A summary of European long-term investment funds (ELTIF) regulation

On 19 May 2015, the European Union's Regulation on European Long-term Investment Funds (the Regulation) was published in the Official Journal of the EU. The Regulation establishes a new investment vehicle, the European Long-term Investment Fund (ELTIF), which would be available for marketing to all types of investors - including retail - across the European Union (EU).

The aim of the Regulation is that, by restricting the asset classes in which ELTIFs can invest, the new vehicles will provide investors with long-term, stable returns and help stimulate employment and economic growth in the EU by increasing investment in, for example, infrastructure projects.

The provisions of the Regulation will be effective from 09 December 2015.

This note summarises the following key features of the Regulation:

• Overview of the ELTIF regime
• Key provisions in the Regulation
  • Authorisation
  • Investment policies
  • Eligible investment assets
  • Qualifying portfolio undertaking
  • Diversification and concentration provisions
  • Investment restrictions
  • Borrowing restrictions
  • Redemption, disposal and distribution
  • Transparency
  • Marketing
  • General provisions
  • Additional provisions applicable where the ELTIF is to be marketed to retail investors
  • Provisions regarding depositaries of ELTIFs marketed to retail investors
  • Review
• Next steps

(A) Overview of the ELTIF regime

The intention behind the Regulation is to enable EU-authorised AIFMs to market EU AIFs which they manage as 'ELTIFs' to both professional and retail investors (as defined under MiFID) across the EU. Authorised managers will be able to make use of an EU-wide passport, subject to a notification procedure established under the EU's Alternative Investment Fund Managers Directive (AIFMD).

The Regulation sets out rules and restrictions on the authorisation, investment policies, and operating conditions of EU AIFs that may be marketed as ELTIFs.

To qualify as an ELTIF, a fund must (among other things):

• be managed by an authorised AIFM
• invest at least 70% of its of its capital in eligible investment assets
• not engage in short selling, and
• observe strict limitations on its use of leverage and derivatives.

In general, ELTIFs will not offer redemption rights before the end of the fund's life -- the "end of life" must be clearly indicated as a specific date in the ELTIF's rules or instruments of incorporation and disclosed to investors.

The Regulation sets out a number of disclosure and other provisions, designed to protect investors - in particular where the ELTIF is to be marketed to retail investors. For example, an ELTIF manager will have to undertake a suitability test to confirm that investment is suitable for the retail investor and to provide that investor with "appropriate investment advice". In addition, the manager must ensure that a retail investor with a portfolio of up to EUR 500,000 does not invest more than 10% of his/her portfolio in ELTIFs, provided that the initial amount invested in one or more ELTIFs is not less than EUR 10,000.

(B) Key provisions in the Regulation

1. Authorisation (Articles 3 to 6 of the Regulation)

Only an EU AIF may be authorised as an ELTIF and only an authorised ELTIF may be marketed as an ELTIF in the EU.

The ELTIF must apply for authorisation to its home state regulator, submitting as part of its application (among other things) its rules of incorporation, the identity of its proposed manager and depositary and a description of the information to be made available to investors.

An EU AIFM that wants to manage an ELTIF must apply to the ELTIF's home regulator for authority to do so. Again, specified information must accompany this application - for example, a written agreement with the fund's depositary; information on delegation arrangements concerning portfolio and risk management and administration; and information about the investment strategies, the risk profile and other characteristics of AIFs that the AIFM is authorised to manage.

Where the ELTIF's competent authority is the same as that of the AIFM, the latter's application can refer to the documentation which it submitted when applying for authorisation as an AIFM under AIFMD.

The ELTIF and the AIFM must be informed within two months of submission of a complete application whether (respectively) authorisation of the ELTIF and approval to manage the ELTIF has been granted.

The ELTIF must comply with the provisions of both the Regulation and AIFMD, while its manager must comply with the provisions of AIFMD but will be responsible for ensuring compliance with the Regulation, being liable for losses or damages resulting from non-compliance.

2. Investment policies (Articles 8 to 17 of the Regulation)

An ELTIF is restricted to investing only in (a) "eligible investment assets" (see below) or (b) assets referred to in Article 50(1) of the UCITS Directive (UCITS assets). The ELTIF must also comply with the diversification requirements set out below.

