Revisiting the Past: Alternative Funds

ELTIF 2.0 – Second Time’s a Charm

February 09, 2022
  • Investor Services
New revisions to the European Long-Term Investment Fund remove many of the regulatory and structural impediments managers face when utilizing them currently and place them neatly into the EU regulated fund structure toolkit, writes Adrian Whelan.

I did then what I knew how to do, Now I know better, I do better

There has been a lot of industry chatter re­garding the democratization of regulated, illiquid funds by making them available to a wider spectrum of eligible investors. While it has become a global theme, the real action was in Europe where both the European Long-Term Investment Fund (ELTIF) and the U.K.’s Long-Term Asset Fund (LTAF) caught the attention of policymakers, investors, and asset managers alike.

Since inception, the ELTIF has not captured investment flows as intended for a vari­ety of reasons, including an eligible asset universe generally considered to be too narrow. Evidence of this opinion may be found in the lack of ELTIFs since its launch in 2015 and the ones that have launched were both small and comprised mainly of local investments and investors in a handful of EU countries (e.g. France, Italy, Spain). Only around 28 ELTIFs have been established, with a low asset base (below €2 billion).1

ELTIF has become more popular and there was discernible growth in 2021 with asset managers launching usually in partnership with a private bank or wealth manager. With that said, for now ELTIFs remain a small corner of the EU regulated funds market. However, with sizeable revisions to its rule-set imminent, are the fortunes of the ELTIF about to change?

The European Commission (EC) has re­moved many of the suggested barriers to ELTIFs’ success to make ELTIF 2.0 more attractive for asset managers. The proposed revisions make both portfolio composi­tion and the distribution to a broad range of investor types easier and more attrac­tive. The ELTIF changes form a sub-set of a range of policy measures which underpin a more general makeover of the EU’s Capital Markets Union and an overarching desire to diversify the financing to Europe’s real economy beyond bank lending.

ELTIF’s future success is not guaranteed. However, this revamp greatly enhances the structure’s attractiveness to product manufacturers, distributors and ultimately investors. So there is rightly some genuine enthusiasm mobilizing around ELTIF and hope that at the second time around, it may act as a legitimate third option within the EU regulated funds landscape to compli­ment the highly successful Undertakings for the Collective Investment in Transferable Securities (UCITS) and the Alternative Investment Fund Managers Directive (AIFMD) frameworks.

Here’s a brief walk through of the latest ELTIF revisions which could mean that the second time’s a charm for ELTIF 2.0.

1. Wider Range of Eligible Assets

Several changes to the ELTIF eligible asset rules significantly widen its investment op­portunities and attractiveness, including:

  • Global Investments

There is explicit clarification that ELTIFs may invest freely in non-EU (“third country”) exposures. Previously ELTIFs were designed as a means of channeling investment into EU industries primarily and non-EU investments had additional conditions ascribed. That constrained investment opportunities and was cited as slightly protectionist. The clarification now allows for a far more diverse range of investment opportunities.

  • Real Asset Definition

A revised definition of “real asset” now includes any asset with “intrinsic value” rather than one that can provide “invest­ment returns” or “predictable cashflow” – this change shows that the devil is always in the detail when framing a fund structure’s ruleset.

  • Real Asset Threshold

The minimum investment in a real as­set by an ELTIF is also lowered from €10 million to €1 million making real asset investments much more accessible.

  • Listed Assets Threshold

The market capitalization threshold for permitted listed investments is raised from €500 million to €1 billion (at time of initial purchase).

  • Other investment funds

ELTIFs may now invest in Alternative Investment Funds (AIFs) who them­selves invest in eligible assets on a “look through basis”; previously an ELTIF could only invest in other ELTIFs, European Venture Capital Funds (EUVECA) or European Social Entrepreneurship Funds (EUSEF) structures.

  • Securitizations

ELTIFs may now invest in eligible se-curitizations which include mortgage-backed securities, commercial, resi­dential, and corporate loans, as well as trade receivables.

  • Minority Co-investments

Another notable revision to allowable investment permissions is that an ELTIF can now make a minority co-investment directly or through investment con­duits but doesn’t need to be owned directly or via a “majority owned” subsidiary. When twinned with the al­lowable investments in other eligible fund structures, the ELTIF now has the type of investment flexibility usually found in other similar regulated fund structures seeking exposure to private market investments and allows for the implementation of indirect investment strategies.

