A unique long-term financing product in the EU
The ELTIF regulation came into force in 2015 with the objective of increasing the long-term financing of the European economy. How? By channeling European savings towards investments in the real economy (to various infrastructure projects, unlisted companies or listed SMEs, for example). Often seen as the backbone of the European economy, SMEs represent 99% of jobs in Europe and are a potential source of jobs and economic growth.
With a passport that authorizes its distribution to European retail investors, the regulation has given ELTIFs a distinguishing feature that sets them apart from other existing vehicles (the EuVECA, for instance).
ELTIFs on the rise?
ELTIF was not like UCITS in that this regulation has not attracted much interest to date. According to the European Commission (EC), there are only 28 established ELTIFs in Europe (launched primarily in Luxembourg and France) representing less than €2 billion in assets. The High-Level Forum (HLF) on capital markets union (CMU) has indicated that the product launch is proving slow. This is mainly due to barriers to investment as a result of the strict requirements enforced when the ELTIF is offered to retail investors and too narrow a field of eligible investments.
In tempore non suspecto
Today, a growing interest for ELTIF seems to be emerging in Luxembourg with various projects in the pipeline or already well underway. Behind these projects are mostly top managers in the field of private equity and multi-asset class.
So, what has sparked this sudden interest?
In 2020 alone, the amount granted to savings in Europe hovered around €2.3 trillion – the highest amount to date, which some attribute to a cautious reaction to the 2020 crisis.
This amount of savings could materialize in long-term investments in the event that investors look for opportunities to diversify their portfolios. Such investments offer attractive returns as well as low correlation with traditional investments, all while taking advantage of historically low bank rates.
And this is where ELTIF comes into its own, as it contains the necessary rules (albeit sometimes restrictive) to protect retail investors.
In Luxembourg, 58 per cent of ELTIFs are distributed to retail investors (mainly under Part II of the Luxembourg Law of 17 December 2010).
The investment strategies favor private or syndicated debt and direct or indirect holdings in SMEs. 75 per cent of these ELTIFs are distributed across multiple countries demonstrating the extensive use of the passport attached to this product to attract retail investors from all over Europe.
A square within a circle
The ELTIF product unites two worlds that rarely collide, and which have very different operational dimensions. In December 2016, ALFI issued a document providing information on certain operational details of ELTIF.
However, the metaphysical question of reconciling a retail distribution product with illiquid asset management remains to be resolved.
Will subscriptions in ELTIF be in the form of a commitment that seems more in line with the nature and cycle of investments of ELTIF or by facilitating the management of retail investors via subscriptions (as in "classic" investment funds, for example)? And what about the right transfer agent platform for the distribution of the ELTIF during the subscription phase?
The ELTIF is aimed at long-term investment and therefore strongly limits the repurchase of shares before five years. The “art” of valuing illiquid assets at fair value would be useless. Let’s not forget, of course, that it’s necessary to calculate the NAV at the frequency defined (and at least once a year for the financial statements). So, art will have to turn to science to align itself with a materiality linked to the Part II fund.
Managing retail investors entails more complexity as compliance must be in line with MiFID requirements; a PRIIPs KID must be issued; greater transparency on the fees must be ensured; and specific investment limits must be monitored. Private equity houses which are more accustomed to managing only large fortunes and institutional investors - allowing for a more flexible approach - may find it too cumbersome and lose interest in ELTIF projects.
High hopes for 2021
ELTIF is set to expand in the months and years to come. The next review of the regulations by the EC (currently underway with a new legislative proposal expected for the third quarter of 2021) will certainly contribute to this as its aim is to make this product even more favorable - in its operating rules, in its access to retail investors and in its investment universe. Favorable tax treatment would undoubtedly set the stage to make ELTIF a flagship product.