If the ELTIF comprises more than one investment compartment, each compartment must be regarded as a separate ELTIF for investment policy purposes.

a. Eligible investment assets

The Regulation defines "eligible investment assets" as being:

• equity or quasi-equity instruments that have been:
  • issued by a qualifying portfolio undertaking and acquired directly by the ELTIF from the qualifying portfolio undertaking (see below) or from a third party via the secondary market
  • issued by a qualifying portfolio undertaking in exchange for an equity instrument previously acquired by the ELTIF from the qualifying portfolio undertaking or from a third party via the secondary market, or
  • issued by an undertaking of which the qualifying portfolio undertaking is a majority-owned subsidiary, in exchange for an equity instrument acquired in accordance with points (i) or (ii) above by the ELTIF from the qualifying portfolio undertaking or from a third party via the secondary market
• debt instruments issued by a qualifying portfolio undertaking
• loans granted by the ELTIF to a qualifying portfolio undertaking with a maturity no longer than the life of the ELTIF
• units or shares of one or several other ELTIFs, European Venture Capital Funds (EuVECAs) and European Social Entrepreneurship Funds (EuSEFs), provided that those ELTIFs, EuVECAs and EuSEFs have not themselves invested more than 10% of their capital in ELTIFs
• direct holdings or indirect holdings via qualifying portfolio undertakings of individual real assets with a value of at least EUR 10 million or its equivalent in the currency, and at the time, in which the expenditure is incurred.

b. Qualifying portfolio undertaking

A "qualifying portfolio undertaking" is an undertaking (other than a collective investment undertaking) which:

is not a "financial undertaking" as defined in Article 2 of the Regulation (ie it is not a credit institution, a MiFID investment firm, an insurance undertaking, a financial holding company, a mixed-activity holding company as defined in the Capital Requirements Directive, a UCITS management company or an AIFM)

• either (i) is not admitted to trading on a regulated market or Multilateral Trading Facility (MTF) as defined in MiFID/MiFIR or (ii) is admitted to a regulated market or MTF and has a market capitalisation of no more than EUR 500 million
• is established in an EU Member State or in a third country which:
  • is not a FATF high risk and non co-operative jurisdiction, and
  • has signed an OECD Model Tax Convention in Income and on Capital agreement with the ELTIF manager's home Member State and with each other Member State in which the ELTIF is intended to be marketed.

c. Diversification and concentration provisions

An ELTIF must invest at least 70% of its capital in eligible investment assets (see section 2(a) above).

The 70% limit:

• applies from the date specified in the ELTIF's rules. This date must take into account the 'peculiarities and characteristics of the assets' in which the ELTIF is to invest and must be no later than five years after authorisation of the ELTIF (or, if earlier, half the life of the ELTIF) -- in exceptional circumstances, this may be extended by up to a further year with the approval of the ELTIF's competent authority
• may be temporarily suspended (for up to 12 months) to allow the ELTIF to raise additional capital (or reduce its existing capital), and
• ceases to apply once the ELTIF starts to sell assets in order to redeem investors after the life of the ELTIF.

The ELTIF must not invest more than:

• 10% of its capital in instruments issued by, or loans granted to, any single qualifying portfolio undertaking
• 10% of its capital directly or indirectly in a single real asset
• 10% of its capital in units or shares of any single ELTIF, EuVECA or EuSEF
• 5% its capital in UCITS assets where those assets have been issued by a single body.

In addition:

• the 10% figure referred to in the first two bullets above can be raised to 20% if the aggregate value of assets held by the ELTIF in qualifying investment portfolios and individual real assets in which it invests more than 10% of its capital does not exceed 40% of the value of its capital
• the 5% limit referred to in the fourth bullet above can be raised to 25% where bonds are issued by a credit institution which has its registered office in a Member State and is subject to special public supervision designed to protect bond-holders
• the aggregate value of units or shares of ELTIFs, EuVECAs and EuSEFs in an ELTIF portfolio cannot exceed 20% of the value of the ELTIF's capital
• the aggregate risk exposure to a counterparty of the ELTIF stemming from OTC derivative transactions or repurchase agreements must not exceed 5% of the ELTIF's capital
• the ELTIF cannot acquire more than 25% of the units or shares of a single ELTIF, EuVECA or EuSEF
• the ELTIF cannot invest in an eligible investment asset in which its manager has a direct or indirect interest, other than by holding units or shares of the ELTIFs, EUSEFs or EuVECAs it manages.

Where the ELTIF breaches the above diversification requirements and the contravention is beyond the control of the ELTIF manager, the manager must rectify the position, "in an appropriate time period", taking due account of the interests of the ELTIF's investors ELTIF.

d. Investment restrictions

An ELTIF cannot:

• engage in short selling
• take direct or indirect exposure to commodities, including via derivatives or indices
• enter into securities lending securities borrowing and repo transactions "or any other agreement which has an equivalent economic effect and poses similar risks" if by doing so, more than 10% of the ELTIF's assets are affected, or
• use financial derivative instruments (except where this solely serves the purpose of hedging risks inherent to other investments of the ELTIF).

e. Borrowing restrictions

An ELTIF may only borrow cash provided that it:

• represents no more than 30% of the capital of the ELTIF
• is used to invest in eligible investment assets (other than loans granted to a qualifying portfolio undertaking with a maturity no longer than the life of the ELTIF), provided that the ELTIF's cash or cash equivalent holdings are not sufficient to acquire the participation in eligible investment assets
• is in the same currency as the assets to be acquired with it
• has a maturity no longer than the life of the ELTIF, and
• does not encumber assets making up more than 30% of the ELTIF's capital.

