Outlines of reform proposals for European long-term investment funds (Eltif), agreed by EU policy-makers last month, have been hailed as major positive step forward by some in the industry. More quietly, though, others suggest the fundamental contradictions at the heart of the vehicle have yet to be resolved.
“We are convinced the new Eltif product will become a global success and a key achievement of the Capital Markets Union policy,” gushed Jiří Król, Global Head of the Alternative Credit Council, the private credit affiliate of the Alternative Investment Management Association. “There are large pools of capital that are not being deployed today in the EU because of significant barriers to their cross-border flows. These reforms to the Eltif will change that by creating an attractive and flexible vehicle focused on the direct financing of EU businesses and infrastructure,” he added.
Version one was a failure
There was definitely a need for reform. “It hasn’t been a terrible success,” was how Claude Marx, the CSSF director general described progress at the ALFI European Asset Management Conference in March 2021. The numbers back up this view. There were 82 Eltifs with net assets under management of €2.4bn in 2021, said Emmanuel-Frédéric Henrion, (pictured below) a partner with Clifford Chance in Luxembourg. Half of these vehicles are in Luxembourg with the rest in France, Spain and Italy.
The Eltif is an alternative investment fund (AIF) which focuses investments in private and public projects over the long-term including private equity, infrastructure, real estate, listed SMEs, equity holdings, debt instruments and more. The idea is that this should be a way to bring together investments from private individuals as well as institutions.
What institutional interest?
Yet a key question that has dogged the Eltif from its inception in 2015 is “why should institutional investors bother?” Will the proposed reforms change things? “Institutional investors already have a great toolbox (especially in Luxembourg) of fund vehicles which are useful for every purpose,” said Oliver Zwick, also a counsel with Clifford Chance in Luxembourg (pictured above). “What is the Eltif actually adding in terms of upside? Not least because you have all of these additional eligibility requirements with this vehicle. But there’s not a lot on the positive side other than adding a label,” he added.
“The new rules will make it easier for asset managers to launch products that cater to both institutional and retail clientele,” said the AIMA press release, “with additional flexibility for the former and important protections for the latter.” The argument goes that Eltif 1.0 was too restrictive, but with these shackles about to be lifted in the second version. With the 20 October announcement by the European Council and European Parliament relating to general principles, a final regulation should probably not be expected before the end of next year.
Will individuals bite?
The proposed reforms include splitting retail and institutional Eltifs, with different regulatory requirements for each type of investor. The aim is to simplify access for wealthy individuals while maintaining diversification, suitability and disclosure rules. For example, there is no longer a need for local marketing facilities, nor minimum thresholds depending on the retail investor’s assets. More generally, there also would be greater flexibility regarding eligible assets, frameworks for master-feeder and fund-of-funds structures, co-investment with other funds and accounts, and a greater access to borrowing.
Yet these moves do not address fundamental challenges for institutional investors. For example “with a standard AIF investing in infrastructure, you need a least two assets, of which one can account for 75% of the NAV, but for the Eltif at least 10 investments are required with a maximum of 10% of the NAV by each,” said Henrion. He cited other technical barriers too, not least over tax treatment. All this adds complexity and cost for funds, which is unappealing for institutions. And whatever the talk of the “democratisation” of private assets, most investment in the alternative space will continue to be from pension funds, insurance companies and the like.
Hence the changes seem particularly designed to increase appeal to wealthy individuals. “The big advantage of the Eltif and I think that’s what most sponsors are looking at when they look at establishing an entity is that it has an EU passport for retail investors in the European Union, unlike the normal AIF,” said Zwick.
What if they get cold feet?
Yet Claude Marx commented on another key aspect of the vehicle at the ALFI conference. “When it comes to retail investors entering this space, we need to be mindful of redemption capabilities, because these are essentially closed funds. We also need to be mindful of MiFID considerations,” he said.
“How can you convince a retail investor to invest into a fund which is largely closed ended with no redemption facility?” said Henrion, going with the grain of Marx’s comments. “There is no magic,” he went on. “You cannot create an open-ended fund for retail investors with illiquid, long-term investments.”
ESMA has been asked to develop proposals on liquidity windows for retail investors. “But we are sceptical that there is a workable solution,” Henrion said. He noted that the new proposals for Eltif 2.0 include the ability to have a larger pocket of liquid assets. “But in that case, you will not get the full performance of a pure Eltif which is designed to make only long-term investments,” he said.