ELTIF 2.0: A new era for European private asset investing
We explore what the updated ELTIF 2.0 regulation means for investors and the private wealth market.
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Key Takeaways
- ELTIF 2.0 overcomes some of the key challenges with the original regulation. The new rules increase investment flexibility and reduce distribution complexity.
RTS details finalised: Effective from 26 October 2024, the Regulatory Technical Standards (RTS) sets out rules on redemptions and liquidity. This means evergreen ELTIFs are now possible.
Market impact: ELTIFs could transform access to private markets for private wealth investors. Managers can offer a wider range of strategies in a more scalable format. However, cross-border challenges remain.
The significant boom in private markets investing is well recognised across the financial services industry. Since 2001, assets under management (AUM) in private assets strategies have surged nearly twentyfold, in stark contrast to the threefold increase seen in public markets.
As previously highlighted, this growth is not only reflected in the rising AUM but also in the diversification of investor types, now including high net worth individuals and retail investors eager to engage in this expanding market. Private markets offer investors a greater variety of investment options to diversify and enhance the risk/return profile of their portfolios. This desire for broader participation has been supported by regulatory developments and product innovation, which have collectively facilitated access to private asset opportunities for a wider range of investors.
The European Long Term Investment Fund (ELTIF) was designed to be the vehicle of choice for high net worth and retail investors in Europe to gain access to the private assets market, but a number of known challenges prevented it taking off. Acknowledging these shortcomings, the European Commission implemented the much-anticipated ELTIF 2.0 regulation, effective from 10 January 2024.
Source: Alfi, November 2023
This update introduced measures to address challenges in the original ELTIF framework. While it included beneficial changes, details on key areas like redemptions and minimum holding periods were delegated to the upcoming Regulatory Technical Standards (RTS), with input from the European Securities and Markets Authority (ESMA).
While regulation has evolved, product innovation has continued. 10 to 15 years ago, private market investing was mainly through closed-ended funds. Recently, open-ended, evergreen funds allowing periodic redemptions have gained popularity. These semi-liquid funds have been largely inaccessible to retail investors in Europe due to their classification as Alternative Investment Funds (AIFs). However, with the ELTIF RTS effective from 26 October 2024, this is expected to change, with more semi-liquid funds structured as ELTIFs being planned.
What were the key changes in the original ELTIF 2.0 regulation?
The ELTIF 2.0 regulation made the following key changes to improve the effectiveness of the structure by offering greater flexibility in the following areas:
- Eligible assets, investment restrictions and diversification requirements, with a broader range of assets being eligible, the definition of a real asset being expanded, and the asset allocation rules being relaxed.
- Structuring options, explicitly allowing fund of funds and master-feeder structures, subject to certain restrictions and requirements.
- Distribution and marketing rules, removing the minimum investment amount per investor (previously EUR 10k), as well as the ELTIF-specific eligibility assessment and aligning with the MiFID rules.
The following topics were left to the RTS:
- The use of derivatives for hedging
- Requirements for an ELTIF’s redemption policy
- Minimum holding periods for investors
- Liquidity management tools
- Matching of transfer requests
- Requirements for cost disclosures.
What’s in the RTS?
The RTS were published in July this year and came into force on 26 October. For retail investors, who need flexibility in their portfolio, the rules on redemptions, minimum holding periods and liquidity management were most eagerly anticipated. A brief summary of each of the topics covered in the RTS can be found below:
- Redemptions: The ELTIF 2.0 framework allows for redemptions, with specific rules defined by the RTS. Redemptions depend on the liquid assets in the portfolio. Two options determine the maximum redemption percentage:
Option A: Based on redemption frequency and notice period. For example, quarterly redemptions with a 90-day notice allow up to 33.3% of liquid assets to be redeemed.
Option B: Based on redemption frequency and a minimum percentage of liquid assets. For example, quarterly redemptions with at least 20% liquid assets allow up to 50% of liquid assets to be redeemed.
Liquid assets include UCITS-eligible assets and expected cash flow for the next year. If the notice period is under three months, it must be justified and agreed upon with the regulatory authority.
- Minimum holding periods: ELTIFs do not have to have a minimum holding period, but managers can apply one if they determine that this would be beneficial to the strategy. Criteria for determining an appropriate minimum holding period is set out in the RTS.
- Liquidity management: The RTS sets out the level of detail managers must give to investors about the liquidity management within the ELTIF and suggests the anti-dilution mechanisms which may be adopted by the manager, but do not have to be.