The ELTIF manager must specify in the ELTIF's prospectus whether or not it intends to borrow cash or not as part of its investment strategy.

3. Redemption, disposal and distribution (Articles 18 to 22 of the Regulation)

Investors in an ELTIF will not ordinarily be able to redeem their units or shares before the "end of life" of the fund. This is a specific date, which must be clearly disclosed to investors and indicated in the ELTIF's rules or instruments of incorporation. The ELTIF's rules may also indicate the right to temporarily extend the life of the ELTIF and set out the conditions in which this right may be exercised.

The ELTIF's rules may, however, allow for redemption before the end of life of the ELTIF where:

• redemptions are not granted before the date specified in the ELTIF's rules as being the date from which the 70% limit will apply -- see section 2(c) above
• at the time of authorisation and throughout the life of the ELTIF, the manager can demonstrate to the regulator that an appropriate liquidity management system and effective procedures for monitoring the liquidity risk of the ELTIF are in place, compatible with the long term ELTIF's investment strategy and proposed redemption policy
• the manager sets out a defined redemption policy, which clearly indicates the periods of time in which investors may request redemption
• the redemption policy ensures that the overall amount of redemptions within any period is limited to a percentage of the ELTIF's UCITS assets and that this percentage is in line with the liquidity management and investment strategy disclosed by the manager
• the redemption policy ensures fair treatment of investors with redemptions being granted on a pro rata basis should the total requests for redemption within any given period of time exceed the percentage referred to above.

The life of an ELTIF must be consistent with its long-term nature and must be sufficiently long to cover the life-cycle of each of the fund's individual assets, measured according to both its 'illiquidity profile and economic life-style' and its stated investment objective.

Redemption to investors must commence on the day following the end of the ELTIF's life and investors must always have the option to be repaid in cash.

The ELTIF's constitutional documents must not prevent shares or units in the ELTIF from either being admitted to trading on a regulated market or MTF, or from being freely transferred by investors to third parties.

The ELTIF must adopt an itemised schedule for the orderly disposal of its assets to redeem investors at its life's end. This schedule must be disclosed to the regulator at least one year before the ELTIF's end of life - the Commission will, in due course, set out the details that such a schedule must contain as part of its work at Level 2.

Proceeds generated by the assets in an ELTIF's portfolio must be 'regularly' distributed to investors, unless required for future commitments of the ELTIF. The ELTIF must set out its distribution policy in its fund rules.

4. Transparency (Articles 23 to 25 of the Regulation)

An ELTIF cannot be marketed in the EU unless a prospectus has been published, complying with the requirements of the Prospectus Directive. In addition, the prospectus must contain certain information specified in Article 21 of the Regulation (including, for example, a statement setting out how the ELTIF's investment objectives and strategy for achieving these objectives qualify the fund as being long-term in nature; and a 'prominent indication' of the categories of assets in which the ELTIF is authorised to invest).

Furthermore, an ELTIF cannot be marketed to retail investors unless a Key Information Document (KID) has been published, which complies with the PRIIPS Regulation.

The prospectus and the latest published annual report must be provided to investors on request and free of charge. The prospectus may be provided in a durable medium or on a website, while a paper copy must be delivered to retail investors on request and free of charge.

The prospectus, KID and other marketing documents must, in particular, prominently notify investors of the illiquid nature of the ELTIF. Such documents must also clearly inform investors of other matters, including the date of the end of life of the ELTIF, whether the ELTIF is intended to be marketed to retail investors and investors' rights of redemption.

In addition, the prospectus must prominently inform investors of the level of different costs which the investor will bear, either directly or indirectly, grouped under the following headings:

• costs of set-up
• costs related to acquisition of assets
• management costs
• distribution costs
• other costs (eg administrative, regulatory, custodial and audit costs).

5. Marketing (Articles 26 to 31 of the Regulation)

a. General provisions

To market an ELTIF to professional and retail investors in the ELTIF's home Member State, the AIFM must notify the home state regulator in accordance with Article 31 of AIFMD.

The Regulation also contains a passport regime, under which the manager of an ELTIF can market a fund to professional and retail investors in Member States other than the ELTIF's home Member State upon notification its home regulator in accordance with the process set out in Article 32 of AIFMD.

