European Long Term Investment Funds - Assessment of EU proposals
The European Commission is proposing a regulation on European Long Term Investment Funds ("ELTIFs") ("draft regulation"). The latest version of the proposal was approved by the Council of the EU's Permanent Representatives Committee ("COREPER") on 25 June 2014.
The proposals are designed to provide a framework for retail investment in illiquid asset classes such as infrastructure projects and unlisted companies. The aim is to channel this as a long-term financing mechanism to support sustained economic growth in Europe.
A summary of the key aspects of the draft regulation is set out below.
Investment Rules – Key Requirements
An ELTIF will be subject to specific investment rules, summarised as follows.
At least 70% of capital must be invested in eligible long-term investments, for example, unlisted instruments, SMEs, commercial property and other infrastructure funds. Up to 30% can be held in assets that are eligible for investment by UCITS.
Specifically, an ELTIF must invest at least 70% in the following:
- equity, quasi-equity or debt instruments issued by a "Qualifying Portfolio Undertaking" (details of which are set out below);
- loans to a Qualifying Portfolio Undertaking;
- units in other ELTIFs;
- investment funds designated as European Venture Capital Funds ("EuVECAs") under EU Regulation 345/2013 or European Social Entrepreneurship Funds ("EuSEFs") under EU Regulation 346/2013 (which themselves have not invested more than 10% in ELTIFs); and
- direct holdings of real assets (e.g. real estate, ships or aircraft) that require up-front capital expenditure of at least €10 million.
A Qualifying Portfolio Undertaking is an unlisted company (or a listed SME) established to finance infrastructure projects, companies or real assets. In the case of unlisted companies they must be established in an EU Member State or a country that is Financial Action Task Force ("FATF") compliant and has signed an agreement of understanding to the effect that it is OECD Model Tax Convention compliant with relevant EU Member States.
The 70% limit referred to above does not apply during the first five years of the ELTIF, may be temporarily suspended for 12 months during the lifetime of the ELTIF where the fund raises additional capital, and does not apply once it begins to sell assets in accordance with its redemption policy.
A maximum of 10% of capital may be invested in assets of a single issuer or any single real asset. There are also a range of other portfolio diversification requirements.
Investment in commodities is not permitted nor is any short selling and derivatives may be used for hedging purposes only. Borrowing is limited for ELTIFs targeting both professional and retail investors.
While ELTIFs are designed to invest in long-term assets appropriate to the term of the fund, the draft regulation does not specify sectors in which investment may be made.
Other Key Elements
Some key elements of this proposed fund product are considered briefly below:
ELTIFs must be authorised by a national competent authority in an EU Member State. They must have an alternative investment fund manager ("AIFM") authorised in the EU under the Alternative Investment Fund Managers Directive1 ("AIFMD"). ELTIFs are therefore categorised as alternative investment funds ("AIFs") within the AIFMD regime.
Type of fund structure available
If targeting retail investors, ELTIFs may not take the legal form of a partnership. Otherwise, there are no restrictions in terms of form of legal structure.
ELTIFs must be closed-ended with a fixed term, the length of which would be determined by the nature of the ELTIF's target assets. Regulatory technical standards to assist in determining the life cycle of the ELTIF appropriate for the life cycle of its investments are to be developed by the European Securities and Markets Authority ("ESMA"). ELTIFs must prepare an asset disposal schedule dealing with the orderly sale of assets before the end of the fund's fixed term. The draft regulation is not clear on whether the fixed term of an ELTIF may be extended.
ELTIFs may make regular distributions of net income, although not to the extent that the income is required in relation to future commitments of the ELTIF.
ELTIFs may be listed so there is the potential for secondary market liquidity.
Marketing of ELTIFs
The draft regulation provides for a product specific label for ELTIFs and an ELTIF passport for marketing to professional and retail investors across the EU based on the notification procedures for cross-border marketing of funds under AIFMD. The key development in the draft regulation is that ELTIFs would have a retail passport, which is not otherwise available for all EU AIFs since the AIFMD passport is limited to marketing to professional investors, subject to local rules in each EU Member State.
Transparency requirements for ELTIFs
AIFMD transparency requirements would apply to ELTIFs. In addition, retail ELTIFs would constitute a packaged retail investment product ("PRIP"), thus requiring a PRIP key information document ("KID") for marketing to retail investors.
AIFMD disclosure requirements would apply to the ELTIF's prospectus. It must also be compliant with the Prospectus Directive2 for closed-ended funds.
Retail investor assessment
The most recent version of the draft regulation requires the manager or a distributor (where investment is made through a distributor) to carry out a suitability assessment on each retail investor.
There is also a requirement that, if the investor's overall portfolio is less than €500,000 in aggregate, the manager or distributor must ensure that the retail investor invests no more than 10% of their portfolio in the ELTIF. This only applies for subscriptions of €10,000 or more.
Each ELTIF must appoint a depositary subject to requirements aligned with the recently finalised provisions of UCITS V3.
There is a specific requirement that the ELTIF may not have any investments in common with the manager.
This is certainly an interesting product proposal and, once implemented, will present a unique opportunity to establish an EU authorised closed-ended infrastructure fund that can be sold to retail investors on a public offering basis across the EU.
Further, that it can be listed and traded on the secondary market presents the prospect of an infrastructure exchange-traded fund ("ETF"), although the retail investor assessment proposals, as currently framed, could present a challenge in this context.
Nonetheless, it would seem that, with a few adjustments, the existing Irish Retail Investor Alternative Investment Fund ("RIAIF") framework could support this product.
For any further information on matters discussed in this update please contact your usual Maples and Calder contact.
1 Directive 2011/61/EU
2 Directive 2003/71/EC
3 Directive of the European Parliament and of the Council amending Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) as regards depositary functions, remuneration policies and sanctions.