ELTIF Regulation: Adoption and Analysis

The European Long-Term Investment Fund (ELTIF) framework, established under Regulation (EU) 2015/760, is a cornerstone of the European Union's Capital Markets Union (CMU) initiative. This initiative seeks to create a single, integrated market for capital within the EU, facilitating the flow of investments and savings across Member States. By providing a structured vehicle for long-term investments, ELTIFs aim to support the financing of infrastructure projects, real estate developments, and small and medium-sized enterprises (SMEs). These funds are strategically designed to aid in the EU’s green and digital transitions, thereby fostering sustainable economic growth and enhancing the overall resilience of the EU's economy.

ELTIFs are unique in the European investment landscape because they are the only type of funds explicitly created for long-term investments that can be marketed to both professional and retail investors across borders. This dual marketability is crucial for maximising the reach and impact of these funds, allowing them to attract a broad spectrum of capital. The ability to appeal to retail investors, in particular, opens up significant new avenues for investment, enabling ordinary citizens to participate in and benefit from large-scale, long-term economic projects.

On 19 July 2024, the European Commission adopted a Delegated Regulation to supplement Regulation (EU) 2015/760. This Delegated Regulation provides detailed regulatory technical standards (RTS) that are essential for the effective operation and oversight of ELTIFs. These standards cover a wide range of operational aspects, ensuring that ELTIFs maintain high levels of transparency, investor protection, and risk management.

Source

[1]

ELTIF Regulation: ESMA’s view on RTS Amendments

ESMA’s April 22, 2024 opinion on ELTIF Regulation proposes adjustments to draft RTS, aiming to balance investor protection and CMU objectives.

GrandAlessandro Micagni

[2]

ELTIF Regulation: Framework Flexibility

The European Long-Term Investment Funds (ELTIF) regime is undergoing a pivotal shift. With ESMA refining its technical rules, ELTIF numbers have surged, indicating a positive regulatory reform impact.

GrandAlessandro Micagni

ELTIF: Context and Objectives of the Delegated Act

The revised regulatory framework for ELTIFs is a critical element of the broader CMU initiative, which aims to enhance the efficiency and integration of capital markets across the EU. By creating a more unified market for capital, the CMU initiative seeks to reduce barriers to investment, increase access to funding for businesses, and ultimately drive economic growth and job creation. ELTIFs play a central role in this vision by channeling long-term capital into projects that are vital for the EU’s strategic priorities, including the green and digital transitions.

The unique positioning of ELTIFs within the EU regulatory landscape allows them to serve as powerful tools for economic development. By financing projects in key sectors such as energy, social infrastructure, and transport, ELTIFs help to build the foundations for a more sustainable and interconnected European economy. These investments are not only essential for meeting the EU’s climate and digitalization goals but also for enhancing the quality of life for EU citizens through improved infrastructure and services.

The amendments to Regulation (EU) 2015/760, enacted through Regulation (EU) 2023/606, became effective on 10 January 2024. These amendments were designed to address the evolving needs of the market and to provide a more robust framework for the operation of ELTIFs. Key objectives of the revised framework include:

1. Enhancing Transparency: The Delegated Regulation mandates comprehensive disclosure requirements, ensuring that investors have access to all necessary information to make informed decisions. This includes detailed information on the fund’s investment strategy, risk profile, and the types of assets held.
2. Strengthening Investor Protection: By setting stringent standards for risk management and compliance, the regulation aims to safeguard the interests of investors. This includes requirements for liquidity management, redemption policies, and the use of financial derivatives.
3. Promoting Effective Risk Management: The regulation provides clear guidelines on the use of financial instruments and the management of investment risks. This helps to ensure that ELTIFs operate within a controlled risk environment, reducing the potential for adverse outcomes and enhancing the stability of the investment.
4. Facilitating Cross-Border Investment: By harmonizing the regulatory framework across Member States, the Delegated Regulation simplifies the process for establishing and marketing ELTIFs on a cross-border basis. This creates a more attractive environment for investors and fund managers, encouraging the flow of capital across the EU.

