ELTIF 2.0 – New opportunities for the fund management industry

WHAT IS ELTIF?

Introduced in 2015 by Regulation (EU) 2015/760 (the ELTIF Regulation), European long-term investment funds (ELTIFs) are authorized and regulated alternative investment funds (AIFs) with a focus on private market investments. ELTIFs are the only type of funds dedicated to long-term investments that can be distributed across borders in the EU to both professional and retail investors.

WHY ELTIF 2.0?

The first version of the ELTIF Regulation fell short of expectations. Only around 84 ELTIFs have been authorized so far and they’re concentrated in a handful of Member States. This is mainly because of significant constraints in the distribution process (i.e. investors’ side) and strict rules on portfolio composition (i.e., investments’ side).

The amending regulation (Regulation (EU) 2023/606) was published on 20 March 2023, in the Official Journal of the European Union. It will enter into force on 9 April 2023 and start to apply on 10 January 2024 (ELTIF 2.0).

ELTIF 2.0 intends to enhance the attractiveness of ELTIFs as go-to vehicles for cross-border regulated infrastructure, real-estate, and private equity financing for both retail and professional investors.

Managers of ELTIFs authorized before 10 January 2024, can choose the ELTIF 2.0 regime, provided the ELTIF’s competent authority is notified and approves the choice. Existing ELTIFs not opened to subscription will be deemed to be complying with the ELTIF 2.0 regime (i.e. grandfathered) for five years following the date of application of ELTIF 2.0.

Managers of ELTIFs subject to the first version of the ELTIF Regulation must comply with ELTIF 2.0 by 11 January 2029.

ELTIF 2.0 – UNLOCKING POTENTIAL FOR INVESTMENTS AND RETAIL INVESTORS?

A wider investment space for fund managers

With ELTIF 2.0, the definition of eligible assets has been revisited and broadened. Here are the main changes:

• The minimum investment requirement in eligible assets has been reduced to 55% from 70%. This lower threshold could enable managers to more easily handle liquidity management to accommodate semi open-ended structures or to propose hybrid strategy vehicles mixing equity instruments and UCITS¹
• Third-country (i.e. non-EU) investments will be eligible under certain conditions.
• The scope of eligible “real assets” has been broadened, notably with the removal of the minimum EUR10 million value per individual real asset.
• The maximum market capitalization of listed qualifying undertakings in which the ELTIF can invest has been increased from EUR500 million to EUR1.5 billion, significantly increasing the investment space in listed instruments and providing ELTIFs with a better liquidity profile.
• Investments in innovative financial undertakings like fintechs will now be possible.
• Investments in simple, transparent and standardized (STS) securitizations have now been included in the list of eligible assets.
• An ELTIF can now acquire up to 30% of the units of a single ELTIF, EuVECA,² EUSEF,³ UCITS or EU AIF managed by an EU AIFM.
• The eligibility of fund of funds strategies has been widened so an ELTIF can now invest in UCITS and EU AIFs. Before it was limited to other ELTIFs.
• ELTIFs will be allowed to use master-feeder structures, though each of the two levels has to be an ELTIF in its own right.
• The borrowing capacity of ELTIFs marketed to retail investors has been increased from 30% to 50% of NAV.
• Evergreen and semi open-ended fund vehicles are possible.
• Co-investments have been facilitated, provided conflicts of interest are identified, managed and disclosed.
• Most of the diversification thresholds will be doubled to 20%.

A more accessible distribution process

ELTIF 2.0 has simplified the distribution process. In the first version it was considered either not in line with established market practices or detrimental to the accessibility of retail investors.

In particular:

• The initial minimum investment of EUR10,000 and the limitation on aggregate investments (i.e. maximum 10% of a retail investor’s financial instrument portfolio invested in ELTIFs) have been removed.
• ELTIF managers are no longer required to provide investment advice when marketing ELTIFs to retail investors. In practice, the second layer of ELTIF specific suitability assessment has been removed.
• An ELTIF no longer needs to have local facilities (infrastructure for making subscriptions, making payments to investors, redemptions and delivering information by ELTIF managers) where its units are being marketed. This should limit cost and unnecessary impediments to the cross-border marketing of ELTIFs.
• Investors can no longer request the winding down of an ELTIF if their redemption request has not been satisfied.