- Matching of transfer requests: The RTS provides rules about how a manager can offer a matching mechanism, whereby shares from an ELTIF investor who wants to sell their shares can be matched with an investor who wants to come into the fund, but there is no obligation to provide such a mechanism.
- Derivatives: ELTIFs are not allowed to use derivatives for speculative investment purposes, but only for hedging risk inherent to the ELTIF’s assets. The RTS provides more information about the circumstances in which derivatives are considered solely for hedging purposes, noting that any derivative in an ELTIF’s portfolio should be economically appropriate, consistent with the risk-profile of the fund and aimed at a verifiable reduction of risks. In addition, the underlying assets of the financial derivative must be assets to which the ELTIF is exposed, or, where not available, of the same or economically similar asset class.
- Costs: The RTS sets out specific categories of cost that must be included in an ELTIF’s offering documents, including costs of setting up the fund, costs of acquiring assets and distribution costs.
How could it impact the market?
Semi-liquid funds have been gaining momentum amongst investors for several years, but their accessibility to private wealth investors could be significantly enhanced if structured as ELTIFs. The feasibility of this transition largely depends on the investment strategy of the specific fund, with certain limitations when it comes to indirect investments. Structuring a fund as an ELTIF opens up its potential investor base amongst wealth investors significantly. This could likely mean that ELTIFs become the default option for many private asset strategies, benefiting both investors and managers alike.
Other important changes brought in under the ELTIF 2.0 rules allow for master-feeder structures. This could yield significant benefits for closed-ended funds as it could enable managers to structure ELTIFs for retail investors that feed into a larger fund, pooling the capital from both retail and institutional investors. Such a setup offers advantages for both investors and managers. For managers, consolidating assets into one pool simplifies the investment process and allocation of new investments. Meanwhile, investors benefit from larger fund sizes through more cost efficiencies, leading to better potential performance as well as a more diversified pool of assets.
Open or closed
With the new regulation in place, ELTIFs can be structured as either open- or closed-ended. So why one or the other?
Feature | Open-ended Funds | Closed-ended Funds |
Structure | Allows buying and selling of shares at the fund's net asset value (NAV). | Issues a fixed number of shares, typically not redeemable by investors until end of fund duration. |
Flexibility | Offers greater flexibility for investors to enter and exit the fund. | Lacks flexibility for investors to access liquidity due to life events. |
Liquidity management | Investment strategy has to account for provision of limited liquidity. | Provides a stable investor base, meaning manager can invest without having to raise liquidity to service redemptions. |
May need to hold a portion of assets in cash or liquid securities, potentially impacting performance. | Listed closed-ended funds can mitigate some flexibility issues but may introduce high volatility and trade at a discount to NAV. | |
Could impose liquidity restrictions during periods of high market stress. | ||
Design for private wealth investors | Designed with features like a single capital call, lower minimum subscription amounts. | Increasingly designed with features like a single capital call, lower minimum subscription amounts. |
Source: Schroders Capital. For illustrative purposes only and not a recommendation to buy or sell any financial instruments or adopt a specific investment strategy.
Ultimately, the choice between open-ended and closed-ended ELTIFs will depend on individual investors' circumstances, including their liquidity needs, risk tolerance and investment objectives.
The introduction of the ELTIF 2.0 rules is a positive development for wealth investors. It allows them to access a broader universe of investments through a wider range of fund structures better adapted to their requirements. By introducing a common set of rules across EU markets it will lead to more competition and more choice, to the benefit of investors. Whilst private markets are not appropriate for all retail investors, for many investors private assets can play an important role in long-term investment planning such as pensions and savings. Having a modern regulatory framework that promotes consistency across EU markets is a great step forward.
Is ELTIF 2.0 an effective cross-border solution?
While the ELTIF regime aims to promote harmonised distribution across Europe, this objective is not without its challenges. Although the ELTIF label facilitates access for a broader range of investors, significant local differences persist from one country to another. Regulatory fragmentation can occur, with some national regulators implementing additional requirements—commonly referred to as 'gold-plating'—that complicate the distribution process. Furthermore, tax incentives in specific jurisdictions often lead to strong preferences among investors for particular local structures.
Outside of the EU, the ELTIF regulatory framework is not recognised so these funds will be treated no differently and it will depend on local regulations. Additionally, certain local jurisdictions are establishing their own frameworks akin to the ELTIF, such as the Long-Term Asset Fund (LTAF) in the UK.
While the ELTIF represents a positive advancement towards the democratisation of private assets, it is not a one-size-fits-all solution, and creating a single fund that meets the diverse needs of investors across various countries remains complex.
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