Infrastructure funds

The Regulation on European Long-term Investment Funds (the ELTIF Regulation) provides a uniform set of rules for the authorisation, investment policies, and operating conditions of EU alternative investment funds (AIFs) that are marketed as European long-term investment funds (ELTIFs). An ELTIF is a type of fund that allows investors to invest into companies and projects that need long-term capital, such as energy, transport, communication infrastructure, industrial and service facilities, housing and climate change technologies.

The intention is to make ELTIFs available to all types of investors, such as insurance companies and pension funds, and to create standardised, transferable investments that can be traded in the secondary markets. The European Commission has in parallel amended the Solvency II regime to allow insurers and reinsurers to invest in ELTIFs as an asset class. Since 2 April 2016, insurers that invest in ELTIFs have been able to benefit from the same capital charges as investments in European venture capital funds and European social entrepreneurship funds, which in turn benefit from the same lower equity capital charge as equities traded on regulated markets.

ELTIFs also have the added advantages of cross-border investment passporting and the possibility of raising long term capital from smaller investors (local pension plans, municipalities, corporate pension plans etc.). An ELTIF will only be able to invest in unlisted or small companies needing long-term capital, real assets that need long-term capital to develop them, and funds regulated under the European Venture Capital Funds Regulation or the European Social Entrepreneurship Funds Regulation.

To qualify as an ELTIF, an investment fund must:

1. invest at least 70 per cent in prescribed types of assets;
2. strictly limit derivative and leverage use;
3. be closed-ended;
4. be managed and offered by an investment manager who is authorised under the Alternative Investment Fund Managers Directive (AIFMD); and
5. be authorized as an ELTIF by the relevant national regulator.

ELTIFs operate under the AIFMD regime, which means that a manager of an ELTIF must be authorised as a full-scope AIF manager under the AIFMD. It should be noted that the Commission is not contemplating the inclusion of ELTIFs in its plans for a staged third-country regime that will govern non-EU AIFs and AIF managers. As a result, ELTIFs will be limited in scope to AIFs that are regulated by Member States.

ELTIFs must invest at least 70 percent of their capital in "eligible investment assets." The remaining 30 percent may be invested in certain undertakings for collective investment in transferable securities (UCITS).

In June 2016, the European Securities and Markets Authority (ESMA) submitted to the Commission for approval draft regulatory technical standards (RTS) that provide details with respect to when an ELTIF has a long enough lifespan to cover the life-cycle of its individual assets. It also submitted RTS that set out the criteria to be used for the assessment of the market for potential buyers, the criteria for establishing when and what derivatives can be used to hedge risks relating to an ELTIF’s investments, and the types and characteristics of the facilities to be made available to retail investors, their technical infrastructure, and the content of their tasks. ESMA is currently consulting on RTS that set out common definitions, calculation methodologies and other related details. The Commission is expected to decide whether to endorse the RTS before the end of 2016.

Eligible investment assets include equity or quasi-equity instruments in qualifying portfolio undertakings, debt instruments issued by them or loans provided to them. At the moment, ‘qualifying portfolio undertakings’ cannot be admitted to trading on a regulated market or on a multilateral trading facility unless their market capitalisation is less than €500m.

While ELTIFs are intended to act as cross-border vehicles for long term projects in energy, transport and communication structures, the ELTIF Regulation is not prescriptive as to the types of projects that ‘eligible investment assets’ can be exposed to. Instead, the Regulation provides some examples, which include:

1. participations in funds that are focused on assets, such as investments in unlisted undertakings that issue equity or debt instruments;
2. direct holdings of real assets that are not securitized, provided that they yield a predictable cash flow;
3. social infrastructure that yields a predictable return, such as energy, transport and communication infrastructure, as well as education, health, welfare support or industrial facilities;
4. infrastructure, intellectual property, vessels, equipment, machinery, aircraft or rolling stock, and immovable property; and
5. investments in commercial property or housing to the extent that they serve the purpose of contributing to smart, sustainable and inclusive growth or to the Union's energy, regional and cohesion policies.

While the definition of what constitutes a long-term investment is very broad, the focus remains on the cashflows as opposed to the speculative value of the assets. That being said, portfolios are expected to include assets with a value of more than €10m that generate an economic and social benefit. Eligible investment assets are generally illiquid, require commitments for a certain period of time, and have an economic profile of a long-term nature.

Eligible investment assets are non-transferable securities and therefore do not have access to the liquidity of secondary markets. They often require fixed term commitments which restrict their marketability. The economic cycle of the investment sought by ELTIFs is essentially of a long-term nature due to the high capital commitments and the length of time required to produce returns.

Going forward, the European Insurance and Occupational Pensions Authority (EIOPA) is advising the Commission on the possibility of extending the preferential regulatory capital treatment to infrastructure companies at the operational stage (rather than limiting it to the development stage). The Commission is also considering a possible recalibration of banks’ capital requirements under the Capital Requirements Regulation to facilitate further investment in ELTIFs.