European Union: European Long-Term Investment Fund ("ELTIF")

ELTIF REGULATION

The European Long-Term Investment Fund ("ELTIF") is a new type of regulated investment fund that invests in longterm investment opportunities and may be marketed to both professional and retail investors across the EU.

The regulation governing the operation of ELTIFs (the "Regulation") was adopted by the Council of the European Union on 20 April 2015 and came into force on 8 June 2015. However, the Regulation will not have actual application in EU member states until 9 December 2015.

AUTHORISATION AND MANAGEMENT OF ELTIFS

An ELTIF must be an EU alternative investment fund ("AIF") and must be authorised by the regulator in its home jurisdiction. An ELTIF may only be managed by an EU authorised alternative investment fund manager ("AIFM"). ELTIF managers will therefore be required to comply with the requirements under Directive 2011/61/ EU ("AIFMD") as well as the Regulation.

PROTECTIVE MEASURES AIMED AT RETAIL INVESTORS

Unlike other AIFs within the scope of AIFMD, the ELTIF will benefit from a marketing passport that enables it to be marketed to retail investors across the EU. As a result, the Regulation provides for certain protections for retail investors:

• the AIFM will be required to establish a specific internal process to assess whether the ELTIF is suitable for marketing to retail investors;
• when directly marketing an ELTIF to a retail investor, the AIFM must carry out an assessment as to whether investment in the ELTIF is suitable for the investor. This exercise will involve the AIFM obtaining information on the investor's knowledge and experience in the investment field relevant to the ELTIF, the financial situation of the investor including its ability to bear losses, and the investor's investment objectives including its time horizon;
• an AIFM may only market directly to investors where it has been authorised to provide the service of investment advice in addition to the "core" AIFM functions;
• where the portfolio of the investor is less than €500,000, the AIFM (where it markets directly to retail investors) or the distributor must ensure that the investor does not invest more than 10% of its financial instrument portfolio in ELTIFs, and that the initial minimum amount invested in one or more ELTIFs is €10,000;
• an ELTIF that is marketed to retail investors must have a key information document ("KID") which will set out the important features of the fund;
• unlike other funds within the scope of AIFMD, the depositary shall not be permitted to discharge itself of liability in the event of a loss of financial instruments held in custody by a sub-custodian, and cannot exclude or limit by agreement its liability where the ELTIF is marketed to retail investors;
• unlike other funds within the scope of AIFMD, the rules or instrument of incorporation of an ELTIF marketed to retail investors may not provide for preferential treatment or specific economic benefits for individual investors or groups of investors; and
• retail investors must be permitted to cancel their subscription, and receive a refund of the subscription amount without penalty, during the subscription period and at least two weeks after the date of their subscription.

ELIGIBLE INVESTMENTS AND TECHNIQUES

An ELTIF must invest at least 70% of its capital in the following:

• equity, quasi-equity or debt instruments that have been issued by a "qualifying portfolio undertaking" (broadly speaking, unlisted companies or listed companies with market capitalisation of less than €500 million);
• loans granted by the ELTIF to a qualifying portfolio undertaking;
• units of other ELTIFs, European Venture Capital Funds ("EuVECAs") and European Social Entrepreneurship Funds ("EuSEFs"); or
• real assets with a value of at least €10 million. A "real asset" means any asset that has value due to its substance and properties and may provide returns, including infrastructure and other assets that give rise to economic or social benefit, such as education, counselling, research and development, and including commercial property or housing only where they are integral to, or an ancillary element of, a long-term investment project that contributes to the EU objective of smart, sustainable and inclusive growth.

An ELTIF may also invest up to 30% of its assets in assets which qualify as eligible assets under the UCITS regime (broadly speaking, liquid transferable securities and money market instruments and related derivative instruments).

INVESTMENT AND BORROWING RESTRICTIONS

An ELTIF is subject to certain investment and borrowing restrictions, including:

• it may not invest more than 10% of its capital in instruments of, or loans, to any single issuer;
• it may not invest more than 10% of its capital in a single real asset;
• the 10% figure referred to in the two bullets above can be raised to 20% if the aggregate value of assets held in qualifying portfolio undertakings and individual real assets in which it invests more than 10% of its capital does not exceed 40% of the value of its capital;
• it may not engage in short-selling;
• it may only use derivatives to manage risk, and not for investment purposes;
• it may not invest directly or indirectly in commodities;
• it may not invest more than 10% of its assets in any single, or 20% in the aggregate in, ELTIF, EuVECA or EuSEF;
• it may not invest more than 20% in aggregate in ELTIFs, EuVECAs or EuSEFs; and
• it is subject to a borrowing limit of up to 30% of its assets.

REDEMPTION AND DISTRIBUTION ARRANGEMENTS

Investors in ELTIFs will not, in general, be permitted to withdraw their investment until the specified end date of their investment. This end date must be clearly disclosed to investors in the ELTIF's prospectus or constitutional document, which may provide for the right to temporarily extend the life of the ELTIF.

However ELTIFs can offer early redemption rights to its investors under certain conditions. For example, the overall amount of redemptions must be limited to a percentage of the ELTIF's investments which qualify as eligible assets under the UCITS regime. If redemption requests exceed this limit then redemptions will be granted on a pro rata basis.

The ELTIF may distribute to investors any proceeds that are generated by its assets unless the proceeds are required for future commitments of the ELTIF.

NEXT STEPS

The Regulation will apply in EU member states from 9 December 2015. ESMA will submit draft regulatory technical standards to the European Commission by 9 September 2015 which will elaborate on the provisions of the Regulation, including:

• establishing the circumstances in which the use of derivatives is permitted;
• specifying the circumstances in which the life of an ELTIF is considered sufficient in length to cover the life-cycle of each of the individual assets of the ELTIF; and
• specifying the types and characteristics of the facilities available to investors for making subscriptions, making payments, redemptions, and for making available the information which the ELTIF is required to provide.

The European Commission will then have three months to decide whether to endorse these standards.

CONCLUSION

The ability to market an ELTIF on a passported basis to retail investors across the EU is a significant advantage over other types of alternative investment funds. However, the ELTIF is subject to significant limitations in terms of the types of assets that it may invest in and the diversification limits that apply. Also, policies and procedures will need to be put in place to confirm the appropriateness of the ELTIF for investment by retail investors. It will be interesting to see whether the potential benefits from a marketing perspective are considered by managers to be worth the additional investment constraints and compliance burdens.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.