ELTIF Regulation: Breakdown of the Commission Delegated Act

Article 1: Derivatives for Hedging Purposes

The ELTIF Regulation imposes strict guidelines on the use of financial derivative instruments by ELTIFs, ensuring that these instruments are employed solely for hedging purposes. This restriction is critical for maintaining the integrity and stability of the fund's investments. Derivatives must correspond directly to the assets to which the ELTIF is exposed, mitigating the inherent risks without amplifying them.

The regulation further specifies that if direct hedging instruments are not available, derivatives from economically similar asset classes can be used, provided they effectively reduce risk. To verify the efficacy of these hedging strategies, ELTIF managers must implement robust risk identification and mitigation systems, ensuring continuous compliance with these stringent requirements.

Article 2: Compatibility of ELTIF Life-Cycle with Asset Life-Cycles

One of the core principles of the ELTIF Regulation is the alignment of the ELTIF's lifespan with the life-cycles of its underlying assets. This alignment is essential for maximizing investment returns and minimizing the risk of forced sales, which can occur if the fund's duration does not match the maturity timelines of its assets.

The regulation outlines specific circumstances that must be considered to ensure this compatibility, such as the liquidity profile of each asset, the overall portfolio liquidity, the timing of asset acquisitions, and asset valuations. Additionally, for ELTIFs that offer redemption possibilities during their lifespan, the redemption policy must be carefully designed to synchronize with the asset life-cycles, ensuring seamless management of both liquid and illiquid assets throughout the fund's duration.

Article 3: Minimum Holding Period Criteria

The ELTIF Regulation mandates that ELTIF managers establish a minimum holding period for each asset, as detailed in Article 18(2)(a) of Regulation (EU) 2015/760. This minimum holding period is crucial for ensuring that investments are retained long enough to achieve their full value potential, thereby upholding the long-term investment nature of the ELTIF.

The criteria for determining this period include the type and characteristics of the assets, the projected time required to realize the investment's value, and the overall strategic goals of the fund. By adhering to these criteria, ELTIF managers can ensure that the fund remains focused on its long-term objectives, providing stability and predictability for investors.

Article 4: Information Disclosure to Competent Authorities

The ELTIF Regulation mandates comprehensive information disclosure requirements to competent authorities to promote transparency and enable effective oversight of the fund’s operations. ELTIF managers must provide detailed information, which includes:

1. Redemption Policy Details:
   • Periodicity and duration of redemptions.
   • Available liquidity management tools and conditions for their activation.
   • Conditions and procedures for requesting and processing redemptions.
2. Redemption Management:
   • Entities responsible for managing the redemption process and documentation procedures.
   • Management of assets and liabilities to meet redemption requests.
   • Procedures to prevent dilution effects for investors.
3. Valuation Procedures:
   • Description of valuation procedures as per Article 19(3), third subparagraph, of Directive 2011/61/EU, and Articles 72 and 74 of Delegated Regulation (EU) No 231/2013.
4. Liquidity Stress Tests:
   • Results, assumptions, and inputs used for liquidity stress tests, demonstrating the ELTIF's capability to handle redemption requests in severe but plausible scenarios.
5. Liquidity Profile and Management:
   • Offered liquidity to investors and the liquidity profiles of investments under normal and stressed conditions.
   • Implementation of liquidity management tools.
6. Other Relevant Information:
   • Any additional information deemed relevant by the competent authority to assess the redemption policy and liquidity management tools.

Article 5: Redemption Policy and Liquidity Management

The ELTIF Regulation specifies stringent requirements for an ELTIF's redemption policy and liquidity management tools to ensure the fund can handle investor redemption requests without compromising its long-term investment strategy. The redemption policy must include the following elements:

1. Conditions for Redemptions:
   • Conditions under which redemptions can be granted.
   • Time window for granting redemptions.
   • Frequency or periodicity of redemptions.
   • Timing limitations, notice period, and procedures for redemptions.
2. Redemption Management:
   • Responsibilities of entities involved in the redemption process.
   • Possibility for investors to cancel unexecuted redemption requests.
   • Provision for in-kind repayments from the fund’s assets.
3. Minimum Holding Period:
   • Duration and conditions for the minimum holding period, if applicable.
4. Liquidity Management Tools:

• Description and conditions for activating liquidity management tools.
• Percentage of liquid assets as per Article 18(2), first subparagraph, point (d), of Regulation (EU) 2015/760.