2. More Flexible Concentration and Diversification Limits

The other criticism of ELTIF was that the portfolio diversification parameters were overly rigid and too narrow to allow for flexible portfolio composition for illiquid strategies. As such, there are substantial proposed changes to a range of invest­ment permissions and restrictions to allow for a much wider investment universe for ELTIFs, including:

  • Maximum allowable amount that may be invested in other funds such as other ELTIFs, UCITS or AIFMD funds is raised from 10% to 20% of capital
  • Maximum allowable amount that may be invested in a single real asset is raised from 10% to 20% of capital
  • Also, the maximum aggregate value of units or shares of other funds such as Alternative Investment Funds (AIFs), UCITS or other ELTIFs is also increased from 20% to 40% of capital
  • An ELTIF may also now own 30% of units or shares outstanding of another ELTIF, EU EUVECA or EUSEF funds
  • The maximum aggregate amount of securitizations an ELTIF may invest in is now 20% of the total value of the ELTIF
  • The maximum amount of capital that must be invested in eligible invest­ments is lowered from 70% to 60% of capital

3. Increased Leverage

Another element of long-term funds that was overly restricted and hence made ELTIFs less attractive was the ability to finance investments by way of borrowing or provision of leverage. This has been ad­dressed to bring ELTIFs more in line with similar fund vehicles elsewhere. Among the changes in this regard are:

  • The cash borrowing limit is raised from 30% to 50% of ELTIF value for retail ELTIFs and 100% of ELTIF value for ELTIFs solely marketed to professional investors
  • The cash borrowing no longer must be in the same currency as the currency the ELTIF buys its assets, so long as it is hedged
  • The fund may encumber its assets to implement its borrowing strategy – pre­viously there was a fixed 30% encum­brance limitation, this meant it was difficult to secure borrowing as liens and pledges of portfolio assets were difficult for ELTIFs and not attractive to lenders

4. Differentiation Between ELTIFs Marketed to Retail and Professional Investors

ELTIF 2.0 formally recognizes that the ELTIF might be sold to distinct constituents and is not exclusively a retail eligible ve­hicle. In particular, much lighter investment strategy and borrowing requirements now apply to ELTIFs solely marketed to profes­sional investors.

Amendments have been made to make it clear that the two-week withdrawal period applies only to retail investors and can only be effective during the two weeks follow­ing effective date of the commitment or subscription agreement.

Distribution and Structuring Enhancements

ELTIFs can be distributed across the EU with a passport to both professional and retail investors. Some positive changes have been made to streamline the autho­rization of ELTIFs under new proposals. The National Competent Authority (NCA) responsible for authorizing the ELTIF will be solely responsible for the authorization of an ELTIF and will not be involved in the additional authorization or ‘approval’ of the EU Alternative Investment Fund Manager (AIFM). The new rules also clarify that an ELTIF doesn’t need to be managed by an AIFM in the same domicile.

There is the removal of duplication in the retail investor suitability tests and align­ment of ELTIF to Markets in Financial Instruments Directive (MiFID) point of sale rules. This ties with the deletion of the minimum-entry ticket (€10,000), replaced with €1,000 minimum and the 10% aggre­gate threshold for retail investors whose fi­nancial portfolios do not exceed €500,000. ELTIFs also retain favorable capital charges under Solvency II rules, which introduce prudential requirements tailored to the spe­cific risks which each insurer bears, so dis­tribution to the EU insurance and pensions segment remains attractive.

Under ELTIF 2.0, retail investors may can­cel their subscription and have the money returned without penalty. The two-week withdrawal period is only effective dur­ing the two weeks following effective date of the commitment or subscription agreement. The national investor facili­ties requirements for retail investors are also deleted to facilitate the cross-border marketing of ELTIFs and align with the new rules on Cross Border Distribution Directive (CBDD).

Second Time’s a Charm

In combination, these ELTIF 2.0 revisions remove many regulatory and structural impediments managers face. Initially they have been broadly welcomed since they address many concerns market participants have with the current rules.

It is hoped that ELTIF 2.0 when ap­plied makes the European Long-Term Investment Fund a viable investment structure for many alternatives managers to the extent they can construct a portfo­lio that falls within the eligible investment criteria. It sits neatly into the EU regulated fund structure toolkit between UCITS and AIFMD funds. It has a cross border market­ing passport and affords opportunity to tar­get a wide range of investor types with di­versified illiquid exposures all with a robust regulatory wrapper. Owing to increasing demand from European private bank and wealth management networks, the latest proposals serve to magnify expectations of more ELTIFs in the future. While the EU ap­proval process means that ELTIF 2.0 would become effective six months and one year after coming into force respectively, so by 2024, market participants who begin to work on their strategies now stand to be on the front foot of the charm offensive.

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