The approval of the European Union's regulation on European Long Term Investment Funds (ELTIFs) provides a new tool designed to assist the continent's emergence from the years of financial crisis and economic sluggishness, and one that offers the financial industry an opportunity to restore its public image, demonstrating that it can be a generator of growth, prosperity and jobs rather than mired in scandal or soaking up taxpayer-funded bailouts.

An EU framework for long-term funds was first proposed in July 2012 as part of the European Commission's discussion points for UCITS VI. It has since developed momentum in its own right, and the timing of its final approval is serendipitous, dovetailing as it does with the Commission's Juncker Plan to mobilise of funds for investment in infrastructure and other assets that can help kick-start the European economy in the short to medium term as well as providing long-term value.

The lengthy period between the first proposal and final agreement on the ELTIF framework, which will come into effect this autumn, reflects the complexity of a concept that straddles the EU's existing AIFMD regime for alternative investment fund managers and their products along with the principle that the new funds should also be available to retail investors, at least those categorised as 'mass affluent'.

The main issue has been finding a balance between the long-term financing stability required in real assets, infrastructure and related sectors with the liquidity needs that are usually important to retail investors, as opposed to institutions that lock up their money in private equity funds for years at a time. After extensive debate within and between EU institutions, especially over protection of investors, a compromise was reached last November in 'trialogue' discussions between the Commission, the European Parliament and the EU Council representing member states.

The agreement places ELTIFs within the regulatory framework for alternative investment funds and managers, with specific criteria regarding eligible assets, diversification, governance and marketing, especially as regards retail investors. At least 70% of their assets must comprise long-term investments in areas including infrastructure, education, research and development and, subject to restrictions, real estate, within the EU or other countries that meet international money laundering and tax transparency standards. They may also invest in small businesses, other ELTIFs, European Venture Capital Funds and European Social Entrepreneurship Funds.

Up to 30% of the ELTIF's investments can be in liquid assets eligible for UCITS funds; they must hold at least eight separate assets. Investors cannot redeem their shares or units before the end of the fund's pre-defined maturity, which will be determined by the nature of the assets in which it is to invest. However, ELTIFs can also be structured as open-ended or semi-open ended, to allow investors to exit before the fund has matured, and its shares and units may be listed on a secondary market to enable them to be traded. ELTIFs will benefit from an EU marketing passport that means that once authorised in one member state, they can be marketed freely to institutions and qualifying retail investors in any other country of the Union, subject to the AIFMD notification procedure. Eligible retail investors are to be determined by a special suitability test based on their financial circumstances and risk profile, and will have a two-week reflection and withdrawal period.

This new type of investment vehicle is likely to be particularly attractive to investors not only because of its intrinsic return opportunities but for the socially and/or economically responsible character of their investments. For both individuals and institutions, they offer the opportunity to pursue their financial goals while participating in the financing of social goods or assets such as roads, schools and hospitals. In due course, ELTIFs could become a widely known and understood label in the same way that UCITS are today both in Europe and beyond.

The type of investments covered by ELTIFs have hitherto been hard to access by any but the most sophisticated individual investors. Although various individual EU member states have their own regimes for infrastructure and similar investments accommodating affluent retail clients, they tend to be opaque and hard to understand. The introduction of ELTIFs provides a harmonised and reliable framework that is easy for investors to grasp and to use, and moreover one that allows fund promoters to reach potential clients throughout the EU, rather than being restricted to marketing country by country.

The Juncker Plan, which explicitly calls for investments to be channelled through the ELTIF framework, should be an important boost for the new regime, signalling as it does the high-level political will underpinning the initiative. This should help to create visibility for the product in the marketplace as well as opening up opportunities for public-private partnerships, in the form of co-investments from retail and institutional investors in schools, hospitals or roads alongside funding made available under the Commission plan.

However, there are still some issues to be resolved in order for ELTIFs to prove a success. One practical problem is that the diversification requirements introduced in order to protect retail investors are something new for the infrastructure sector, where investment vehicles often target just two, three or five assets. Because it is not feasible to invest small sums in major projects such as hospitals or highways, and ELTIFs will need to invest in at least eight assets, this presupposes that a fund will require a substantial critical mass to be able to meet the diversification rules and still find attractive investment opportunities.

Right now the market for ELTIFs does not really exist and it will have to be created. There is no reason why the long-term funds cannot be highly successful – especially given the potential convergence between locked-up long-term investments and the retirement savings needs of ordinary Europeans – but changes will be needed in the way infrastructure investment portfolios are conceived.

Promoters and distributors also have work ahead in managing the complexities of the retail investor assessment process and ensuring the robustness of suitability tests, which will require a commitment of time and resources at the administrative level. The acceptance of investors will entail more questions and checks than for other products, although to some extent the MiFID II compliance process to which distributors are subject will already cover some of the additional requirements.

However, the impetus for the ELTIF concept was also driven by the desire to create a win-win situation that would meet the needs of investors as well as benefiting the European economy. In the wake of the financial crisis many investors have been reluctant to trust the stock market with their retirement savings, and in many cases bank accounts are subject to negative interest rates. Mass affluent people have struggled to find ways of earning a return on their assets.

While some of the Commission documents have spoken about ELTIFs making investments that deliver a "predictable income", the industry was reluctant regarding this formulation, given that an investment fund's income cannot be described as predictable. However, schools, hospitals and other public infrastructure assets less vulnerable to unforeseen volatility than, for instance, shopping centres that depend on the economic and financial health of the businesses within them. They are capable of delivering a stable return that is attractive to individual investors as well as smaller pension funds and similar institutions that may not have the volume of capital to access traditional infrastructure funds.

The ability of investors to enjoy access to liquidity before the termination date of the ELTIF will depend to a large extent on the assets in which the fund invests. While roads might not be suitable for structuring an open-ended or semi-open ended vehicle, strategies involving investments in SMEs, for instance, through short-term direct lending, may enable the manager to allow redemption rights once the minimum investment period of five years has elapsed. But the feasibility of redemptions will be down to the way the portfolio is structured.

Another option for investors to exit is through secondary market trading, even if this might entail selling shares or units at a discount to their net asset value. A final area of uncertainty surround ELTIFs is how the regulation will be interpreted by the individual member states as they put it into practice, and whether this will open up the risk of regulatory arbitrage, but this is something that arises with any new piece of legislation or rule-making. Some adaptation will certainly be needed, and divergences of views may arise, but such issues will be resolved over time. They should not be allowed to detract from an initiative with the potential to offer substantial benefits to both Europe's investors and its economy.

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