ELTIF Regulation: Advanced Liquidity Management and Redemption Policies

When adopting the redemption policy, managers must consider the ELTIF's liquidity profile, including:

1. Portfolio Composition:
   • Types of assets and their liquidity.
   • Balance between liquid and illiquid assets to ensure adequate liquidity for redemptions.
2. Life of the ELTIF:
   • Alignment with the life-cycles of the assets.
   • Consideration of the fund’s overall investment strategy and objectives.
3. Market Conditions:
   • Impact on the implementation of the redemption policy.
   • Strategies to address market fluctuations and economic changes.
4. Valuation Procedures:
   • Ensuring timely and accurate valuation of assets to reflect their true market value.
5. Liquidity Management Tools:
   • Calibration and activation conditions for tools such as anti-dilution levies, swing pricing, and redemption fees to manage liquidity and protect investor interests.
6. Liquidity Stress Tests:
   • Regular testing to assess the fund’s ability to handle redemption requests under severe but plausible market conditions.

Article 6: Criteria for Liquid Assets

To meet redemption requests and maintain operational stability, the ELTIF Regulation mandates that ELTIFs hold a specified percentage of liquid assets. Article 6 details the criteria for determining this percentage, balancing the need for liquidity with the fund's long-term investment strategy. The regulation requires ELTIF managers to evaluate the following factors:

1. Liquidity Profile:
   • Assess the liquidity of the ELTIF’s assets, considering factors such as asset type, market conditions, and expected inflows and outflows.
2. Asset Type:
   • Identify the nature of assets held by the fund, including liquid and illiquid assets, to determine the appropriate percentage of liquid assets.
3. Market Conditions:
   • Evaluate current and projected market conditions to ensure the fund maintains sufficient liquidity to meet redemption requests.
4. Expected Inflows and Outflows:
   • Consider expected cash flows and liquidity needs to align the fund’s liquid assets with redemption obligations.

Transfer Requests and Matching Mechanisms

Article 7: Policy Requirements for Matching Transfers

The ELTIF Regulation provides a comprehensive framework for the matching of transfer requests of units or shares between exiting and new investors. This mechanism ensures liquidity and flexibility for investors wishing to enter or exit the fund without impacting the ELTIF's long-term investment strategy. Key technical details of this regulation include:

1. Format and Process:
   • The format and procedural requirements for matching transfers must be clearly defined.
   • Managers must establish a standardized process that is transparent and easy for investors to understand and follow.
2. Timing of Matching:
   • Specific dealing dates must be set for matching transfer requests.
   • Submission deadlines for both purchase and exit requests must be clearly communicated.
   • Settlement and pay-out periods need to be established to ensure timely transactions.
3. Frequency and Duration:
   • The regulation mandates that the frequency or periodicity of the matching window must be specified.
   • The duration of each matching window should be clearly defined to manage investor expectations and operational logistics effectively.
4. Safeguards Against Arbitrage:
   • To ensure fairness and prevent arbitrage, the regulation requires safeguards against information asymmetry.
   • These safeguards protect investors from potential exploitation due to unequal access to information.
5. Distinction Between Redemptions and Matching:
   • If the ELTIF provides for redemptions during its life, the policy must clearly distinguish between redemptions and the matching process.
   • Differences in frequency, periods, execution price, and notice periods must be outlined to prevent confusion and ensure clarity for investors.

