ELTIF as a way of obtaining capital from retail clients

ELTIFs, and in the Polish language version EDFIs, are European long-term investment funds that were introduced into EU law by Regulation (EU) 2015/760 of the European Parliament and of the Council of 29 April 2015 on European long-term investment funds (hereinafter: “Regulation 2015/760”). However, this year, significant amendments were made to Regulation 2015/760, which will enter into force on 10 January 2024. What will the transformed ELTIFs look like and what are they anyway?

What are ELTIFs?

Pursuant to Regulation 2015/760, EU alternative investment funds (hereinafter: “EU AIF”) and EU AIF sub-funds may be marketed as ELTIFs. However, in order to market such a fund, appropriate authorisation must be obtained in advance. Only EU AIF can obtain such an authorisation. EU AIF are collective investment undertakings, including investment compartments thereof, which:

1. raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors and do not require authorisation pursuant to Article 5 of Directive 2009/65/EC;
2. are authorised or registered in a Member State under the applicable national law;
3. are not authorised or registered in a Member State, but have their registered offices or head offices in a Member State of the European Union.

Pursuant to Polish national law, the EU AIF criteria are met by alternative investment companies registered in Poland.

Eligible ELTIF investments

A characteristic feature of ELTIFs is the fact that they can only invest in specific assets – long-term assets. It is difficult to define long-term assets, but they are generally illiquid, require commitments for a certain period of time and have an economic profile of a long-term nature.

To clarify the above, assets are eligible for investment by an ELTIF only where it falls into one of the following categories:

1. equity instruments (ownership interest) or quasi-equity instruments (any type of financing instrument where the return on the instrument is linked to the profit or loss of the qualifying portfolio undertaking and where the repayment of the instrument in the event of default is not fully secured), which have been:

• issued by a qualifying portfolio undertaking and acquired by the ELTIF from the qualifying portfolio undertaking or from a third party via the secondary market;
• issued by a qualifying portfolio undertaking in exchange for an equity or quasi-equity instrument previously acquired by the ELTIF from the qualifying portfolio undertaking or from a third party via the secondary market;
• issued by an undertaking in which the qualifying portfolio undertaking holds an equity participation, in exchange for an equity or quasi-equity instrument acquired in accordance with points a or b above by the ELTIF;

2. debt instruments issued by a qualifying portfolio undertaking;
3. loans granted by the ELTIF to a qualifying portfolio undertaking with a maturity no longer than the life of the ELTIF;
4. units or shares of one or several other ELTIFs, EuVECAs, EuSEFs, UCITSs and EU AIFs managed by EU AIFMs, provided that those ELTIFs, EuVECAs, EuSEFs, UCITSs and EU AIFs invest in eligible investments and have not themselves invested more than 10% of their assets in any other collective investment undertaking;
5. real assets;
6. simple, transparent and standard securitisations;
7. bonds issued, in accordance with the EP and the Council Regulation on European green bonds, by a qualifying portfolio undertaking.

In addition to the above, the ELTIF may invest in assets referred to in Article 50(1) of Directive 2009/65/EC, i.e.:

1. transferable securities and money market instruments admitted to or dealt in on a regulated market;
2. recently issued transferable securities, provided that the terms of issue include an undertaking that an application will be made for admission to official listing on a stock exchange or to another regulated market and that the admission is secured within a year of issue;
3. units of UCITS (undertakings for collective investment in transferable securities) or other collective investment undertakings, provided that a number of conditions are met;
4. deposits with credit institutions which are repayable on demand or have the right to be withdrawn, and maturing in no more than 12 months;
5. financial derivative instruments, including equivalent cash-settled instruments, dealt in on a regulated market or financial derivative instruments dealt in over-the-counter (OTC derivatives);
6. money market instruments other than those dealt in on a regulated market, if the issue or issuer of such instruments is itself regulated for the purpose of protecting investors and savings.

