If there’s one thing clear from recent months, it’s that Luxembourg is placing a major bet on the future of Eltifs, or European Long Term Investment Funds. The EU’s adoption of a major upgrade of the Eltif regulation is opening the doors to private markets for high-net-worth investors and wealth management clients.
Thanks to Eltifs, private markets will no longer be the exclusive domain for institutional investors like pension funds and insurance companies. Investors in the ‘retail plus’ segment now will also be able to tap into promising opportunities offered by long-term commitments to private debt and equity. Luxembourg, with its ecosystem of international fund distribution, is keen to embrace the Eltif era.
The London-headquartered Alternative Investment Management Association, or Aima, has been a strong advocate for Eltif funds ever since plans for the regulation emerged a decade ago. Aima deputy CEO Jiří Król explained that Eltifs have been inspired by the success in US markets of BDC’s, or Business Development Companies, that first were introduced during the 1970s.
Eltifs could be a 100 billion euro market
Aima believes that, based on its growth projections for private assets, particularly private credit, that Eltifs in Europe could reach a level of 100 billion euro. “We think that private credit will be one of the main strategies to be offered,” said Król. “It lends itself nicely for a retail type investment. You have current income. You shouldn’t have much volatility. It’s a fairly liquid product, loans get repaid roughly every three years. So it does lend itself to being one of the dominant strategies and one of the more popular strategies with not just retail but also professional.”
BDC’s today are a 300 billion dollar market, and can be seen as a “huge equivalent” of the Eltif. In the US, BDC’s have become a key factor in channelling funds from investors to small- and medium-sized enterprises. Such a mechanism is something that Europe - dominated by bank debt-finance as opposed to market-based risk-finance - needs in order to diversify funding in its economy.
“That’s actually what the BDC world is like,” said Król, “Not just listed on a stock exchange. They are actively traded. There’s real volume. Real evidence. Lots of coverage by investment banks, and lots of capital markets activity for the BDC. For example, they issue bonds as well. They do IPOs. So there’s a whole ecosystem around BDC which does not currently exist in the Eltif world.”
Improved design in Eltif 2.0
With some 2,100 members that collectively manage more than 2,400 billion dollars, Aima was a key driver of the adoption of Eltif 2.0. “The very large global managers who have been behind this effort are our members who are also interested in replicating that kind of success in Europe,” said Król. “So we’ve been super active since three or four years ago to look at the Eltif framework because it wasn’t designed in as good a manner as it could have been, and had a number of rigidities.”
That push led to a transformation of the initial Eltif regulation introduced in 2017. Intense negotiations between EU political groups, the European commission and the EU’s member states in February led to the adoption of a far more flexible Eltif framework. From 2024, such products can now be easily marketed and distributed in 30 European countries under a single passport. Hundreds of management companies and an alternative investments ecosystem are keen to get involved.
Managers now learning how to design Eltifs
In Luxembourg, EY partner Norman Finster, focusing on alternative investments, said fund managers now are learning what it takes to design a fund under Eltif 2.0. Together with Aima, EY has prepared a comprehensive paper on Eltifs to elucidate stakeholders, especially in Luxembourg, on the subject.
Managers will need to address, amongst other issues, liquidity management tools and redemptions, Finster said. Eltif 2.0 can have so-called “gating mechanisms,” which require that not more than a certain percentage of net asset values is redeemed at different moments, such as per quarter, per year, or per NAV day.
“That is a crucial part,” said Finster. “Investors will need to understand that an Eltif will never provide for the same degree of liquidity like Ucits because it is a completely different asset profile that we are seeing here.”
The new Eltif rules also create the opportunity for a secondary market. Such a market is required to be opened by the manager, outside an Eltif’s built-in redemption mechanism. “It’s the first time ever we see this in a regulation. How that is meant to work and how then operationally and what technical infrastructure we need to get this operating, I have to say that still remains to be seen because we have not tested that before.”
A key number of technical issues regarding the new Eltif regime are expected to be addressed during the coming months in discussions on the so-called RTS, the regulatory and technical standards, involving industry representatives and the European Securities and Markets Authority, Esma.
Secondary market matching mechanism
“Most industry focus is on the process of designing the redemptions from the fund as opposed to the secondary market matching mechanism,” said Aima’s Król. “Redemptions are going to be the main mode of providing liquidity to investors.”
Another challenge for alternatives managers based in Luxembourg - and elsewhere in Europe - will be in distribution. Król said that the distribution network will be “the most critical part of making Eltif a success”, and means educating a distribution network that is not only in Luxembourg. “The education of advisors in retail banks, or independent financial advisors who will advise retail clients to invest in such a product is key. If you today go to your local bank and ask them how many Eltifs they have on the shelf. Or ‘could you tell me about Eltifs’, I don’t think you would see a lot.”
BDC’s in the US generally are held for 80 per cent by retail investors and 20 per cent by institutions. The industry, noted Król, is pushing for a bigger share to be held by institutional investors - especially smaller institutions and family offices - allowing the limit in some cases to become 50 percent.
Since Eltifs were first launched under the old regime, some 84 funds have been launched, half of them domiciled in Luxembourg. Considering the ecosystem in Luxembourg, with its service providers, knowledge for distributing products cross-border, and at the existing cross-border distributed Eltifs, “then Luxembourg clearly comes first”, said Finster. “It may sound a bit arrogant, but there’s no way around Luxembourg when you look at Eltifs.”
“There are very few jurisdictions that have any experience with Eltifs,” said Król. “Luxembourg stands out as number one. And what managers want is certainty and speed to market when it comes to this.”
Related articles on Investment Officer Luxembourg:
- Lack of liquidity not seen as show-stopper for Eltif 2.0
- BlackRock has ‘aggressive plans’ for the Eltif market
- European parliament adopts Eltif upgrade