Last week, the European Securities and Markets Authority (ESMA) published its response to the European Commission's (EC) request for amendments to the European long-term investment fund (ELTIF) regulatory technical standards (RTS).
In response to the slow uptake of ELTIFs in the EU since the introduction of the product in 2015, the EC amended the original ELTIF rules with Regulation (EU) 2023/606 (the ELTIF Regulation, commonly referred to as ELTIF 2.0), which came into force on 10 January 2024. The new regulations aim to make the product more appealing to asset managers and investors alike.
ELTIF 2.0 provided that ESMA must develop draft RTS to determine, in particular, the following:
- the circumstances in which the life of an ELTIF is considered compatible with the life-cycles of each of the individual assets, as well as different features of the redemption policy of the ELTIF; and
- the costs disclosure.
On 19 December 2023, ESMA published its draft RTS and submitted it to the EC for adoption. The EC responded to ESMA on 6 March 2024 with a strongly worded letter implying that ESMA had strayed outside of its purely technical mandate, particularly in relation to redemptions and liquidity management tools.
On 22 April 2024, ESMA issued its rebuttal to the EC, with an opinion and revised set of RTS which focus on six key areas:
- Notification of material changes to redemption policy
ESMA had initially proposed that ELTIF managers would be required to inform their regulator of any changes to the fund's redemption policy after the fact, i.e. within 3 business days of a material change becoming known to the manager.
The EC disagreed with this "ex post" approach. It felt that material change notices should be submitted in advance so that competent authorities would have the updated information in advance. By way of example, the EC said that an ELTIF manager should not be able to change its fund's redemption frequency without prior authorisation of its regulator.
To address the EC's concerns, ESMA has suggested that material changes should be flagged as soon as possible and, in any event, at least one month before the change is implemented (unless the change was not planned by the manager, in which case the obligation is to notify the competent authority as soon as possible after the change has occurred).
ESMA noted in its opinion that the new wording proposed by the EC would address the concerns it raised "while retaining the key supervisory requirement that material changes should be notified to competent authorities by ELTIF managers" so has agreed to adopt the changes in the revised RTS.
- Minimum notice periods for redemption and liquidity requirements related to standardised notice periods
In its original draft of the RTS, ESMA had proposed a blanket 12-month minimum notice period for redemptions of shares or units from all ELTIFs, with certain exceptions for funds with significant proportions of their holdings in UCITS-eligible (i.e. liquid) assets, based on a sliding scale. For example, ESMA originally proposed that an ELTIF with a redemption period of less than 6 months would be required to hold at least 40% of its portfolio in liquid assets. A notice period of less than 9 months to 6 months would require a liquid holding of 27% and so on.
In the EC's view, a view with which many market participants had sympathy, ESMA's proposals in this area were too prescriptive for this product, which was designed to increase investment in illiquid alternative assets (such as real estate, infrastructure and private equity) across the EU. The requirement to hold up to 40% of the fund's assets in UCITS-eligible investments was considered far too burdensome and counterproductive.
Alongside these minimum requirements for liquid assets, ESMA had also set maximum redemption limits for any fund with a redemption notice period of less than 12 months.
By way of background, the ELTIF rules do already require that an open-ended ELTIF makes clear to investors, in its redemption policy, that redemptions are limited to a certain percentage of the fund's assets which would be eligible investments for the purposes of the UCITS rules. This maximum threshold essentially acts as a gate on redemptions from the fund. Under normal circumstances, the manager has discretion (subject to considering criteria developed by ESMA) to set the threshold at which this gate applies.
ESMA felt, however, that these maximum thresholds should be mandated for funds with redemption periods of less than 12 months. So, for example, ESMA initially proposed that an ELTIF with a redemption notice of less than 6 months to 3 months (included) could only redeem a maximum of 40% of its UCITS-eligible assets in any one period.
In addition to the minimum and maximum thresholds outlined above, ESMA had also built in an extra layer of bureaucracy, which meant that managers proposing a redemption notice period of less than 3 months would be required to justify this decision to their regulator.
In response to these strict requirements on the minimum amount of liquid assets to be held by a fund and the maximum percentage of redeemable assets, the EC felt that linking the length of ELTIFs' redemption notice periods with these “fixed” percentages failed to sufficiently take into account the specific situation of ELTIFs. In its view, ESMA did "not appear to respect the scope of the legal mandate laid down [by] the ELTIF Regulation". It called for ESMA to remove the requirement of a minimum 12-month notice period and amend the minimum and maximum thresholds to take "into account the principle of proportionality, the existing market practices for retail long-term funds and the individual situation of ELTIFs".
In response, ESMA has removed the blanket 12-month notice period rule from its draft RTS and, as you can see in the table below (which summarises ESMA's revised notice period limits), ESMA has also decided to relax the liquidity requirements somewhat for funds with a notice period of less than a year. For example, ELTIFs with a redemption notice period of less than 6 months will now only be required to hold 15-25% of their assets in liquid investments (depending on the exact notice period) as compared to 40% in the first draft of the RTS submitted to the EC.
| Notice Period | Minimum percentage of liquid assets to be held by the fund[1] | Maximum percentage of liquid assets that can be redeemed[2] |
| Less than 12 months to 6 months (included) | 10% | 90% |
| Less than 6 months to 3 months (included) | 15% | 67% |
| Less than 3 months to 1 month (included) | 20% | 50% |
| Less than 1 month | 25% | 20% |
However, it is clear that ESMA remains of the view that a "certain level of prescriptiveness" is needed in this area. It has added a 90% redemption gate to funds with a redemption period of less than 12 months up to and including 6 months (where the EC had proposed that 100% of such a fund's assets could have been redeemed in one go).
