ELTIF Regulation Review. Less European, more Sustainable

The long-awaited European Commission proposal for the ELTIF Regulation review is now out. Taking stock of the hard facts and that the full potential of the ELTIF is still far from having been achieved, the proposal for the ELTIF regulation review is based on some laser focused measures to tackle the most evident shortcomings of the current iteration of the ELTIF regulation.

Amongst other things, the ELTIFs regulation review proposes to broaden the scope of ELTIF eligible assets as well as make European cross border distribution less cumbersome. And whilst widening the eligible retail audience and eliminating some duplications in the suitability and investment advice will for sure support the momentum recently experienced by ELTIFs in southern Europe – and maybe expand it also to other EU member states – it still remains to be seen whether a secondary market will ever flourish for these products.

Get in touch here with your contacts at Veneziano & Partners to see how we can help with understanding the ELTIF Regulation Review.

Less European more Sustainable

Many US fund managers have been asking over time whether the scope of ELTIFs eligible investments was essentially – and exclusively – European. And for the ELTIF having been developed mainly to foster European capital markets, in the context of the so-called Capital Markets Union, the idea was to channel through the ELTIF the funding of European long-term investment opportunities only. The ELTIF regulation review is set to change that rather dramatically. ELTIFs leave behind their former identity of European centric investment products. The new wording proposed by the European Commission for article 1.2 of the ELTIF regulation no longer bears accordingly reference to European long-term projects, opening up this vehicle to global investment mandates.

And whilst it is very difficult to argue that this way the ELTIF will still be entirely aligned with one of the main objectives of the Capital Markets Union – providing new avenues of funding for European SMEs or European infrastructure and other longer-term initiatives – there are of course still benefits for European investors. In its second life, the ELTIF could well be used to fund investments in environmental preservation or sustainability projects in third countries, which have nevertheless the potential to benefit ELTIF investors and the long-term growth of Europe.

On this particular note, it is also noteworthy to mention that the ELTIF regulation review contains a revision of the definition of real assets, to include any assets that have an intrinsic value due to their substance or properties. Broadening the concept of real assets means, on the one hand, that those assets may, but not necessarily have to, provide cash-flows or investment returns. This way the ELTIF is set up to become the vehicle of choice for sustainable type of investment opportunities, by switching the focus from European long-term opportunities to global sustainability goals.

On the other hand, real assets will include rights attached to or associated with more traditional types of real assets, like water, forest and mines. Also, interesting to note that ELTIF now can invest directly in such real assets and no longer necessarily via a qualifying portfolio undertaking.

From the Upper Class to the Masses

Where we believe the ELTIF Regulation review will really facilitate the momentum around this investment vehicle is with regards to the simplification of the provisions related to suitability and appropriate investment advice. One of the practical issues most often encountered in the dynamics of the European distribution of ELTIFs has always been around pinning down the entity in charge with the additional suitability checks imposed on ELTIF managers and appropriate investment advice, with contention mostly centred around having local distributors to formally undertake to carry out these activities. A very welcome simplification, which would make engaging with local distributors in pan-European distribution endeavours much easier going forward.

On the same note, we also see that there will be no more thresholds for retail investors to be able to invest in ELTIFs. A very radical change, in our view, which will allow to truly democratise the access to long-term investment opportunities. In its first iteration, the ELTIF retail audience was a more qualified one. By way of oversimplification and analogy, the ELTIF was conceived to be an investment product for the upper class, having an investment portfolio of a certain size, which could allow for the decision to commit to an investment for the longer term.

And whilst we don’t believe there being excessive harm in opening up ELTIFs to the mass retail investor – as many and more exoteric strategies are nevertheless already available to them – the weight that the substantially illiquid nature of this product could have on its success with the retail audience is known. However, the evolution of the debate on the subject of long-term investment opportunities for retail investors has somehow reduced concerns over liquidity. Realistically long-term investments might suit very well retirement/pension contribution situations better than products so far traditionally employed for this purpose. From this perspective, we believe that liquidity might become a less pressing issue.

In addition to that, the proposal of the European Commission opens up to the introduction of a secondary market liquidity mechanism. In simple terms, before the end of the life of an ELTIF it would be possible for investors to exit their investment upon being matched with new entrant investors on a secondary market. ESMA will be in charge of drafting regulatory technical standards for this particular process and provide more granular details on how to establish in practice a secondary market.

Conclusions

With a different identity, less European, but a more sustainable twist to them, ELTIFs are here to stay and time only will tell whether the changes proposed by the European Commission will have the desired effect.

However, we take the view that the ELTIF regulation review should not be seen in a vacuum, rather also in conjunction with the AIFMD review Rules on Marketing non-EU AIFs under NPPR. AIFMD Review rolled out at the same time. The success of ELTIFs in the future will clearly come from a balancing act between making more efficient and versatile the ELTIFs itself, but also make more prohibitive some other practices, like accessing Europe with foreign products, offering investors access to strategies that could well be hosted within a European product.

Get in touch here with your contacts at Veneziano & Partners to see how we can help with understanding the ELTIF Regulation Review.