors simplified
The updated regulation brings several improvements to ease the retail investors access to ELTIFs, as follows:
- Barriers alleviated
- The EUR 10,000 initial minimum investment requirement will be removed.
- The 10% limit on aggregate investment will be removed.
- The diversification requirement will raise from 10% to 20%.
- The borrowing limit will be raised from 30% to 50% of the ELTIF’s net asset value.
- The local marketing facilities requirements for retail investors will be removed.
- Retail investors’ protection maintained
To ensure a high level of protection of retail investors, a suitability assessment should be carried out irrespective of whether the units or shares of ELTIFs are acquired by retail investors from distributors or managers of ELTIFs, or via the secondary market. Under the updated regulation, where a retail investor has been provided with investment advice under MiFID II,2 the requirement to provide a suitability assessment will be considered to be fulfilled.
Retail investors will be able to cancel their subscription and have the money returned without penalty during the subscription period and during a two-week period after the signature of the initial commitment or subscription agreement of the units or shares of the ELTIF.
- Early exit possible
Under the updated regulation, ELTIF managers will be able to provide for the possibility of an early exit of ELTIF investors during the life of the ELTIF, subject to the ELTIF manager putting in place a policy for matching potential investors and exit requests specifying the transfer process, the role of the manager of the ELTIF or the fund administrator, the periodicity and duration of the liquidity window during which the units or shares of the ELTIF can be exchanged, the rules determining the execution price and proration conditions, the disclosure requirements, and the fees, costs and charges and other conditions related to such a liquidity window mechanism.
This aims at fostering adherence of retail investors as the illiquid nature of most of the ELTIF investments may no longer represent a hurdle to redemption.
ESMA is to develop draft regulatory technical standards (RTS) specifying, among other things, the criteria to determine the minimum holding period and the requirements to be fulfilled by the ELTIF in relation to its redemption policy and liquidity management tools. ESMA must submit this draft RTS by the date of application of the updated regulation (i.e., Q1 2014).
Date of application: early 2024
The updated regulation is expected to be published in the Official Journal of the European Union in March or April 2023. It will start to apply nine months after its publication, i.e., Q1 2024.
Existing ELTIFs will have up to five years to comply with it. However, they may want to benefit from the updated regulation before the end of the grandfathering period. To do so, they must notify their national competent authority accordingly.
Existing ELTIFs that do not raise additional capital will be deemed compliant for five years following the entry into application of the updated regulation.
1 As referred to in Article 18 of the EU Securitization Regulation.