ELTIF 2.0 reforms designed to boost European Long-Term Investment Funds

ELTIF 2.0 will apply within all EU member states from 10 January 2024 - subject to the particular provisions of the grandfathering regime - without the need for each country to adopt it into national law. The new regulation contains several enhancements to the previous ELTIF regime, known as ELTIF 1.0, bringing significant new opportunities for the investment fund industry.

Background

ELTIFs and the ELTIF 1.0 regulatory framework were introduced in April 2015. The regime established a fully harmonised European regulatory framework for alternative investment funds (AIFs) which invest in a broad range of long-term projects such as infrastructure projects and investments in real estate and small and medium sized enterprises (SMEs).

ELTIF 1.0 established uniform rules on the authorisation, investment policies and operating conditions and marketing of ELTIFs, thereby aiming to facilitate long-term investment in the above-mentioned assets by institutional and retail investors.

Despite the benefits already created by ELTIF 1.0 for both promoters and investors, including the possibility of marketing ELTIFs across the EU member states through a European marketing passport, the highly anticipated and desired breakthrough for the funds market failed to materialise. As of the start of 2023, only 84 ELTIFs had been authorised in four EU member states, of which more than half were set up in the fund hub of Luxembourg.

The attractiveness of ELTIFs was reduced by inadequacies in the design of the legal framework. Criticism from the financial industry was acknowledged by the European Commission, which, along with the European Securities and Markets Authority (ESMA), concluded that the ELTIF framework needed to be refreshed.

Simplification of conditions for investments

ELTIF 2.0 simplifies the conditions for investment in real assets, new eligible investments and investment strategies. The new regulation:

• Broadens the scope of eligible assets by removing the reference to “European long-term projects”, thereby opening for the possibility of investments located outside of the EU;
• Redefines "real assets", allowing for a flexible and large range of qualifying investment strategies;
• Removes the minimum value requirement of €10 million for real assets;
• Introduces the possibility of conducting co-investment strategies and sponsor/staff co-invests, subject to appropriate conflicts of interest procedures and disclosures;
• Increases the market capitalisation threshold for listed qualifying portfolio undertakings from €500m to €1.5 billion;
• Creates the possibility to invest in financial undertakings, like fintech assets, subject to certain conditions;
• Introduces the possibility to invest in non-EU qualifying portfolio undertakings, save for non-EU qualifying portfolio undertakings in jurisdictions identified as high risk for money laundering or listed on the EU list of non-cooperative jurisdictions for tax purposes, which are still prohibited;
• Explicitly clarifies that indirect investments, through "intermediary entities, including special purpose vehicles and securitisation or aggregator vehicles or holding companies" including through minority participations in intermediary entities, are possible; and
• Introduces ‘simple, transparent and standardised’ (STS) securitisations with underlying assets consisting of mortgage-backed securities, commercial, residential and corporate loans. Trade receivables have also been included in the list of eligible assets.

Reform of investment, borrowing and diversification rules

New investment rules

New rules lower the mandated minimum investment threshold in eligible investment assets from 70% to only 55%, allowing liquidity management for fund managers to better accommodate semi open-ended structures and vehicles with hybrid strategies.

ELTIF 2.0 also introduces ‘fund of funds’ strategies, removing the 20% investment limit. It also expands the scope of eligible collective investment undertakings (UCIs) to include not only ELTIFs, European Venture Capital Funds (EuVECAs) and European Social Entrepreneurship Funds (EuSEFs), but also Undertakings for the Collective Investment in Transferable Securities (UCITS) and EU Alternative Investment Funds (AIFs) managed by EU Alternative Investment Fund managers (AIFMs).

The new rules allow ‘master-feeder’ ELTIFs, provided that one ELTIF invests at least 85% of its assets into another ELTIF, aligning more closely to the requirements for master-feeder AIFs within the meaning of the AIFM Directive (AIFMD).

Extended borrowing rules

Under ELTIF 2.0, borrowing arrangements that are fully covered by outstanding capital commitments are excluded from borrowing limits. The change also increases flexibility for ELTIFs that do loan-originating. This is because, in the context of granting loans to qualifying portfolio undertakings, maturity rules have been slightly enhanced to a maturity which might not exceed the lifecycle of the ELTIF in question.

