In 2015, the European Commission came up with the concept of European Long Term Investment Funds (ELTIFs) as a way of encouraging badly needed investment in long-term assets such as infrastructure, private equity and real assets.
On the upside, such investments often pay a reasonable and reliable income stream, possibly with some inflation protection, making them popular with long term investors, including pension schemes and insurance companies.
On the downside, some of these investments can be volatile and lack liquidity, meaning they are unsuitable for investors who need access to their savings at short notice.
Over the following six years, new ELTIFs were few and far between. In 2021, ESMA, the European securities regulator, had a register of 51 funds with total assets of less than EUR 2.5bn, which led to a revised ELTIF Regulation in April 2023. The main thrust of the amendment was to find a way to make ELTIFs attractive to retail investors without exposing them to unacceptable risks.
The revised rules for ELTIFs applied from 10 January 2024. Given the long-term nature of investments in ELTIFs, the few existing funds have five years to be brought into line.
What exactly are ELTIFs?
Given that they do not invest predominantly in transferable securities, ELTIFs are alternative investment funds (AIFs). The 2023 regulation requires an ELTIF marketed to retail investors to invest at least 55% in eligible illiquid assets, including other ELTIFs, European venture capital funds (EuVECAs) or European Social Entrepreneurship funds (EuSEFs), but, to make up for that, they benefit from cross-border marketing freedoms similar to UCITS.
To make ELTIFs more attractive and accessible to retail investors, the minimum investment requirement has been removed. But a sale to a retail investor will be subject to a suitability assessment to ensure it is within the client’s risk tolerance, time horizon, etc. As an AIF, a PRIIPs KID will also need to be provided to the client before the sale, after which there will be a two-week cooling-off period. And if the ELTIF has a life of more than 10 years, a clear alert to this effect must be provided.
The additional safeguards for retail investors do not apply to ELTIFs marketed only to professional investors.
What about LTAFs?
Since Brexit was finalised before the revised ELTIF rules, the UK has not applied these, so the FCA consulted on broadening retail access to what it calls Long Term Asset Funds (LTAFs) in 2022 and published policy statement PS23/7 in June 2023, followed by a feedback statement (FS23/7) in October.
The policy statement introduced a number of changes to make LTAFs available to retail investors, the most important of which was their reclassification from a Non-Mass Market Investment (NMMI) to a Restricted Mass Market Investment (RMMI), meaning that they can be marketed to retail investors, as well as self-select DC pension schemes and SIPPs.
Firms need to provide adequate risk warnings, advisers need to conduct an appropriateness assessment and, for non-advised retail investors, they are limited to investing 10% of their investable assets in RMMIs.
Similar to ELTIFs, LTAFs marketed only to non-retail investors will not be subject to the retail investor protection rules. Unlike ELTIFs, LTAFs will not have a cooling-off period.
The feedback statement confirmed that LTAFs would not be excluded from the Financial Services Compensation Scheme for relevant clients and regulated activities.
Funds of funds and redemption policies
Both ELTIFs and LTAFs may operate within certain master-feeder structures, while UK Non-UCITS Funds of Alternative Investment Funds (NURS FAIFs) may invest up to 35% in a single LTAF.
Unsurprisingly, one of the key issues with ELTIFs and LTAFs is the question of liquidity at the fund level, ie how easily a retail investor could sell their units/shares.
ELTIFs were originally intended to be closed-ended funds with no access to early redemption. Under the revised regulation, however, they may be open-ended with redemptions permitted after an initial minimum holding period. If this is to be allowed, the ELTIF must have a clear redemption policy, including a pro rata redemption policy if requests exceed the liquidity available.
As LTAFs are open-ended funds, they must have a minimum notice period for redemptions of 90 days and dealing no more frequently than monthly.
A new mindset
There is a pressing need for private investment in infrastructure and other illiquid assets and as more retail investors have control over the assets within their pension savings, it could be argued that such long-term savings are ideal vehicles for this. It is a big departure from investing only in liquid listed assets and requires a whole new mindset from investors, the investment industry and those who provide intermediate services, such as investment platforms.
No longer will all parties concerned be able to think only about selling units in all funds on a daily basis or easily liquidating the underlying investments to fund client redemptions. Matching redemptions to investment demand, offering partial redemptions, demanding 90 days’ notice of redemption requests and so on all may mean tearing up the rules and starting again. But if retail investors want access to the benefits available from illiquid long-term assets, should they be denied?
Mikkel Bates, Regulation Manager, FE fundinfo