Article 8: Execution Price and Pro-Rata Conditions for Transfers

Article 8 of the ELTIF Regulation outlines the detailed criteria for determining the execution price for matched transfers and the conditions for handling mismatches between exit and purchase orders. This ensures that all investors are treated fairly and equitably during the transfer process. Key components include:

1. Determination of Execution Price:
   • The manager of an ELTIF may use the net asset value (NAV) or other methodologies to determine the execution price.
   • If using NAV, the matching of transfer requests must align with the ELTIF's valuation dates to ensure consistency.
   • If alternative methods are used, the matching should be conducted outside the regular valuation dates to avoid discrepancies.
2. Alignment with Valuation Dates:
   • Ensuring that transfer matching aligns with valuation dates helps maintain the integrity and fairness of the execution price.
   • This alignment prevents potential manipulation and ensures that the prices reflect the true value of the fund's assets.
3. Fees and Charges:
   • The regulation sets out clear rules for any exit or purchase fees related to the matching of transfer requests.
   • Transparency in fee structure ensures that investors are fully informed about the costs associated with their transactions.
4. Pro-Rata Matching Conditions:
   • The regulation specifies conditions for pro-rata matching to handle mismatches between exit and purchase orders.
   • This includes criteria for managing excess orders and ensuring that matching is conducted based on the size of each exit order.
   • Pro-rata conditions help balance the interests of all investors, ensuring fair treatment in the matching process.

Article 9: Information Disclosure for Matching Transfers

Article 9 mandates comprehensive information disclosure to investors when matching transfers of units or shares. This requirement enhances transparency and helps investors make informed decisions. The regulation specifies the following details:

1. Predetermined Dealing Dates and Settlement Periods:
   • Managers must clearly state the dealing dates and settlement or pay-out periods for matched transfers.
   • This information ensures that investors are aware of when their transactions will be processed and completed.
2. Submission Deadlines:
   • The deadlines for submitting purchase or exit orders must be explicitly communicated to investors.
   • Clear submission deadlines help streamline the matching process and prevent delays.
3. Frequency of Matching:
   • The regulation requires disclosure of how frequently matching is available.
   • Investors need to know the periodicity of matching windows to plan their transactions accordingly.
4. Execution Price Criteria:
   • If the execution price is not based on NAV, the criteria used to determine the price must be detailed and communicated to investors.
   • Transparent pricing criteria help investors understand the basis of their transaction values.
5. Fees and Charges:
   • All fees, charges, or costs related to matching transfer requests must be disclosed to investors.
   • Comprehensive fee disclosure ensures that investors are fully informed about the costs involved in their transactions.
6. Notice Periods:
   • Information on any notice period for receiving purchase or exit orders must be provided.
   • Clear notice periods help manage investor expectations and facilitate smooth operations.
7. Communication with Investors:
   • Managers must explain when, by whom, and how new investors will be informed of their acquisition of units or shares.
   • Similarly, exiting investors must be informed about how they will receive the corresponding amount.
8. Pro-Rata Matching Rules:

• The rules for matching on a pro-rata basis must be outlined to ensure fair treatment of all investors.
• This includes managing excess orders and ensuring that the matching process is equitable.

ELTIF: Asset Disposal and Market Assessment

Article 10: Criteria for Assessing the Market for Potential Buyers

The ELTIF Regulation mandates a rigorous assessment process for evaluating the market for potential buyers of assets in which the ELTIF invests. This comprehensive evaluation is crucial for ensuring that assets can be disposed of efficiently and at fair value, thereby protecting investor interests and maintaining the fund's integrity. The following key technical details are emphasized:

1. Identification of Potential Buyers:
   • Managers must actively identify and document potential buyers for each asset.
   • This involves market research and analysis to understand the buyer landscape and ensure there are adequate potential purchasers.
2. Evaluation of Dependence on External Financing:
   • The regulation requires managers to assess whether potential buyers are likely to rely on external financing to complete the purchase.
   • Understanding the financing capacity and creditworthiness of potential buyers helps in gauging the feasibility of the sale.
3. Estimation of Timeframe for Finding Buyers:
   • Managers must estimate the length of time required to locate suitable buyers if none are immediately available.
   • This includes considering market conditions, asset liquidity, and demand trends.
4. Assessment of Asset Maturity Profile:
   • The regulation necessitates a detailed analysis of the maturity profile of the asset.
   • This involves understanding the lifecycle stage of the asset, including any pending developments, operational milestones, and revenue generation potential.
5. Legislative and Political Risks:
   • Managers must evaluate legislative and political risks that could impact the market for potential buyers.
   • This includes changes in regulations, political stability, and policy shifts that might affect asset valuation and buyer interest.
6. Economic Conditions:
   • The assessment must consider the broader economic conditions that could influence the market.
   • Factors such as economic growth, interest rates, inflation, and market cycles are critical in understanding how they may affect the asset’s attractiveness to buyers.

