A Guide To European Long-Term Investment Funds

Section 1

Introduction

On 10 January 2024, the regulatory framework for European long-term investment funds ("ELTIFs") was significantly overhauled. Regulation (EU) 2015/760 (also referred to as ELTIF 1.0) was amended by Regulation (EU) 2023/606 (also referred to as ELTIF 2.0, and together with ELTIF 1.0, the "ELTIF Regulations"). Regulation (EU) 2024/2759 containing the regulatory technical standards ("RTS") entered into force on 26 October 2024. This regulatory overhaul of the ELTIF regime seeks to make ELTIFs a more attractive product for private fund managers seeking to access 'retail' (including high net worth and private wealth) capital.

ELTIFs are regulated EU alternative investment funds ("EU AIFs"), managed by EU alternative investment fund managers ("EU AIFMs"), that are designed to invest in "real economy" asset classes, such as venture capital, energy, credit, private equity, infrastructure, and real estate.

Importantly, unlike the AIFMD marketing passport which is limited to professional investors (i.e., a MiFID "professional client") only, ELTIFs can be distributed on a cross-border, pan-EU basis to both professional and retail investors.

Section 2

What can an ELTIF invest in?

Categories of Assets

An ELTIF can only invest in the following categories of assets:

1. eligible investment assets ("Eligible Assets"); and
2. assets referred to in Article 50(1) of Directive 2009/65/EC ("UCITS Eligible Assets").

Eligible Assets

Only assets which fall into one of the following categories shall be Eligible Assets for the purpose of ELTIF investment:

1. real assets, meaning an asset that has "an intrinsic value due to its substance and properties", including immovable property, such as communication, environment, energy or transport infrastructure, social infrastructure, including retirement homes or hospitals, as well as infrastructure for education, health and welfare support or industrial facilities, installations, and other assets, including intellectual property, vessels, equipment, machinery, aircraft or rolling stock ("Real Assets");
2. equity or quasi-equity instruments which have been:
   
   
   1. issued by a qualifying portfolio undertaking ("QPU") (see below) and acquired by the ELTIF from that QPU or from a third party via the secondary market;equity or quasi-equity instruments which have been:
   2. issued by a QPU in exchange for an equity or quasi-equity instrument previously acquired by the ELTIF from that QPU or from a third party via the secondary market;
   3. issued by an undertaking in which a QPU holds a capital participation in exchange for an equity or quasi-equity instrument acquired by the ELTIF in accordance with point (i) and (ii) above;

3. debt instruments issued by a QPU;
4. loans granted by the ELTIF to a QPU with a maturity that does not exceed the life of the ELTIF;
5. units and shares of one or several other ELTIFs, EuVECAs, EuSEFs, UCITS and/or EU AIFs managed by EU AIFMs provided that those ELTIFs, EuVECAs, EuSEFs, UCITS and EU AIFs invest in eligible investments (per Article 9(1) and (2) of the ELTIF Regulations) and have not themselves invested more than 10% of their assets in any other collective investment undertaking ("ELTIF-Eligible Funds"). Furthermore, it is possible to establish an ELTIF as a master-feeder structure, provided both the feeder and master are each authorised as ELTIFs;
6. simple, transparent and standardised securitisations ("STSS") where the underlying disclosures correspond to certain assets, such as mortgage-backed residential/ commercial loans, credit facilities, trade receivables (provided that the proceeds from the securitisation bonds are used for financing or refinancing); and
7. bonds issued by a QPU pursuant to Regulation (EU) 2023/2631 (i.e., European Green Bonds).

What is a QPU?

A QPU shall be an undertaking that fulfils the following requirements at the time of the initial investment:

1. it is not a financial undertaking (meaning a credit institution, an investment firm, an AIFM, a UCITS management company, an insurance/reinsurance undertaking, a financial holding company or a mixed-activity holding company) unless:
   1. it is a financial undertaking that is not a financial holding company or a mixed-activity holding company; and
   2. that financial undertaking has been authorised or registered more recently than 5 years before the date of the initial investment;
2. it is an undertaking which:
   1. is not admitted to trading on a regulated market or on a multilateral trading facility; or
   2. is admitted to trading on a regulated market or on a multilateral trading facility and has a market capitalisation of no more than €1.5 billion; and
3. it is established in a Member State, or in a third country provided that the third country is not identified as a high-risk third country or listed on the EU list of non- cooperative jurisdictions for tax purposes.

It is also possible for a financial undertaking to be a QPU where that financial undertaking exclusively finances QPUs or Real Assets.

Where an ELTIF has invested in a QPU which no longer complies with (b) above (e.g., its market capitalisation has simply exceeded €1.5 billion), such QPU will be deemed to be an Eligible Asset, for the purposes of the ELTIF needing to hold at least 55% of its capital in Eligible Assets, for a period of 3 years from the date on which the QPU no longer fulfils (b) above.

