With major themes such as decarbonisation, demographic shifts and deglobalisation reshaping the investment landscape at pace, investors are increasingly looking to opportunities in private markets to achieve their financial goals.
In the not-too-distant past, opportunities in private markets were not accessible to individual investors and were the domain of large institutions and ultra-high-net-worth clients. This has also been changing. Investment managers and regulators have been working to facilitate access and solve some of the historic challenges faced by private clients wanting to invest in these opportunities.
In Europe, the most significant regulatory change in this space began in 2015 with the introduction of the European Long Term Investment Fund (“ELTIF”). The new ELTIF structure aimed to provide a consistent way of making long-term investments in private assets across EU member states and to widen access to a broader set of clients, including individual investors The regulator hoped that the ELTIF structure would fulfil the dual aims of boosting the real economy and supporting the ‘democratisation’ of private assets for a larger pool of investors.
Despite initial optimism, the structure struggled to take off. By 2021, six years after the introduction of the ELTIF, there only were 53 launched products and €7 billion in ELTIF structures vs an estimated €5.9 trillion in Alternative Investment Funds (AIFs) as a whole. While market participants supported the aims of the new structure, in practice certain investment and distribution restrictions were holding them back.
Recognising these challenges, the EU undertook a review of the regulation and in March 2023 it published an update offering a more flexible set of rules (“ELTIF 2.0”) that will apply from 10 January 2024.
We look at what the changes mean and the outlook for the ELTIF structure going forward.
The ELTIF 2.0 regulation aims to remove some hurdles present in the original regulation. The most significant of changes can be broken down into the following four key categories:
Eligible Assets: The definition of what counts as an eligible asset is being expanded to include additional asset classes like FinTech, certain securitised assets and green bonds. It will also be more flexible about the minimum size of real assets and the maximum size of listed ones. Crucially, the new rules also clarify that global investments are permitted and strategies don’t just have to focus on European assets.
Investment Restrictions and Diversification: Various changes are being introduced to allow more flexibility in asset allocation and structuring options. As part of this, fund of fund strategies will be permitted (as long as target funds are EU AIFs), the maximum investment in a single asset is being raised from 10% to 20%, and the minimum investment in eligible assets is being lowered from 70% to 55%. Master feeder structures will also be permitted, but only if the master fund is also an ELTIF. Some of the rules are also more flexible if the ELTIF only targets professional investors and not retail.
Distribution and Marketing: The ELTIF 2.0 removes the minimum investment amount per investor (previously €10,000) and also the ELTIF-specific eligibility assessment, which required distributors to ensure that investors with a portfolio of less than €500,000 did not invest more than 10% of their overall assets in ELTIFs. The suitability assessment will now be aligned with MiFID tests as for other products. These changes are very significant in enabling private clients to access ELTIFs with ease.
Liquidity: The original regulation allowed closed-ended funds only but the new rules introduce the possibility of redemptions before the end of a fund’s fixed term life. The precise rules for redemptions are not directly set out in the ELTIF 2.0 text, but will be clarified by a set of ‘Regulatory Technical Standards’ or RTS, which is yet to be finalised by the European Securities and Markets Authority (ESMA).
What remains uncertain?
Although the ELTIF 2.0 regulatory text has been published and will come into effect on 10 January 2024, there are still some aspects that need clarifying. The legal text defers to the RTS that will be drafted by ESMA and that will give more detail and guidance on certain elements of the new rules. These are summarised below:
Redemption policy and life of ELTIFs: Key terms such as minimum holding periods, minimum notice periods, criteria to determine the maximum percentage of redemptions permitted, required anti-dilution mechanisms and other appropriate liquidity management tools.
Provision of secondary markets: The circumstances and processes for ELTIF managers/administrators that want to offer a service of matching redemption requests from exiting investors with subscription requests from potential investors, and the information that must be disclosed to investors in such a scenario.
Costs: The definition and calculation methodologies for costs, as well as how costs should be presented to investors. This includes set-up costs, costs relating to the acquisition of assets, management and performance fees and distribution costs as well as other expenses.
ESMA released a consultation on the draft version of the RTS on 23 May 2023 and asked industry stakeholders for feedback, which has been provided. Only when the final version is published will we know what will be permitted under the new regulation.
Will the ELTIF 2.0 solve all the challenges?
The reformed 2.0 regulation is set to improve ELTIFs for both wealth managers and investors. For managers, the increased flexibility to invest in a wider range of assets, particularly in underlying funds, will help them to offer private investors efficient access to the broadest possible range of investment capabilities.
The removal of the minimum investment amount and the alignment of the suitability assessment with MiFID will enable a wider range of wealth managers to offer ELTIFs to a broader range of suitable investors.
The finalisation of the RTS, and in particular the rules around redemptions and liquidity, will be crucial in ensuring the full success of the updated regulation. We know that a key concern for private clients can be the lack of redemption possibilities when life events such as divorce or death occur; for this reason, open-ended evergreen funds can be preferable.
With sensible rules that balance flexibility with appropriate risk management and investor protection, we believe that the introduction of liquidity options could make a defining difference to the popularity and scalability of ELTIFs.
Despite these welcome reforms, some key challenges for the ELTIF remain. ELTIFs will continue to require highly skilled investment managers to understand the needs of private investors. As the new rules widen the potential for distribution to a broader set of clients, it will be more crucial than ever to onboard investors in a more scalable way considering both their operational and investment needs. For this reason, digital technology platforms will likely have an important role to play.
Another challenge for scalable distribution can be preferences in local markets such as France, Belgium and Italy for local structures that offer tax incentives. This of course can be beneficial to investors in one single market but can prohibit the consistency and scale that could be achieved by offering one vehicle across the EU and beyond. To benefit fully from the breadth of distribution that the ELTIF regulation seeks to achieve, managers will need to think proactively about structuring funds with appropriate local requirements built in or launching feeder structures.
Overall, it is clear that the new rules are designed to make things easier and better for investment managers, wealth managers and their clients alike. We believe that the finalisation of the liquidity rules and investment managers' adaptability to private client needs will be the determining factors in how effective the ELTIF will be in fostering the democratisation of private assets.
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