Introduction

The European Commission’s (EC) recent amendments to the European Long Term Investment Fund (ELTIF) rules have the potential to significantly increase both the volume and source of capital flows into European private markets.

ELTIFs were initially met with a slow uptake, followed by criticism that the investment governance was too prohibitive to achieve their aim of giving retail investors access to a wider range of more illiquid asset classes.

Under ELTIF 2.0 a series of new proposals were created aimed at broadening the appeal. By increasing the range of potential holdings and reducing barriers to retail investors, we could see €100 billion of inflows in the next five years, according to the Alternative Investment Management Association (AIMA).¹

The amended proposals were announced in late 2021, following a process of consultation and consideration by European lawmakers and received political agreement from the European Parliament in October 2022.² ELTIF 2.0 was formally adopted on the 15 February 2023 with a nine-month early adoption, opt-in grace period for existing ELTIFs, with a deadline period of five years until the 11 January 2029 to formally adopt the 2.0 regime.³ New ELTIFs under the 2.0 regime can launch as of 10 January 2024.

In the agreement announcement, the EC cited retail inflows as a key part of the proposals: “ELTIFs ultimately democratise finance by granting citizens access to new investment opportunities currently only available to professionals.” 

In addition to meeting political demand within the European Union to direct more investment into infrastructure projects and growth industries, the ELTIF is also in sync with investor sentiment within the region.

In a survey of institutional investors conducted on behalf of State Street in the fourth quarter of 2022, 50% of European respondents said they saw ‘strong demand’ for access to private markets from individual investors.⁴

The movement to provide access to private market long-term investments to non-institutional investors is not new or specific to Europe. In North America, business development companies (BDCs), interval funds and REIT structures, have looked to bridge the gap for some time. For example, BDCs have operated in the US market since the early 1980s, however after several structural and regulatory updates have proven themselves as very effective format, with many new entrants and significant capital raised from institutional as well as non-individual investors. BDCs have shown that there can be an effective vehicle to bridge the gap in the market, as indicated by their substantial growth from 2014 to 2022, from US$50 billion to US$265 billion, with majority of the investment strategies most suited to private credit and debt portfolios.

ELTIFs history and overview 

ELTIF was introduced in 2015 by the European Union to help fund the union’s digital, social and sustainable transition. It was intended as a way to democratise the private market industry and aimed at facilitating the raising and channeling of capital towards long term investments in the real economy. Since its launch there have only been 84 funds registered and marketed, raising less than US$10 billion amongst them, which is significantly lower than forecasted. The original intention of the legislation was too rigid to allow full adoption, and a clear need for update (2.0) was presented. After years of discussion and planning, the latest ETLIF regulation (2.0) was formally adopted by the European Parliament on the 15 February 2023. With the latest changes, the European Parliament is forecasting the size to be €100 billion by 2028.

This growth can be attributed to the growing attractiveness of private markets and the desire of further diversification in the portfolio of professional and retail investors. ELTIFs are viewed to be the investment vehicle of choice in the private market space.

Problems with ELTIFs in their original form

• Lack of pragmatism or feasibility when it came to eligible assets
• Diversification and concentration requirements that were considered too stringent
• Barriers for marketing their products to retail investors
  • E.g., ELTIFs were required to have facilities in place in member states where retail investors targeted were located for the purpose of subscriptions, payments and information

The new regulation has not tackled every issue, but 2.0 is still an important step to making ELTIFs an attractive investment vehicle and we expect further improvements to be made in the future.

Updated ELTIF rules

• Broader definition of real assets
  • Under 2.0: 
    • Broader scope of eligible assets such as listed companies with market cap of up to €1.5 billion (up from €500 million), fintech companies, simple transparent and standardised securitisation (STS), green bonds, etc.
    • Broader definition of a real asset, which is now simply “an asset that has an intrinsic value due to its substance and properties”
      • Example: communication, environment, energy, transport infrastructure, social (retirement homes, hospital), education and intellectual property
    • Removal of the required minimum value of a real asset an ELTIF can invest in, thus broadening the options available
       
• Diversification/distribution rules and target funds
  • ELTIFs are now authorised to invest in Undertaking for Collective Investment in Transferable Securities (UCITS) or other EU Alternative Investment Funds (AIF) managed by EU Alternative Investment Fund Managers (AIFM)
    • Provided that these AIF are investing in eligible investments for ELTIF, allowing ELTIFs to deploy fund of funds strategies or master feeder structures
    • Differentiated regime between ELTIFs that will be solely be marketed to professional investors and those that can be sold to retail investors
      • Retail investors should benefit from a higher level of protection than professional investors
      • Borrowing limit has been increased to 50% of the NAV for retail ELTIFs and 100% of NAV for professional ELTIFs
        • Gives ability to provide liquidity and to pay costs and expenses as needed
• Co-investment
  • ELTIFs under 2.0 are allowed to make minority co-investments
    • Provides additional flexibility to implement investment strategies and attract more promoters of investment projects and increase the range of possible eligible target assets.
      ​​​​​​​
• Investor rules
  • Only the MiFID suitability test will have to be performed in relation to retail investors. No additional ELTIF-specific suitability test is required.
  • Minimum investment requirements have been removed.
    • The original regulation requirement whereby the financial instrument portfolio of a retail investor does not exceed €500,000, the ELTIF manager must ensure that the potential retail investor invests at least €10,000, but not more than 10% of their financial instrument portfolio in ELTIFs has been removed. 
      ​​​​​​​
• Investment rules
  • ELTIFs can now invest the majority of their assets in investments located in third countries
    • The reference to the European nature of the long-term investment has been removed, lifting an uncertainty on the possibility to have assets that are located outside of the EU. As a result, investments in third countries can now benefit the economy of the EU. 
    • Examples include, the development of boarder regions, subsea fiber optic cables connecting Europe with other continents, construction of LNG terminals, renewal energy installations that contribute to the resilience of the electrical grid and energy security of the EU.
       
• Education
  • The suitability test for retail investors is still required, but there is no longer an obligation to provide investment advice, with the possibility for a retail investor to bypass a negative conclusion to that test by giving express consent to proceed with the transaction.

Conclusion

The recent 2.0 updates have been met with optimism. The changes create a promising runway for increased visibility and uptake of ELTIFs. The welcomed simplifications and ease of accessibility is expected to open ELTIFs to a broader audience. 

1 https://www.aima.org/article/press-release-aima-and-the-acc-applaud-positive-progress-on-eltif-regulation-reforms.html
2 https://finance.ec.europa.eu/news/capital-markets-union-political-agreement-review-european-long-term-investment-funds-eltif-2022-10-20_en
3 https://www.europarl.europa.eu/doceo/document/TA-9-2023-0040_EN.html
4 https://www.statestreet.com/us/en/insurer/insights/future-of-private-markets-2022-23

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