07 May 2015

Private equity's passport to retail?

A new type of regulated fund – the European Long Term Investment Fund, or ELTIF – could be available to private equity and venture capital fund managers by the end of this year, giving them access to retail investors right across the EU. But despite encouragement from the European Commission to take advantage of the new regime, who argue that it will establish a "brand" from which prospective investors will draw comfort, it remains very unclear whether this new product will really have an impact on the sector, especially given the "AIFMD-plus" regulatory rules which will apply.

In 2013, the European Commission set out to create a vehicle which would facilitate investment in long-term assets, particularly infrastructure projects. They wanted this vehicle to be accessible to both professional and retail investors (including smaller European pension funds) - despite the lack of liquidity inherent in such funds, which can be off-putting for those with less substantial investment portfolios, or unpredictable cash requirements. After an unusually speedy legislative process, the final text of the regulation was adopted last month, which means that the regime could be available for use as early as the end of this year. Moreover permitted investments include debt and equity investment in, and loans to, most unlisted and small listed companies.

Initially, it was hard to envisage that ELTIFs would be used by private equity fund managers, because proposed restrictions on structures, terms and redemptions seemed to make it unsuitable for most buyout or venture strategies. But the European Private Equity & Venture Capital Association (EVCA) worked with policy-makers to identify these issues, and some of them were ironed out – not least the ability to use partnership structures, which is now permitted by the final text, and a limited ability to repay investors before the end of the fund's life. ELTIFs could therefore prove to be useful for some fund managers who want to target investors that don't fit into the category of "professional investors", especially in those EU countries where accessing such investors is currently difficult (including, for example, France and Belgium). It will also be possible to use ELTIFs just for professional investors, in which case less stringent rules will apply, but it is not clear at this stage why a manager would accept the additional regulatory burden of the ELTIF regime unless it wanted the retail passport.

Managers who decide to use ELTIFs will need to issue a full prospectus, whether marketing to retail investors or not, and issue a "key information document" (KID) as prescribed under the Packaged Retail Investments Products (PRIPS) legislative package when marketing to retail investors. Managers will also need to have permission from their regulator to provide the additional services permitted under article 6(4) of the AIFMD and carry out an assessment on the "suitability" of the ELTIF for retail investors all of whom will need to receive appropriate investment advice from either the manager or a distributor before they invest. Where a retail investor has an investment portfolio of less than €500,000 there will be additional requirements that its initial minimum investment in ELTIFs should be at least €10,000 but its maximum aggregate investment in them should be no more than 10% of its investment portfolio. The requirement to have a depositary is now familiar to AIFMD authorised managers, but for ELTIFs which are sold to retail investors, this will need to be a bank depositary in the same way as for UCITS funds.

In addition, only EU based managers managing EU based fund vehicles can launch ELTIFs, and fund of funds managers are unlikely to benefit unless they are investing in EuVECAs (the lighter touch regime designed for certain European venture capital funds), other ELTIFs, and European Social Entrepreneurship Funds (EuSEFs). Investments into these categories of funds is only permitted up to a maximum of 20% of an ELTIF's capital. Investments in other funds that do not fall into these three categories are not permitted.

No doubt, these additional requirements will put many fund managers off, but others may find a place for ELTIFs alongside more traditional structures, or as a separate product to offer to a new type of investor. They could also be of interest to banks looking to provide access to more illiquid investments to their high net worth clients. As the search for investors intensifies, it also seems likely that an increasing number of managers will look for ways to attract investment from defined contribution pension funds, and this vehicle could help with that. Finally if any Member States decide to give ELTIFs special tax advantages, as the EU clearly hopes they will, the interest from both investors and managers would sharply increase.

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EVCA members can get more details on the ELTIF regime by clicking here.

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