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Avoiding legal and regulatory pitfalls in digital transformation projects
This article first appeared in the September 2024 issue of Financier Worldwide.
Luxembourg | Publication | April 2023
The revised European Long-Term Investment Fund (“ELTIF”) regime is based on Regulation (EU) 2023/606 of the European Parliament and of the Council (the “2023 ELTIF Regulation”), amending Regulation (EU) 2015/760 (the “2015 ELTIF Regulation”). The 2023 ELTIF Regulation was published in the Official Journal of the European Union on 15 March 2023. It is effective as of 9 April 2023, but the revised ELTIF regime under the 2023 ELTIF Regulation will apply only from 10 January 2024.
An ELTIF is an alternative investment fund ("AIF”) under the Directive 2011/61/EU of the European Parliament and of the Council on Alternative Investment Fund Managers (“AIFMD”), that must be managed by a fully authorised alternative investment fund manager (“AIFM”) established in the EU or that can be internally managed when its legal form permits such management (in each case, the “ELTIF Manager”), with the particular feature of benefiting from a European Union (“EU”) wide passport for marketing to both professional investors and retail investors, subject to certain requirements.
The purpose of the ELTIF framework has been, from the outset, to facilitate investment in longer-term assets such as transport and social infrastructure projects (energy, hospitals, social housing), property and small and medium enterprises (“SMEs”). It is overall subject to substantial and strict investment and diversification rules (in particular, under the 2015 ELTIF Regulation).
The 2023 ELTIF Regulation is the result of an extended legislative process spanning several years and factoring in the outcomes of various consultations, discussions, reports and negotiation rounds with the view of amending the 2015 ELTIF Regulation to the effect of making ELTIFs vehicles more attractive to investors with various profiles. As a result, the 2023 ELTIF Regulation focuses on:
2.1. Authorisation
The launch of an ELTIF is subject to the approval of the competent financial supervisory authority of the ELTIF which is to be launched. In the case of Luxembourg, this will be the Commission de Surveillance du Secteur Financier (“CSSF”). The CSSF must process the approval within two months of filing the complete application for an externally managed ELTIF, or three months in the case of an application by an internally managed vehicle. The ELTIF Manager itself is additionally supervised as an AIFM by its competent national authority.
The authorisation application under the 2023 ELTIF Regulation must comprise, in addition to the identity of the ELTIF Manager and the depositary of the ELTIF: (i) whether it is intended for the ELTIF to be marketed to retail investors, and (ii) information regarding a potential involvement of the ELTIF in a master feeder structure (and related information on those other Feeder ELTIFs or Master ELTIFs).
2.2. Service Providers
An ELTIF must appoint:
2.3. Structuring
The following Luxembourg legal forms are available for an ELTIF:
In addition, it is possible in Luxembourg to add to the ELTIF vehicle a regulatory wrapper under a specific Luxembourg product law so that an ELTIF fund (subject to the available legal forms in each case) can also qualify as a:
It is important to note that we expect ELTIFs to be soon exempt from the subscription tax that would normally be payable under any such regulatory wrapper1.
Eventually, an ELTIF may include one or several compartments if the product law applicable to the relevant vehicle allows it, and each compartment shall be regarded as a separate ELTIF for the purpose of the rules applicable to it (notably marketing, portfolio composition, assets diversification, etc.). Moreover, one single compartment of an umbrella fund may individually apply for the ELTIF label and co-exist with non-ELTIF compartments within the same umbrella fund.
Furthermore, the 2023 ELTIF Regulation provides for the possibility for an ELTIF (or ELTIFs) to be structured as a master/feeder structure ELTIF, whereby a feeder ELTIF invests at least 85% of the assets available to it (a “Feeder ELTIF”) in a master ELTIF or a compartment of a master ELTIF (a “Master ELTIF”). It is also specified in the 2023 ELTIF Regulation that the documentation of a Feeder ELTIF shall comprise the following information:
2.4. Term
The lifespan of an ELTIF must be consistent with the long-term nature of the ELTIF and should be long enough to cover the life cycle of each of its assets, measured on the liquidity profile and economic life cycle of the asset concerned, and the stated investment objective of the ELTIF.