Article 11: Valuation Timing and Procedures

Accurate and timely valuation of assets is essential for maintaining investor confidence and ensuring regulatory compliance. Article 11 of the ELTIF Regulation sets forth stringent criteria and deadlines for the valuation of assets to be divested, ensuring that valuations reflect the current market conditions and the true value of the assets. Key technical details include:

1. Start and Completion of Valuation:
   • The valuation process must commence before the deadline specified in Article 21(1) of Regulation (EU) 2015/760.
   • The completion of the valuation must occur within six months prior to this deadline, providing a recent and relevant valuation.
2. Use of Existing Valuations:
   • Managers are permitted to use valuations conducted in accordance with Article 19 of Directive 2011/61/EU, provided they were finalized no more than six months before the divestment deadline.
   • This provision ensures cost-effectiveness while maintaining the relevance and accuracy of the valuation.
3. Conservative Valuation Approach:
   • The regulation emphasizes a conservative approach to asset valuation, taking into account the long-term nature of the assets and potential market fluctuations.
   • This includes stress-testing assumptions and scenarios to ensure robustness.
4. Inclusion of All Relevant Factors:

• Valuations must consider all pertinent factors, including market conditions, asset-specific characteristics, and economic trends.
• This comprehensive approach ensures that valuations are thorough and reflective of the asset’s true market value.

Article 12: Cost Disclosure Requirements

Article 12 of the ELTIF Regulation mandates standardised definitions, calculation methodologies, and presentation formats for cost disclosures associated with ELTIFs. This standardization is critical for enhancing transparency and allowing investors to make informed decisions. The regulation covers various types of costs, ensuring that all expenses are clearly communicated to investors. Key details include:

1. Setup Costs:
   • All administrative, regulatory, depositary, custodial, professional service, and audit costs related to setting up the ELTIF must be disclosed.
   • Transparency in setup costs helps investors understand the initial financial burden of establishing the fund.
2. Acquisition Costs:
   • Costs associated with the acquisition of assets, including administrative, regulatory, depositary, custodial, professional service, and audit costs, must be clearly presented.
   • This allows investors to see the direct expenses related to expanding the fund’s asset base.
3. Management and Performance Fees:
   • All payments to the ELTIF manager and any delegated functions, excluding acquisition-related fees, must be detailed.
   • Disclosing management and performance fees provides insight into the ongoing operational costs of managing the fund.
4. Distribution Costs:
   • Administrative, regulatory, professional service, and audit costs related to the distribution of the fund must be included.
   • This helps investors understand the expenses involved in marketing and distributing the fund’s units or shares.
5. Other Costs:
   • Payments to depositaries, custodians, investment advisers, and various service providers not classified under setup, acquisition, or distribution costs must also be disclosed.
   • Comprehensive disclosure of all other costs ensures that no hidden expenses affect the investor’s understanding of the fund’s financial obligations.
6. Cost Calculation and Presentation:

• Costs must be expressed as a percentage of the ELTIF’s net asset value over a one-year period.
• The overall cost ratio should be calculated as the total costs relative to the net asset value per annum, expressed as a percentage to two decimal places and updated annually.
• This standardised presentation format allows for easy comparison and assessment of the fund’s cost efficiency.

ELTIF Regulation Annexes: Detailed Technical Specifications

The ELTIF Regulation's annexes are critical in providing comprehensive methodologies and technical standards that ensure effective fund management and investor protection. These annexes offer granular details on the calculation of maximum redemption percentages and the minimum liquid asset requirements, tailored to various redemption frequencies and notice periods.

