‘ELTIF 2.0’ is a welcome step forward but will need time to kick in

What are ELTIFs?

European long-term investment funds (ELTIFs) are investment funds created to facilitate long-term investment in the European Union through a framework that channels investments towards infrastructure projects and other long-term assets.

ELTIFs are regulated investment funds that must meet certain requirements, such as the current obligation to invest at least 70% of their capital in eligible assets, diversifying their investments, and having a minimum holding period of five years. ELTIFs also have specific rules on borrowing and leverage that are designed to limit risk.

Limitations of the ELTIF regime

In terms of the overall growth of EU investment funds since ELTIFs were introduced in November 2015, they have been a failure. According to the Commission’s own data (34-page / 481KB PDF), as of October 2021, only 57 ELTIFs had been launched with a relatively small amount of net assets under management. The Commission estimated that total assets under management in ELTIFs were approximately €2.4 billion in 2021. Several factors may have contributed to their limited adoption.

Complexity

The regulatory requirements for ELTIFs are complex, and some investors and fund managers may find the rules challenging to navigate. The strict requirements around diversification, leverage, and liquidity make it difficult to structure and manage a portfolio that meets the criteria of the regulatory framework.

Lack of investor demand

ELTIFs are a relatively new asset class, and many investors may not be familiar with the concept or may be hesitant to invest in a fund with limited track record. In addition, the minimum investment thresholds for some ELTIFs may have been higher than what some investors were willing or able to commit.

Competition

There are many other investment options available to investors, and some of these options may offer similar benefits to ELTIFs. For example, some investors may prefer to invest in listed infrastructure or real estate funds, which offer greater liquidity and transparency than ELTIFs or Luxembourg Part II UCIs, which are more common and avoid the complexity of ELTIFs. And professional investors may simply invest in the wider universe of unregulated funds.

The ELTIF 2.0 regime

The EU is planning a number of changes to the existing ELTIF rules to broaden their scope of investments and universe of eligible investors. The most significant liberalisation is perhaps the reduction in capital required to be invested in eligible assets, which has been reduced from 70% to 55%, together with the increase in the single position limits in Article 13(2), effectively doubling the headroom for each type of asset.

Furthermore, a much broader pool of eligible assets has been opened up, both geographically and by type. Previously a real asset could not be considered eligible unless its value exceeded €10 million – but this requirement has now been removed.

The position limits will not apply to ELTIFs that are marketed solely to professional investors, and they will also benefit from a higher leverage limit: 100% versus 50% for retail, up from 30% for both under the previous regime. However, such products may have limited use case, as they will compete against the existing regime for authorised investment funds (AIFs), albeit ELTIFs now having a use case for a pan-European standardised AIF.

For retail investors, the main challenge to date has been considered to be the barriers to entry into ELTIFs. As such, the €10,000 minimum investment and 10% portfolio exposure cap for retail investors with portfolios below €500,000 have been abolished, with ELTIFs falling within the more general MiFID II product governance and suitability regime.

There are a number of other small changes that may offer more flexibility in structuring, whether around master-feeder or fund-of-funds structures and exit liquidity, though some of these rules will remain dependent on specific Regulatory Technical Standards. The ELITIF 2.0 changes will enter into force nine months after the amending regulation’s publication in the Official Journal of the EU, though the implementing Regulatory Technical Standards on exit liquidity will follow later.

The future of ELTIFs

The changes have been hailed by many in the industry as a panacea, but there is cause to be slightly more circumspect. Broadening the range of eligible assets and more sensible position limits will allow promoters to develop more useful products that can align more closely to their wider stable and lowering the barriers for retail investors broadens their potential market at the same time. These are welcome developments, moving on from what was a barely workable regime. But the rules remain complex.

A significant uptake for professional-only ELTIFs remains unlikely, as there is already a well-developed market for regulated AIFs offered by Specialised Investment Funds (SIFs) and Qualifying Investor Alternative Investment Funds (QIAIFs). However, the lack of a position limit for professional ELTIFs would be beneficial versus the 30% limit in a SIF – no such limit exists for a QIAIF.

Ultimately, the changes in ELTIF 2.0 are welcome, particularly for opening-up the retail market at a time when listed investment funds are subject to wider market pressures. Despite this, it might take some time for the industry to adopt these products, and there is something of a sense of being back at square one, with many promoters being unfamiliar with the technical rules.