The lifespan of an ELTIF is considered sufficiently long when the following conditions are met:
An “end of life” must be defined for the ELTIF. In ALFI’s view2, this shall not be understood as the “term” (within the meaning of Luxembourg corporate laws) of the ELTIF but as the date:
The ELTIF documentation may provide for the right to extend temporarily the life of the ELTIF, provided that the possibility of such extension is clearly limited in time and the conditions for such extension are also clearly disclosed to the investors.
2.5. Investment Policy and Restrictions
2.5.1. Eligible investment assets
Based on the 2023 ELTIF Regulation, an ELTIF will be required to invest at least 55% of its capital in eligible investment assets3 (instead of the previous 70% under the 2015 ELTIF Regulation).
Broadly speaking, eligible investment assets are assets that yield a predictable regular or irregular cash flow. They are generally illiquid, require commitments for a certain period of time, and have an economic profile of a long-term nature. It was emphasised in the 2015 ELTIF Regulation that investments in commodities should be excluded from eligible investment assets as they do not require a long-term investor commitment. The rationale behind such assumption is that the liquid nature of commodities and of the related financial derivative instruments. Counterexamples were deemed to be investments in infrastructure, in companies related to commodities or in companies whose performance is linked indirectly to the performance of commodities4.
More specifically, eligible investment assets include, under the new ELTIF Regulation, the following:
It is further indicated that, for the determination of (i) the thresholds of the ELTIF eligible assets, (ii) compliance with the portfolio composition limits and (iii) borrowing limits at the level of a given ELTIF, those elements shall be combined with the assets and borrowing cash positions of other collective investment undertaking(s) in which the ELTIF may invest (if applicable), such determination being based on information available and updated on a quarterly basis.
2.5.2. Notion of qualifying portfolio undertaking
The eligible investment assets may be located in the EU or outside the EU since long-term investments in projects, undertakings and infrastructure in third countries may bring capital to ELTIFs and thereby benefit the EU’s economy.
With the 2023 ELTIF Regulation, several rules become more flexible in relation to the prohibition of investments in related vehicles / affiliated vehicles of the ELTIF Manager: an ELTIF may not invest in an eligible investment asset in which the ELTIF Manager holds or acquires a direct or indirect interest, other than by holding units or shares of the ELTIFs, EuSEFs, EuVECAs, UCITS or EU AIFs that it manages.
Furthermore, the 2023 ELTIF Regulation renders more flexible the condition for investments / co-investments by the management team along the ELTIF: The ELTIF Manager and undertakings that belong to the same group (such as an AIFM managing an ELTIF), and their staff may co-invest in that ELTIF and co-invest with the ELTIF in the same asset, provided that the ELTIF Manager has put in place organisational and administrative arrangements designed to identify, prevent, manage and monitor conflicts of interest and provided that such conflicts of interest are adequately disclosed.
2.5.3. Investment in real assets
According to the 2023 ELTIF Regulation, the definition of real asset is considerably simplified as follows: “real assets means an asset that has an intrinsic value due to its substance and properties”.
This was also confirmed in the developments of the European Commission substantiating such update.
Accordingly, the scope of the real asset investment strategies that ELTIF Managers can pursue shall be broadened and thus shall include “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, investments in commercial property, in facilities or installations for education, counselling, research, development, including infrastructure and other assets that give rise to economic or social benefit, sports, or in housing, including in senior residents or social housing, should also be deemed to be eligible assets due to the capacity of such assets to contribute to the objectives of smart, sustainable and inclusive growth,”.
