The revised European Long-Term Investment Funds Regulation (ELTIF 2.0) came into force on April 9, 2023, and contains a number of enhancements to the previous ELTIF regime (ELTIF 1.0), bringing new opportunities to the private markets sector.
ELTIFs were initially introduced in April 2015 and were designed for investors who want to make long-term investments in companies and projects such as infrastructure projects and real estate investments. ELTIF 1.0 established uniform rules on investment and operating conditions as well as the marketing of ELTIFs, in an effort to facilitate long-term investment by institutional and retail investors.
The ELTIF framework was originally welcomed with much enthusiasm as it allows ELTIFs to be marketed to retail investors with a European marketing passport. However, the original ELTIF regulation has not achieved the desired success with only 84 ELTIFs registered in the EU (as of January 2023). This is why the revised ELTIF (2.0) framework was proposed, to address what was perceived as the main shortcomings of the original ELTIF Regulation.
Impact on the private market sector
The ELTIF 2.0 framework is set to impact the private market sector in a positive way. There will continue to be increased interest and pool of capital that can be allocated to the sector as well as increased potential for liquidity, which will need careful management. There will also be an increase in volatility and additional focus by regulators on related investments as well as a focus on costs and fees, marketing, disclosures and conflicts.
When it comes to “retailization,” ELTIF 2.0 offers flexibility for managers as to how far into retail they want to go (e.g., “semi-professional” or genuinely retail). There will be an increased focus on suitability and investor protection and a challenge matching investment strategies to time horizons of retail investors. The broadening of the eligible investments is helpful, and given the trend towards “retailization” and the additional flexibility provided for ELTIFs that are used only by professional investors, this will make ELTIFs an attractive vehicle for this segment of the market.
Addressing the unique characteristics and needs of private market funds
A potential mismatch between liquidity and retail market expectations is important to note, but having investors subscribing and redeeming funds also places more importance on valuation. The value of private assets requires significant work and judgment. In a closed-ended fund, valuations are important to give investors an overview of performance and are necessary to calculate fees. However, due to the mix in ELTIF portfolios of long-term illiquid assets and a smaller percentage of securities traded with readily verifiable prices, there will be more focus on process, responsibility and ultimately liability for the valuation process.
In addition, while ELTIFs would, under the initial ELTIF regulation, have to be structured as limited-duration funds, they may under ELTIF 2.0 be structured as open-ended funds. Such open-ended ELTIFs shall, at least once a year, offer a subscription and redemption opportunity.
The manager of an ELTIF needs to strike a balance between exposing the ELTIF to illiquid assets in order to generate returns while ensuring the ability to pay out redeeming investors.
Evergreen and semi-open-ended fund vehicles are possible, but some further clarifications are still expected with the publication of the final rules and technical standards.
New rules regarding investment eligibility criteria
New rules regarding investment eligibility criteria will affect the investment strategies and opportunities available to private market managers operating under ELTIF structures. The revised investment eligibility criteria have been broadened and include investment requirements being reduced from 70% to 55% of capital resulting in greater liquidity and flexibility, as well as non-EU investing (subject to some restrictions) and the removal of 10 million minimum value for real assets vastly increasing the investment universe. In addition, the maximum market value of listed companies going from 500 million to 1.5 billion significantly broadens the scope and opportunity for private market managers. And, the eligibility of funds strategies has been widened so an ELTIF can now invest in UCITS and EU AIFs. Before it was limited to other ELTIFs.
Emphasis on sustainability and ESG considerations
The ELTIF 2.0 is very much aligned with the EU Green Deal Agenda and SFDR. Moving to a sustainable economy requires significant investment in infrastructure, and retail access to ELTIF 2.0 is part of this picture. Opening up investment opportunities in the EU real economy to a broader pool of capital is key for this. Retail investors have a demand for investing in “green” and ESG data is a massive challenge, particularly when investing in non-EU assets. This is likely to improve to a certain extent with CSRD (phasing in from FY24) and global ISSB standards but will take time and vary between jurisdictions. The pace of rollout of corporate ESG reporting requirements will drive this. There are some expected challenges around Article 9 Funds with regards to credibility due to data gaps and promoters will need to be careful as to how they define the “green” aspects of their investment universe, to make sure that it can be supported by solid evidence for investor reporting.
Facilitating cross-border investment
The ELTIF 2.0 framework is expected to have a positive impact on cross-border private market transactions. Managers can currently sell AIFs to professional investors on a cross-border basis. This opens up the retail market, but much like UCITS, the ELTIF creates a standard set of rules for a type of fund, and this uniformity brings certainty to the market, particularly in the retail space. At the moment, we see UCI Part II funds in Luxembourg being heavily used to make private market funds available to retail investors, who do not typically have access to private markets.
There has also been a removal of the need for local facilities agents in countries where ELTIF is marketed to retail investors, which could potentially significantly reduce the cost burden on ELTIF managers.
Provision related to investor protection and disclosure requirements
These measures aim to enhance transparency and ensure that investors are well-informed about the risks associated with ELTIF investments. By providing clearer and more comprehensive information, investors can make smarter decisions and have a better understanding of the potential returns and risks involved.
Future improvements or clarifications to better accommodate private market funds
There are still areas where future improvements or clarifications are needed to better accommodate private market funds within the ELTIF framework. It is essential to balance promoting investment opportunities and ensuring adequate investor protection. Ongoing discussions and collaboration between regulators, industry stakeholders and market participants are necessary to address any challenges and refine the framework to better align with the unique characteristics of private market funds.
Synergies and potential conflicts between ELTIF and other fund structures
Synergies and potential conflicts between ELTIFs and other fund structures are also important considerations. ELTIF 2.0 aims to provide a framework for long-term investment funds, targeting specific investor groups and investment strategies. It is essential to assess the potential overlaps or conflicts with other fund structures, such as UCITS or AIFs, to ensure regulatory coherence and harmony. Finding synergies between different fund structures can lead to a more comprehensive and efficient investment landscape while avoiding duplication or unnecessary complexity. In addition, there is potential for the matching mechanism under Article 19 to open up a secondaries market.
The future of private market funds operating under the revised ELTIFs framework
It is still too early to tell what the full impact of the revised ELTIFs framework will be, but jurisdictions like Ireland need to keep up with the likes of Luxembourg, France and Spain who are already adopting the ELTIF structure. There is potential for fund failures involving retail investors to “taint” brands and reduce investment appetite from this class of investor. There does seem to be strong pent-up demand and good tailwinds for ELTIF 2.0, and we have seen larger managers use ELTIF 1.0.
Risks could include a market correction in private assets, and the way the market manages to deal with liquidity mismatches and valuations issues could also impact things. Where the CSSF in Luxembourg is already accepting applications for ELTIFs designed to convert to 2.0 in January, and with France already publishing legislation around ELTIFs, the Central Bank of Ireland also needs to update its AIF rulebook to reflect specific requirements for ELTIFs as a regulated AIF.
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Written by Alagie Faye
Director, Private Markets