The borrowing threshold, exceeding the short-term borrowing, has also been increased for retail investors from 30% to 50% and is now based on the net asset value (NAV) of the ELTIF, rather than the value of the capital of the ELTIF. The borrowing threshold for professional investors has been raised from 30% to 100% of the NAV of the ELTIF.

Other changes to extended borrowing rules include:

• removal of the 30% limitation on security over assets of the ELTIF;
• introduction of borrowings in other currencies appropriately hedged;
• clarification that subscription facilities covered by undrawn commitments are not subject to the borrowing rules; and
• introduction of a specific ramp-up period for borrowing limits, including a ramp-up period for borrowing limits of up to three years as of the marketing of the ELTIF and a temporary suspension of up to 12 months of the limits when the capital is reduced or raised

New diversification rules

New diversification rules, which only apply to ELTIFs that are not solely reserved to professional investors, include:

• doubling the diversification threshold for instruments issued by, or loans granted to, any single qualifying portfolio undertaking, any single real asset and units, interests or shares of any single ELTIF, EuVECA, EuSEF, UCITS or EU AIF managed by an EU AIFM from 10% of an ELTIF’s capital to 20%. This does not apply to feeder ELTIFs.
• doubling the diversification threshold for any UCITS-eligible asset issued by one single body, the risk exposure to any counterparty with respect to over-the-counter (OTC) derivative transactions, repurchase agreements or reverse repurchase agreements from 5% of an ELTIF's capital to 10%; and
• up to 20% of an ELTIF’s capital may now be invested in STS securitisations.

Removing barriers for retail investor access

The new rules distinguish between ELTIFs solely marketed to professional investors and ELTIFs marketed to retail investors, to better address the specific requirements of each investor type. ELTIF 2.0 also removes the local facilities requirement in each EU member state of distribution, through which units can be subscribed and redeemed by retail investors, to the benefit of decreasing costs and bureaucratic efforts.

In addition, ELTIF 2.0 removes both the minimum initial investment into an ELTIF and the 10% aggregate investment amount for retail investors with less than €500,000. This change will make it more attractive to investors who do not qualify as, and may not opt-in as, professional investors within the meaning of Annex II of the Markets in Financial Instruments Directive (MiFID). This is also the case for asset managers who no longer need to carry out a suitability assessment on the retail investor’s knowledge and experience in addition to the suitability test already required under MiFID, and who no longer need to provide investment advice when marketing to retail investors.

Simplified regime for professional investors

Relaxed investment restrictions mean ELTIFs solely reserved to professional investors can acquire 100% of the units, shares or interests of a single ELTIF, EuVECA, EuSEF, UCITS or EU AIF managed by an EU AIFM.

Enhanced redemption rules for ELTIFs

The new rules introduce the possibility of evergreen and semi open-ended fund vehicles. ELTIFs under ELTIF 2.0 have a limited duration, but can be structured as open-ended funds under enhanced redemption rules. This allows them to redeem their units, shares or interests, as the case may be, before the end of the ELTIF’s life cycle, because the mandatory lock-up period during the ramp-up period has been removed and a shorter lock-up period is now possible.

Restrictions on the liquidity management requirements have also been removed and investors are no longer able to require the dissolution of the ELTIF if their redemption requests have not been satisfied within one year following the request. Further regulatory technical standards (RTS) are in the process of being developed by ESMA in connection with redemption policies and liquidity tools.

The ELTIF 2.0 grandfathering regime

Existing ELTIFs, and those launched and authorised between 9 April 2023 and 10 January 2024, can opt-in to ELTIF 2.0, subject to prior notification to the ELTIF competent financial authority and its approval of the choice. Alternatively, they can remain subject to ELTIF 1.0 and be deemed to comply with ELTIF 2.0 by the end of 10 January 2029 at the latest, regardless of any additional capital raising taking place on or after 10 January 2024.

Cooling-off period

ELTIF 2.0 clarifies that the cooling-off period set out in ELTIF 1.0, which allows retail investors to cancel their subscription and have the money returned without penalty up to two weeks after the date of their subscription, begins on the date of signature of the initial commitment.