In addition, “to enable real investment strategies in areas where direct investments in real assets are not possible or uneconomical, eligible investments in real assets should also comprise investments in water rights, forest rights, building rights and mineral rights”, but eventually excluding “works of art, manuscripts, wine stocks, jewellery or other assets, which do not in themselves represent long-term investments in the real economy”.
The preamble of the 2023 ELTIF Regulation provides the important clarification that “[t]he eligibility of real assets should not depend on their nature and objectives, or upon environmental, social or governance matters and related sustainability disclosures and similar conditions, which are already covered by Regulations (EU) 2019/20881 and (EU) 2020/8522 of the European Parliament and of the Council [(SFDR)]”. Hence, it is now clear from the 2023 ELTIF Regulation that an ELTIF investing in real assets is not necessarily required to promote environmental or social characteristics (article 8 SFDR) or have sustainable investment as its objective (article 9 SFDR) but could also fall within article 6 SFDR.
2.5.4. Ramp-up period
The ramp-up period must not be longer than 5 years as of authorisation by the CSSF (or half of the term of the ELTIF if shorter) and may be extended by one year upon authorisation by the CSSF.
2.6. Diversification rules
As mentioned above, as per the 2023 ELTIF Regulation, an ELTIF must invest at least 55% of its capital in eligible investment assets.
Globally, all the limits in terms of asset diversification are relaxed. An ELTIF must invest no more than:
For securitisation instruments, the aggregate value of simple, transparent and standardised securitisations in an ELTIF portfolio must not exceed 20% of the value of the capital of the ELTIF.
The aggregate risk exposure to a counterparty of the ELTIF stemming from OTC derivative transactions, repurchase agreements, or reverse repurchase agreements must not exceed 10% of the value of the capital of the ELTIF.
Apart from the 55% limit and the specific increase in relation to transferrable securities and money market instruments from 10% to 25% in a single issuer (as detailed under the last bullet point above), the investment thresholds set out above shall not apply where the ELTIF is marketed solely to professional investors.
When calculating the above-mentioned diversification rules and limits, companies that are aggregated for the purpose of consolidation of accounts are considered a single qualifying portfolio undertaking or a single entity.
In terms of concentration limits (i.e. limits in relation to the investment of the ELTIF itself), under the 2023 ELTIF Regulation, an ELTIF may not acquire more than 30% of the issued units or shares of a single ELTIF, EuVECA, EuSEF, UCITS or of an EU AIF managed by an EU AIFM in which it considers investing. That limit shall not apply where ELTIFs are marketed solely to professional investors.
In case of loss of status of qualifying portfolio undertaking, the rules on the eligible investment assets (see section 2.5) and diversification rules (see section 2.6) remain unchanged for a period of 3 years as of the qualifying portfolio undertaking no longer fulfils the requirements.
In addition, the investment rules and diversification rules may be suspended (i) during the period of disinvestment of shares after the end of the life of the ELTIF or (ii) for a maximum of 12 months in case the ELTIF raises additional capital or reduces its existing capital.
2.7. Investment restrictions
The investment restrictions which currently apply remain unchanged under the 2023 ELTIF Regulation. Various types of investment techniques cannot be used: (i) short selling, (ii) taking direct and indirect exposure to commodities, (iii) entering into financial techniques and instruments (such as securities lending, securities borrowing or repurchase transactions) if they affect more than 10% of the ELTIF’s assets, or (iv) using financial derivatives that do not serve the purpose of hedging risks inherent in other investments of the ELTIF.
2.8. Leverage
Subject to being allowed in the ELTIF documentation, the 2023 ELTIF Regulation provides that ELTIF may have recourse to borrowing in proportion to, and within circumstances that are compared to, the current version of the 2015 ELTIF Regulation.
Accordingly, leverage at the level an ELTIF shall:
When borrowing cash, an ELTIF may encumber assets to implement its borrowing strategy. It is further clarified, as for other AIFs in relation to the concept of leverage, that borrowing arrangements that are fully covered by investors’ capital commitments shall not be considered to constitute borrowing under the ELTIF framework. The borrowing limits shall be indicated in the prospectus of the ELTIF, as well as the relevant date of applicability of the borrowing limits, which shall not be later than three years following the start of the marketing of the ELTIF.
