The European Commission on 19 July 2024 the regulatory technical standards (RTS) for the regulation on European long-term investment funds (Eltifs). Partner and senior associate Sebastiaan Hooghiemstra from Loyens & Loeff provided more details on what’s in the RTS.

In a nutshell, what do these RTS cover?

The RTS published by the European Commission on 19 July 2024 specify:

-when derivatives will be used solely for hedging the risks inherent to other investments of Eltifs;

-the requirements for an Eltifs redemption policy and liquidity management tools (LMTs);

-the circumstances for the matching of transfer requests of units or shares of the Eltif;

-certain criteria for the disposal of Eltif assets; and

-certain elements of the costs disclosure.

The requirements related to the Eltif’s redemption policy and liquidity management tools is seen, in practice, as being the most important topic covered by the RTS.

Do you consider that these have taken into account the concerns of the market voiced earlier in the process (such as when it comes to liquidity and redemption)?

Under the Eltif 2.0 RTS final report (original Eltif 2.0 RTS), as drawn up and published by the European Securities and Markets Authority (Esma) in December 2023, Esma proposed a mandatory cocktail of liquidity management tools, intervening in the liberty of choice and the tools made available in the recently adopted AIFMD 2.0.

A mandatory notice period was proposed that would be by default 12 months and was suggested to be complemented by one anti-dilution liquidity management tool, which could be anti-dilution levies, swing pricing or redemption fees and redemption gates.

The original Eltif 2.0 RTS required a minimum notice period of 12 months for investors. Those open-ended Eltifs that wish to implement a shorter notice period are required to comply with rigid standards in terms of both liquidity pockets and redemption gates. If redemption notices are less than 12 months, the proposed maximum redemption gates were generally considered to be high enough to meet market standards, in particular, as they are “ceilings”, which are fairly high.

However, the minimum liquidity pockets required for Eltifs with a notice period of less than 6 months was proposed to be 40% as a minimum, which is more than double than the current Luxembourg market and regulatory practice for products with either monthly or quarterly redemption windows. In order to approach such standards, managers would need to impose a minimum notice period of, at least, nine months to a year. These high liquidity pockets where 40% of the assets would be held in Ucits eligible assets were perceived by the market to negatively impact the return profile of (semi-)open-ended Eltifs and make them unattractive.

After a period of intense discussion that involved a letter from the European Commission sent to Esma on 8 March 2024 and a response of Esma in an “opinion” on 22 April 2024, the RTS have taken most of the concerns of the market voiced with respect to liquidity and liq into account. In particular, with respect to the (i) minimum holding period, (ii) minimum notice period, (iii) LMTs, (iv) redemption gates and (v) liquidity pocket provisions that are applicable to open-ended Eltifs.

What can you tell us about the minimum holding period?

Unlike earlier iterations published, the final RTS do not contain any strict requirements with respect to the duration of the minimum holding period of an Eltif. To enable Eltif managers to complete the investments of the capital contributions received by an Eltif, the RTS determine certain criteria on the basis of which managers are required to determine the length of the minimum holding period. A justification with respect to the appropriateness of the duration of the minimum period has to be given by the Eltif manager upon an explicit request by the competent authority of the Eltif.

What do the RTS say about minimum notice periods, redemption frequencies/gates and liquidity pockets?

The final RTS allow for a proportional approach with discretion for Eltif managers in terms of (a combination of) (i) minimum notice periods, (ii) redemption frequencies/gates and (iii) liquidity pockets.

In this respect, Eltif managers may, at their discretion:

-calibrate the (maximum) percentage of the redemption gate on the basis of the redemption frequency and the notice period of the Eltif, including the extension of the notice, if any, depending on which of one of the three options referred to in Annex I of the RTS is selected by the Eltif manager; or

-comply with a minimum percentage of a liquidity pocket and a maximum percentage of a redemption gate that is mandatorily linked to the redemption frequency set by the Eltif manager, as specified in Annex II of the RTS.

To determine the maximum size of redemption gate at a given redemption date under Annex I and II of the RTS, Eltif managers may apply a sum of Ucits eligible assets at the redemption date and the expected cash flow forecasted on a prudent basis over 12 months. With respect to the latter, Eltif managers may only take into account those expected positive cash flows for which the Eltif manager can demonstrate that there is a high degree of certainty that they will materialise. Eltif managers shall not consider as expected positive cash flows the possibility that the Eltif can raise capital through new subscriptions. 

If an Eltif manager of an open-ended Eltif opts to apply Annex II of the RTS and the minimum percentage of a liquidity pocket falls below the thresholds set out therein, such manager is expected to take the necessary measures to reconstitute the minimum percentage of the liquid assets, while maintaining the ability of investors to redeem their units or shares, taking due account of the interests of the investors in the Eltif.