Annex I: Determination of Maximum Percentages Based on Redemption Frequency and Notice Periods

Annex I of the ELTIF Regulation delineates the methodologies used to determine the maximum percentage of liquid assets that can be allocated based on the redemption frequency and notice periods. This framework is essential for maintaining the liquidity of ELTIFs while accommodating redemption requests without compromising the fund's long-term investment strategy.

1. Redemption Frequency:
   • 12-Month Notice Period: With a 12-month notice period, the maximum redemption percentage is set at 100%, irrespective of the redemption frequency. This extended notice period provides sufficient time for fund managers to plan and adjust the portfolio, ensuring liquidity to meet redemption requests.
   • Shorter Notice Periods: For notice periods shorter than 12 months, the maximum redemption percentage decreases proportionally. For example:
     • 6-Month Notice Period: A shorter notice period necessitates a reduction in the maximum redemption percentage to manage liquidity risks.
     • 3-Month Notice Period: Further reduction in the maximum redemption percentage to accommodate the higher liquidity demands associated with more frequent redemption opportunities.
     • 1-Month Notice Period or Less: The most frequent redemption intervals, such as monthly, require the lowest maximum redemption percentage to ensure that sufficient liquid assets are available at all times.
2. Calculation Methodology:
   • The annex provides specific formulas and calculation methods to accurately determine the maximum percentage based on the given notice period and redemption frequency. This ensures consistency and transparency in how these percentages are derived across different ELTIFs.
3. Impact on Liquidity Management:
   • By defining clear maximum redemption percentages, Annex I helps fund managers implement effective liquidity management strategies. This includes maintaining an appropriate balance between liquid and illiquid assets to meet investor demands while adhering to the fund's long-term investment objectives.

Annex II: Determination of Maximum Percentages Based on Minimum Asset Percentage

Annex II offers another layer of specificity by outlining the maximum redemption percentage as a function of the redemption frequency and the minimum percentage of liquid assets required to be held by the ELTIF. This annex ensures that ELTIFs maintain a sufficient buffer of liquid assets to handle redemption requests, particularly under varying market conditions and investor behaviors.

Minimum Liquid Asset Requirement:

• 12-Month or Less Frequent Redemption Schedule: ELTIFs with a redemption schedule of 12 months or less frequent must maintain a minimum liquid asset requirement of 10%, allowing a maximum redemption percentage of 100%. This ensures that the fund can fully meet annual redemption requests.
• More Frequent Redemption Schedules: As the redemption frequency increases, so does the minimum liquid asset requirement:
  • 6-Month Schedule: Requires a higher minimum liquid asset percentage, typically around 15%, with a correspondingly lower maximum redemption percentage to balance liquidity needs.
  • 3-Month Schedule: Further increases the minimum liquid asset requirement to approximately 20%, reducing the maximum redemption percentage to ensure liquidity.
  • Monthly or More Frequent: Requires the highest minimum liquid asset percentage, often around 25%, with the lowest maximum redemption percentage to manage the frequent redemption requests effectively.

1. Methodologies for Determination:
   • Annex II includes detailed methodologies for calculating these percentages, ensuring that the minimum liquid asset requirements are met consistently. This involves analyzing historical data, market conditions, and the specific liquidity profiles of the assets held by the ELTIF.
2. Regulatory Compliance and Investor Protection:
   • These detailed requirements help ensure that ELTIFs remain compliant with regulatory standards while providing a high level of protection to investors. By maintaining adequate liquid assets, ELTIFs can meet redemption requests promptly, reducing the risk of liquidity crises and enhancing investor confidence.
3. Scenario Analysis and Stress Testing:
   • Annex II emphasizes the importance of scenario analysis and stress testing to validate the adequacy of liquid asset holdings. Fund managers are required to simulate various market conditions and redemption scenarios to ensure that the ELTIF can withstand periods of high redemption activity without jeopardizing its long-term investment strategy.