Finally, it is also specified in the 2023 ELTIF Regulation that the applicable borrowing threshold shall be temporarily suspended where the ELTIF raises additional capital or reduces its existing capital. Such suspension shall be limited to the period that is strictly necessary taking due account of the interests of the investors in the ELTIF and, in any case, shall not last longer than 12 months.
2.9. Instruments
2.9.1. Issuance and transfer of units/shares, distributions of proceeds.
There are no preferential rights required under the ELTIF regime itself, unless the new units/shares of the ELTIF are issued at a price below their NAV.
Also, there are transfer restrictions attached to the ELITF regime itself and units/shares may be admitted to trading in a regulated market or in a multilateral trading facility.
An ELTIF may regularly distribute to investors the proceeds generated by the assets contained in its portfolio which may include (i) proceeds that the assets regularly produce and (ii) capital gains realised after the disposal of an asset. However, the proceeds shall not be distributed to the extent that they are required for future commitments of an ELTIF.
The 2023 ELTIF Regulation also forecasts the possibility for matching the units or shares during the life of the ELTIF between the investors, under certain conditions.
2.9.2. Redemptions
As a departure from the 2015 ELTIF Regulation, under the 2023 ELTIF Regulation, a redemption of units/shares issued by an ELTIF may be permitted during the life of the ELTIF if all the following conditions are met:
Investors must always have the option to be repaid in cash. The ESMA must also issue draft regulatory technical standards to the European Commission in relation to, inter alia, the minimum holding period during which it could be prevented to allow for redemptions in the above-mentioned scenario, the requirements to be fulfilled by the ELTIF in relation to its redemption policy and the liquidity management tools.
An ELTIF must inform its competent authority of the orderly disposal of its assets in order to redeem investors' units or shares after the end of the life of the ELTIF, at the latest one year before the date of the end of the life of the ELTIF. Upon the request of the competent authority of the ELTIF, the ELTIF shall submit to that competent authority an itemised schedule for the orderly disposal of its assets. The schedule shall include (i) an assessment of the market for potential buyers, (ii) an assessment and comparison of potential sales prices, (iii) a valuation of the assets to be disposed of and (iv) a timeframe for the disposal schedule.
2.10. Marketing of an ELTIF
Units/shares of an ELTIF may be marketed to both professional investors and retail investors within the EU.
The 2023 ELTIF Regulation has removed the obligation for an ELTIF Manager to put in place facilities (e.g. for subscriptions and payments) in the relevant Member States where it intends to market an ELTIF to retail investors.
A suitability test for retail investors investing in an ELTIF is required, irrespective of whether the shares or units of ELTIFs are acquired by retail investors from the ELTIF Manager or a distributor on the primary market, or via the secondary market.
The 2023 ELTIF Regulation aligns the suitability test to the relevant suitability test provided for in Directive 2014/65/EU (MIFID II).
In case of marketing of an ELTIF to retail investors, the ELTIF Manager must:
In addition, it should be noted that for an ELTIF marketed to retail investors:
We trust the above information is helpful to you. Please do not hesitate to contact us should you have any additional queries.
Disclaimer:
The purpose of this legal note is to set out a brief general overview of the updated ELTIF regime assuming a Luxembourg based ELTIF offered to retail investors and/or professional investors and having appointed a Luxembourg AIFM. This overview is high-level in nature and does not intend to address all the legal considerations that may be relevant to any particular or possible fund or structure. We have not reviewed any documents or agreements relating to a specific business or particular circumstance for the matter subject of this legal note. This legal note speaks as of its date and refers to the dates therein. It is also limited to the laws of the Grand Duchy of Luxembourg.
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This article first appeared in the September 2024 issue of Financier Worldwide.
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