As well as any documentation and information required under Articles 31 or 32 of AIFMD, the manager must provide the regulator with:

• the ELTIF's prospectus
• its KID (where it is marketing to retail investors), and
• information on the facilities referred to in section 5(b) below.

The manager must also inform the regulator whether or not it intends to market the ELTIF to retail investors

b. Additional provisions applicable where the ELTIF is to be marketed to retail investors

The Regulation contains a range of provisions with which the manager must comply when it intends to market an ELTIF to a retail investor.

These include that the manager must have in place, in each Member State in which it intends to market the ELTIF, facilities for making subscriptions, making payments to investors, repurchasing or redeeming units or shares and making available the information which the ELTIF and/or the manager must provide. The Commission will produce Level 2 measures within three months of the Regulation entering into force, clarifying the types and characteristics of these facilities, along with their technical infrastructure.

The manager of an ELTIF which is intended to be marketed to retail investors must also:

• establish a process for assessing whether the ELTIF is suitable for distribution to retail investors taking into account at least the lifecycle of the ELTIF and its intended investment strategy
• where the ELTIF is being distributed directly, obtain information necessary to ensure that the ELTIF is suitable for the retail investor -- this will include information on the investor's knowledge and experience in the investment field relevant to the ELTIF, his/her financial situation including his/her ability to bear losses and his/her investment objectives including his/her time horizon
• where the ELTIF has a lifecycle of ten years or more, issue a clear written alert that the product may not be suitable for those retail investors unable to sustain such a long term and illiquid commitment
• provide retail investors with "appropriate investment advice", and
• establish appropriate complaint procedures which allow retail investors to file complaints in the official language of their own Member State.

In the event that the manager has performed the suitability test and provided appropriate investment advice, but the potential retail investor's portfolio does not exceed EUR 500,000, the manager must also ensure that the investor does not invest in aggregate more than 10% of his/her portfolio in ELTIFs, provided that the initial minimum amount invested in one or more ELTIFs is EUR 10,000.

Additional investor protection provisions include that:

• the ELTIF's constitutional documents must provide that all investors benefit from equal treatment and that no preferential treatment (such as side letters) or specific economic benefits are granted to individual investors or groups of investors
• the fund must not be structured as a partnership, and
• retail investors must be allowed a cooling off period during the subscription period and for at least two weeks after subscription, in which to cancel their subscription without charge.

c. Provisions regarding depositaries of ELTIFs marketed to retail investors

Where the ELTIF is marketed to retail investors:

• the ELTIF's depositary must be a type of entity permitted to be a depositary under UCITS V
• the depositary's liability cannot be excluded or limited by agreement where the ELTIF is marketed to retail investors - any agreement that contravenes this provision will be void. Nor can the depositary discharge itself of liability in the event of a loss of financial instruments held in custody by a third party
• no ELTIF assets held in custody by the depositary can be reused for their own account by the depositary or by any third party to whom the custody function has been delegated. Reuse comprises any transaction of assets held in custody including, but not limited to, transferring, pledging, selling and lending.

Assets held in custody by the ELTIF's depositary may only be reused provided that:

• the reuse of the assets is executed for the account of the ELTIF
• the depositary is carrying out the instructions of the manager of the ELTIF on behalf of the ELTIF
• the reuse is for the benefit of the ELTIF and the interest of the shareholders or unit-holders, and
• the transaction is covered by high quality and liquid collateral received by the ELTIF under a title transfer arrangement with the market value of the collateral having at all times to amount to at least the market value of the reused assets plus a premium.

6. Review (Article 37 of the Regulation)

By no later than 09 June 2019, the Commission must start a review of its application, including, in particular:

• the impact of the restriction on investors from redeeming their units or shares before the end of the ELTIF's life
• the impact on asset diversification of the 70% minimum threshold of eligible investment assets referred to above, and
• the extent to which ELTIFs are marketed in the EU, including whether AIFMs falling beneath the threshold set out in Article 3(2) of AIFMD might have an interest in marketing ELTIFs.

C. Next steps

The Regulation was published in the Official Journal of the EU on 19 May 2015 and its provisions will take effect on 09 December 2015.

As a Regulation, its provisions will have directly applicability across the EU - there will be no need for member states to transpose the Regulation into national law.

As noted above, a number of matters remain to be clarified by the Commission as Level 2 measures - the European Securities and Markets Authority (ESMA) was to have submitted draft measures to the Commission within three months of the Regulation entering into force (ie by 09 September 2015). ESMA will miss this deadline. However, on 31 July 2015, it published a consultation paper, setting out its proposed regulatory technical standards. The consultation period closes on 14 October 2015 and it is likely that the Commission will be in a position to adopt final measures by the time the regulation becomes effective on 09 December 2015.