ELTIF II Easing Demand and Supply for Long-Term Investments  

The formal adoption of the text of the ELTIF II regulation by the European Council last March 7th signs the end of the legislative process for the redefinition of the regime applicable to European long-term investment funds. After the usual rounds of proposals, related positions and negotiations, the European Parliament voted on the text of the ELTIF II regulation in mid-February 2023, then formally adopted by the European Council.

Whilst we have covered already extensively the various iterations of the proposals surrounding ELTIF II regulation that brough us to the adopted version, it remains of interest to look at the issue surrounding European long-term investment funds in terms of supply and demand for ELTIFs and see how the second version of the regulation might succeed in achieving the scale desired by European authorities for these vehicles.

 

Get in touch here with your contacts at Veneziano & Partners to see how we can help with ELTIF II.

 

Demand restrictions 

The EU Commission, in a report on the functioning of the ELTIF framework dated November 2021, identified some key constraints for both the demand and the supply side of ELTIF.  

We personally believe that part of the demand side constraints was related to investor preference. More specifically, retail investors did not have a developed understanding – a taste if you like – for long-term investment opportunities at the time when ELTIFs were first launched. The EU Commission in the report instead focusses on the current duplications and other limitations provided for by the ELTIF regulation itself. This is where the assessment of knowledge and experience of retail investors, one of the obligations of the ELTIF manager, goes away under ELTIF II. In essence, this requirement duplicated the suitability assessment under MiFID. Most often than not, this was also a very sticky point in the negotiations with local distributors, for the few ELTIFs that were launched since inception, with distributors not always clear on – and reluctant to undertake – the type of additional activity required to be carried out. AIFMs managing ELTIFs very rarely want to get involved with retail investors, if ever.  

Lastly, the minimum initial investment of Euro 10 000 combined with the 10% limitation on aggregate investments for retail investors with a portfolio below Euro 500 000 did constitute a significant limitation for the masses to access ELTIFs. These limits, applied together, realistically capped the investment into ELTIF at Euro 10 000 even in cases where the 10% threshold would be higher than that, based on the actual size of the portfolio of a retail investor. At the same time, these were values not always accessible to distributors and subject to indication of the client. A welcome improvement of the regulation, which in our view will facilitate investment from the masses and not only white-collar retail investors in these vehicles.   

 

And the Ones on the Supply Side 

The issue of the supply constraints is multifaceted. We have discussed already how the ELTIF II regulation ended up diverging quite significantly from its previous version on some of the core axioms to facilitate the scaling up of these vehicles. We refer to the enlargement of the geographical scope of the underlying investments, which went from being essentially limited to Europe to being global under ELTIF II. Also, the type of investments seem to have changed, with possibility to invest also in fintech and green bonds.   

What seems to have also emerged under ELTIF II, is a clearer distinction between ELTIFs for professional investors and ELTIFs for retail investors. This was one of the most significant arguments under a technical advice from ESMA. In essence, ESMA purported that retail and professional investors’ interests and needs are not always aligned. Considering the different characteristics of each type of investor, ELTIFs should foster participation of retail investors as well as meet the specific needs of professional investors. A very ambitious proposition, left at the creativity of European authorities to implement in practice. Even when looking at the closest example under European regulation – the UCITS – we don’t see set of different rules applicable depending on whether professional or retail investors will be the target market for these products.   

The approach adopted under ELTIF II is to create a more clear-cut distinction between types of ELTIFs depending on the type of investor. Use of leverage, portfolio diversification, and composition, concentration limits as well as limits on eligible assets are the areas where there will be significant divergence depending on the type of investors. On this point, the ESMA ELTIF register, under the second iteration of the regulation, will have to have a separate entry for each ELTIF to specify whether the marketing is allowed to professional investors only or also to retail. There will be of course consequences depending on whether an ELTIF can be marketed to professional investors only or also retail.  

 

PRIIPs KIDs and local facilities 

So far, ELTIFs did fall under the PRIIPs regulation and had to produce KIDs accordingly. It seems a fair conclusion that, under ELTIF II, all long-term investment funds which can be marketed to professional investors only will not technically be retail products and not required to produce a PRIIPs KID. Very similar to what happens currently for all UCITS marketed to professional investors, where there is optionality to retain the UCITS KIID rather than producing a PRIIPs KID.  

Last, but not least, there is the point is on the local facilities. The requirement to appoint local facilities was considered one of the drags on the supply side and was consequently removed already in one of the early drafts of the revised regulation. In the final text of ELTIF II we no longer have related provisions. This said, the wording of whereas 38, which tackles the local facilities, seems to be unclear especially for what concerns the reference to the Crossborder distribution directive. This directive eliminated merely the requirement of local physical presence, rather than the concept of local facilities as such, which are still required. As it stands, rather than aligning to the Crossborder distribution directive, the ELTIF II no longer provides for a requirement that is indeed still applicable to UCITS.  

Get in touch here with your contacts at Veneziano & Partners to see how we can help with ELTIF II.