Therefore, ELTIFs have a very wide range of possible cash deposits. However, this is not what distinguishes ELTIFs from other funds, only the investment prohibitions that such a fund must observe.

Investment prohibitions

ELTIFs cannot undertake any of the following activities:

1. short selling of assets;
2. taking direct or indirect exposure to commodities, including via financial derivative instruments, certificates representing them, indices based on them or any other means or instrument that would give an exposure to them;
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;
4. using financial derivative instruments, except where the use of such instruments solely serves the purpose of hedging the risks inherent to other investments of the ELTIF.

The above prohibitions result from the characteristics of ELTIFs activities. As the name suggests, the asset portfolio of these funds should focus only on long-term products such as equity or debt instruments issued by SMEs listed on regulated markets and by enterprises not listed on regulated markets, as well as real assets. Such prohibitions established for ELTIFs are intended to ensure that exposure to risks other than those that might be expected in a fund dedicated to long-term investments is eliminated or limited.

Qualifying portfolio undertaking

The catalogue of assets that are eligible for investment by ELTIFs introduces the concept of a qualifying portfolio undertaking. In order for an investment to be made, such an undertaking must fulfil the following requirements:

1. it cannot be a financial undertaking, unless it is a financial undertaking that is not a financial holding company or a mixed-activity holding company and that financial undertaking was authorised or registered more than five years before the date of the initial investment;
2. it is an undertaking which is not admitted to trading on a regulated market or on a multilateral trading facility or is admitted to trading on a regulated market or on a multilateral trading facility and has a market capitalisation of no more than EUR 1,500,000,000;
3. it is established in a Member State or in a third country, provided that the third country has not been recognised as a high-risk third country and is not listed as a non-cooperative jurisdiction for tax purposes.

Therefore, ELTIFs have substantial investment potential, but are limited to non-public companies or public companies from the SME sector. Due to the risk of money laundering and terrorist financing, geographical requirements should be considered necessary.

Investment policy

In order to implement the statutory assumptions, the ELTIF must have a specific investment policy, according to which:

1. it invests at least 55% of its capital in the eligible investment assets referred to above;
2. it invests no more than 20% of its capital in instruments issued by or loans granted to any single qualifying portfolio undertaking;
3. it invests no more than 20% of its capital in single items of real assets;
4. it invests no more than 20% of its capital in units or shares in any single ELTIF, EuVECA, EuSEF, UCITS or EU AIF managed by EU AIFM;
5. it invests no more than 10% of its capital in the assets referred to in Article 50(1) of Directive 2009/65/EC, where these assets have been issued by a single entity;
6. the total value of simple, transparent and standard securitisations in the ELTIF portfolio may not exceed 20% of the capital value of that ELTIF.

Therefore, the ELTIF must diversify itself and invest in various assets, thereby mitigating investment risk. It is impossible to create an ELTIF that will invest only, for example, in real assets, even though these will be real assets of various types. However, these limits do not apply when the ELTIF is introduced only among professional investors (except for the limit indicated in item 1).

Marketing ELTIFs to retail clients

Interestingly, ELTIFs operating in Poland as alternative investment companies can be marketed to retail clients. Pursuant to Article 70f(1)(2) of the Act on investment funds and management of alternative investment funds, an alternative investment company may be marketed to retail clients – if it has obtained authorisation for the European long-term investment fund referred to in Regulation 2015/760.

Taking into account the recent changes in the functioning of alternative investment companies introduced by the so-called “greengrocer” act and the prohibition on marketing AICs to retail clients, the ELTIF is an interesting alternative when a potential retail investor does not have “loose” EUR 60,000 to invest in the AIC. Naturally, it is subject to specific requirements, but the specificity of the activities of many AICs shows that they prefer long-term investments. Therefore, instead of looking for investors who want to invest at least a quarter of a million into something that does not guarantee success, it is worth considering remodelling the AIC and obtaining authorisation to operate as an ELTIF.