Prohibitions

An ELTIF is prohibited from undertaking the following activities:

1. short selling of assets;
2. taking direct or indirect exposure to commodities (including via financial derivative instruments);
3. entering into securities lending, securities borrowing, repurchase transactions (or any other agreement which has an equivalent economic effect and poses similar risks), if thereby more than 10% of the assets of the ELTIF are affected; and
4. using financial derivative instruments (except where such use is solely for the purposes of hedging the risks to other investments of the ELTIF.) Under Article 1 of the RTS, the following conditions with respect to use of financial derivative instruments must be met by the ELTIF: the use of the derivative must be "economically appropriate" for the ELTIF; it must be consistent with the ELTIF's risk profile; and, it must be aimed at a verifiable reduction of risks.

Diversification

There are certain portfolio composition and diversification requirements (the "Diversification Rules") with which ELTIFs must comply.

The Diversification Rules are set out below, though the investment limits at points (b) to (e) shall not apply to ELTIFs marketed solely for professional investors, and companies which are included in the same group for the purposes of consolidated accounts shall be regarded as a single body when calculating the limits below.

1. An ELTIF shall invest at least 55% of its capital in Eligible Assets.
2. An ELTIF shall invest no more than 20% of its capital:
   1. in instruments issued by, or loans granted to, any single QPU;
   2. in a single Real Asset; or
   3. in units or shares of any single ELTIF-Eligible Fund. In addition, an ELTIF may not acquire more than 30% of the units or shares of an ELTIF-Eligible Fund, noting that both the 20% diversification limit, and the 30% concentration limit, shall not apply to feeder ELTIFs.
3. An ELTIF shall invest no more than 10% of its capital in any UCITS Eligible Assets issued by one single body. This limit may be increased to 25% where bonds are issued by a credit institution that has its registered office in a Member State and that is subject by law to special public supervision designed to protect bond-holders.
4. The aggregate value of STSS in an ELTIF portfolio shall not exceed 20% of the value of the capital of the ELTIF.
5. The aggregate risk exposure to a counterparty of the ELTIF stemming from over-the-counter derivative transactions, repurchase agreements, or reverse repurchase agreements shall not exceed 10% of the value of the capital of the ELTIF.
6. With respect to the UCITS Eligible Assets, the concentration limits set out in Article 56(2) of the UCITS Directive will need to be complied with (e.g., no more than 10% of the of the non-voting shares, or debt securities or money market instruments, of a single issuing body and no more than 25% of the units of another UCITS or UCITS- eligible collective investment scheme).

Section 3

Borrowing

An ELTIF is permitted to borrow cash provided that such cash borrowing:

1. represents no more than 100% of the ELTIF's net asset value (for ELTIFs that are marketed solely to professional investors), or 50% of the ELTIF's net asset value (for ELTIFs that can be marketed to retail investors);
2. serves the purpose of making investments and providing liquidity, including to pay costs and expenses, provided that the holdings in cash or cash equivalent of the ELTIF are not sufficient to make the investment concerned;
3. is contracted in the same currency as the assets to be acquired with the borrowed cash, or in another currency where currency exposure has been appropriately hedged; and
4. has a maturity date no longer than the life of the ELTIF, (the "Borrowing Limits")

It being noted that an ELTIF may encumber assets to implement its borrowing strategies and borrowing arrangements that are fully covered by investors' capital commitments shall not be considered to constitute "borrowing" for the purposes of the Borrowing Limits (e.g., a fund financing facility).

Section 4

Compliance with the diversification rules and borrowing limits

The Diversification Rules shall:

1. apply by the date specified in the rules or instruments of incorporation of the ELTIF (the "ELTIF Rules"), taking account of the particular features and characteristics of the assets to be invested in by the ELTIF and in any event, which shall be no later than five years after the date of authorisation of the ELTIF, or half of the life of the ELTIF, whichever is earlier, with it being noted that it is possible to apply, in exceptional circumstances, to the relevant competent authority (which for Irish ELTIF will be the Central Bank of Ireland (the "CBI")) to have this timeline extended by no more than one additional year (the "Ramp-Up Period");
2. cease to apply once the ELTIF starts to sell assets in order to redeem investors' units or shares after the end of the life of the ELTIF; and
3. be temporarily suspended where the ELTIF raises additional capital or reduces its existing capital so long as such a suspension lasts no longer than 12 months.

The Borrowing Limits (or any narrower borrowing limits self-imposed by the ELTIF within its prospectus) shall only apply as from the date specified in the rules or instruments of incorporation of the ELTIF, which shall be no later than three years after the date on which the marketing of the ELTIF commenced.

Further, the determination of compliance with the Diversification Rules and the Borrowing Limits shall be carried out on the basis of information updated on at least a quarterly basis and, where that information is not available on a quarterly basis, on the basis of the most recent available information. In the event that the ELTIF infringes the Diversification Rules and/or the 50% or 100% borrowing threshold, as applicable, and the infringement is beyond the control of the manager of the ELTIF, the manager shall, within an appropriate period of time, take such measures as are necessary to rectify the position, taking due account of the interest of the investors.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.