Where the notice period of the Eltif, including the extension of the notice period, if any, is less than three months, Eltif managers are required to inform the relevant competent authority thereof, including the reasons for such shorter notice period, and shall explain how that shorter notice period is consistent with the individual features of the Eltif. Eltif managers marketing an Eltif solely to professional investors may, upon request, be exempted from this requirement.

How about liquidity management tools and redemption gates?

In relation to LMTs, the final RTS, contrary to earlier iterations thereof, do not require anti-dilution LMTs to be adopted by “default” for which a derogation request for the use of any other LMT would need to be made to a competent authority. Instead, the RTS mention that Eltif managers “may” select and implement, at least, one anti-dilution LMT, including anti-dilution levies, swing pricing or redemption fees.

Lastly, the RTS also mention that other LMTs “may” be selected, if appropriately justified to the competent authority. Again, Eltif managers may request their competent authority with respect to their “professional Eltifs” to be exempted from this requirement.

How do you anticipate these RTS to impact retail investment?

We anticipate that the RTS will, from a retail investment perspective, positively impact investments in both closed-ended and open-ended Eltifs.

With regards to closed-ended Eltifs?

To date, open-ended AIFs with liquidity pockets have established themselves as the “to-go model” in Europe for retail AIFs investing in illiquid assets. Given the flexibility in the RTS, considering closed-ended Eltifs with a “matching mechanism” could be a worthwhile alternative.

Eltif 2.0 and the RTS namely provide for a mechanism to allow investors to dispose of their shares in an Eltif before the end of the fund’s life on a “matched” secondary market basis to promote the secondary trading of Eltif units/shares. This mechanism is open for both closed-ended and open-ended Eltifs. Going forward, we see, based upon the principle-based approach in the RTS, at least, two ways in which closed-ended retail Eltifs could be viably structured on the basis of this mechanism.

The first viable solution would be to establish a closed-ended Eltif with a “matched secondary market” that would operate through a digital marketing pool with thousands of investors. The matching mechanism would work in a very simple manner: new investors indicate to the Eltif manager or the fund administrator on behalf of the Eltif manager their interest to invest. Conversely, investors willing to step out of the fund would indicate their interest in a selling notice and the price would be fixed based upon the NAV (net asset value) or a bid/ask mechanism.

By absence of a digital marketing pool that would generate sufficient (secondary market) liquidity opportunities for retail investors, fund promoters could establish periodic liquidity windows in which a sponsor-led or external affiliated secondaries fund could offer retail investors periodically to step out of the fund based upon the price fixed on the NAV. For this to effectively and fairly function, however, strict valuation and NAV calculation, as well as conflicts of interest policies/procedures need to be put in place.

Layers of protection which make these solutions, in our view, viable is that the “matched secondary market mechanism” is required to be described in detail in the Eltif’s prospectus and fund documentation which are both subject to the review and approval of the responsible local regulator. Furthermore, Eltif managers and/or distributors would have the responsibility in taking into account the liquidity profile of the Eltif when retail investors invest in the product and to properly assess whether this matches their risk profile and appetite.

Albeit these both sound as viable solutions, none of these mechanisms have been “tried and tested” on a large scale. We will, thus, need to await how such mechanisms might eventually work in practice in a retail context.

What about when it comes to open-ended Eltifs?

In our view, Annex I of the RTS allows for redemption gate percentages which are high enough to cover the liquidity management set-ups of most types of semi-liquid funds that are being set up in Luxembourg. This is less the case with respect to Annex II of the RTS. Both, the required liquidity pocket percentages with respect to monthly and quarterly redemptions, as provided under Annex II of the RTS, are slightly higher than Luxembourg market practice. However, Eltif managers may choose to apply either Annex I or Annex II of the RTS. Albeit complex, we believe that Eltif managers will, in practice, choose for either one of the options under Annex I, as redemption gates are easier to apply and have no impact on risk/return profile and, thus, the returns of an Eltif, whereas liquidity pockets do. In any case, an Eltif manager would choose a combination of both anyway and Luxembourg market practice seems, on the face of it, to fit into this table.

Although we expect that the tables under both Annex I and II of the RTS will be considered to be reasonably workable by industry practitioners, it will be interesting to see if, as is currently expected, indeed the adoption of the RTS will accelerate the uptake of Eltif 2.0 semi-liquid products. In any case, several competent authorities have already helpfully indicated to be willing to apply the definitive RTS ahead of the official application date.

What’s the next step in the process and when should we expect this?

On Friday 19 July 2024, the European Commission formally adopted its RTS supplementing the Eltif regulation. This text will now be subject to a 3-month scrutiny period by the European Parliament and the Council of the EU. If no objections will be raised, the application date is expected to be towards the end of October 2024.