ELTIFs and professional investors: Unleveraged potential for fund managers?

The first version of the ELTIF Regulation provided almost identical rules for both professional and retail investors. So it was a much more cumbersome investment vehicle than unregulated AIFs. ELTIF 2.0 introduces a simplified regime for ELTIFs for professional investors.

In particular:

• Most investment restrictions related to diversification and concentration have been relaxed.
• The borrowing threshold has been raised to 100% of the ELTIF value.
• The ELTIF is allowed to acquire 100% of the units of a single ELTIF, EuVECA, EUSEF, UCITS or EU AIF managed by EU AIFM.

In practice, for private debt strategies, ELTIFs reserved for professional investors may benefit from a cross-border passport, allowing them to lend up to 100% of their NAV, including in EU countries that have strict banking monopoly rules. From a loan origination perspective, in some countries, ELTIFs are the only fund vehicles allowed to originate loans alongside banks or other licensed professionals. But this may cease to be the case when the AIFMD⁴ is reformed regarding loan originating funds and the possibility to passport loan originating activity by AIFMs⁵ across the EEA.

Following an amendment to Solvency II⁶ by Commission Delegated Regulation 2016/467, ELTIFs can also benefit from the same capital charges as equities traded on regulated markets, which are lower than for other equities. So ELTIFs benefit from a better Solvency II treatment.

FOCUS ON TAX AND CERTAIN JURISDICTIONS

In general, there’s no specific tax treatment associated with the ELTIF Regulation. An ELTIF can be set up using different legal forms in individual jurisdictions. And its tax treatment will generally depend on the legal form or status chosen for the vehicle (e.g. this is the approach in France or Luxembourg).

Some jurisdictions provide tax incentives for ELTIF investors.

Belgium has introduced an attractive set of tax rules for Belgian resident ELTIFs and their Belgian and foreign investors. This framework aims to make the investment through an ELTIF tax neutral from a corporate income tax perspective. This is to eliminate economic double taxation for corporate investors and to waive withholding tax on dividend distributions for non-resident corporate investors. Finally, foreign and individual investors may also be entitled to various withholding tax exemptions if they meet certain conditions.

In Italy, no benefits are provided specifically for ELTIFs. Some tax benefits are provided for individuals that participate in certain Italian investment funds (called PIR) with characteristics (in terms of investment policy and concentration limits) that are similar to ELTIFs. Even if they’re not necessarily ELTIFs under EU laws. But often these PIRs are set up as ELTIFs, so 99% of Italian ELTIFs can benefit from the special regime.

In Spain, some tax incentives apply for investors resident in the Basque Country for ELTIFs incorporated there.

National investment compliance rules for insurance wrappers also enable them to invest in ELTIFs under certain conditions. For example, French retail investors can already invest up to 10% of units of their life insurance contracts in an ELTIF. And professional investors can invest up to 50% of their life insurance contracts, within the limit of 10% of their personal wealth.

REMAINING UNCERTAINTIES

Some further clarifications are still expected with the publication of the final rules and technical standards. In particular, we need clarification on liquidity management issues in open ended/semi open-ended ELTIFs, conditions of eligibility of EU AIFs as eligible assets (i.e. transparent alignment with ELTIFs limits).

ELTIF 2.0 certainly provides significant improvements and should reach a larger audience of asset managers and investors. But there are still some obstacles, like the burdensome master/feeder structuring which requires a double layer of ELTIFs.

It’s fair to say the flexibility introduced by ELTIFs 2.0 should increase the use of these investment vehicles in the future – both from an investment and investor perspective.

Effective education of the distribution industry is the key to the success of ELTIFs.

For more info:

Investment Management and Funds | DLA Piper

ELTIF 2.0 Regulation

¹Undertakings for the Collective Investment in Transferable Securities.
²European Venture Capital Fund.
³European Social Entrepreneurship Fund.
⁴Alternative Investment Fund Managers Directive.
⁵Alternative Investment Fund Managers.
⁶Solvency II is an EU legislation governing the capital adequacy regime for the European insurance industry. It establishes a set of EU-wide capital requirements and risk management standards. The Solvency II regime was introduced by Directive 2009/138/EC.