In addition, and apparently as a quid pro quo for relaxing some of its liquidity limits, ESMA wants to bring more managers within scope of the additional requirement to justify shorter redemption notice periods. Under the revised RTS, the need to justify the appropriateness of the notice period to the competent authority will be triggered if the notice period is less than six months, instead of the previous three-month limit mentioned above.
- Liquidity management tools
In its original proposals, ESMA had included an obligation for an ELTIF manager to implement at least one anti-dilution liquidity management tool, with three options on the table (anti-dilution levies, swing pricing or redemption fees).
In its response, the EC warned that this proposal would disincentivise ELTIF managers from implementing other liquidity management tools which may be more appropriate to the circumstances. The EC said that the draft RTS should be amended in a manner that does not introduce new ELTIF-specific requirements with respect to selecting and implementing liquidity management tools, as it could not see the argument for treating ELTIFs differently from other AIFs in this respect.
ESMA argued in its response that ELTIFs' liquidity management tools should differ from other AIFs as the former is a "more specific" type of investment fund which may invest in illiquid assets, is marketed to retail investors and benefits from a passport.
However, ESMA has ultimately conceded to the EC's key demand on this point by removing the mandatory requirement for ELTIFs to implement at least one anti-dilution tool to "ensure a timely implementation of the ELTIF provisions".
- Redemption gates
In its draft RTS, ESMA had sought to tie the use of redemption gates to its redemption notice period prescriptions (see paragraph 2 above), alongside a broader requirement that redemption gates be implemented in "certain specific circumstances", including where such a tool is needed to mitigate any potential risk to financial stability and where "numerous" redemption requests are received by a manager in stressed market conditions.
The EC raised concerns that the original draft implied that redemption gates should only be used in "exceptional circumstances". ESMA disagreed with this interpretation, noting that its original proposal had called for a more nuanced approach (although ESMA was clear that redemption gates should not been seen as a normal liquidity management tool).
Nevertheless, ESMA has clarified in the revised RTS that redemption gates can be used in addition to other liquidity management tools.
- Cost disclosure
The EC's view was that ESMA's proposed cost disclosure requirements represented a new methodology which was at odds with similar rules in existing EU legislation (e.g. PRIIPs, MiFID II and AIFMD).
The EC noted in its response to the original RTS that the ELTIF cost disclosures should not give rise to sector-specific requirements unless duly justified by the characteristics of the ELTIFs.
To that end, the EC proposed that instead of calculating the overall cost indicator as a “percentage of the capital of the ELTIF”, it should be calculated as a percentage of the “net asset value of the ELTIF per annum”.
In its response, ESMA noted that the overall cost ratio should be calculated as a ratio of costs to the capital of the ELTIF because this would align with the specific cost components required to be disclosed in an ELTIF's prospectus. These component costs (e.g. the cost of setting up the ELTIF) are expressed as ratios of the capital of the ELTIF.
Despite disagreeing with the EC's interpretation of the PRIIPs regulation and its evident concerns regarding the consistency of cost disclosures, ESMA has decided that the switch to a NAV-based approach is acceptable and this will be reflected in the revised RTS.
- Minimum holding periods
Article 18(2)(a) of the ELTIF Regulation requires that redemptions are not granted before the end of a minimum holding period.
ELTIF 2.0 provided that ESMA should set out criteria to determine this minimum holding period. In the first draft of its RTS, ESMA had proposed a detailed set of criteria (including the investment strategy of the fund and the fund's investor base etc.) which an ELTIF manager had to consider when setting this obligatory (as ESMA saw it) lock-up period.
However, in its feedback on the RTS, the EC warned that ESMA's drafting on this point "could lead to a misleading interpretation" that a minimum holding period is mandatory for an ELTIF. This, the EC felt, would be at odds with the flexibility enshrined in the ELTIF rules.
In its latest opinion, ESMA has shot back at the EC, making it clear that it is the latter institution which is propounding a "misleading interpretation" of the rules, noting in a short paragraph that the setting of minimum holding periods for an ELTIF manager is not optional under the ELTIF Regulations, and is in fact one of the key aspects of the redemption policy of an ELTIF. ESMA has therefore refused to amend its RTS in line with the EC's recommendation on minimum holding periods.
Next steps
Overall, ESMA has shown in its revised RTS that it is prepared to accommodate the EC's arguments on the liquidity management and cost disclosure provisions in ELTIF 2.0. However, there are still open issues for the EC to consider, especially around redemption notice and minimum holding periods.
The EC may now adopt the RTS with the amendments it considers relevant or reject it.
The European Parliament and the Council then have the opportunity to object to the version of the RTS adopted by the EC within a period of three months.
[1] Minimum percentage of liquid assets referred to in Article 9(1), point (b) of the ELTIF Regulation.
[2] Maximum percentage referred to in Article 18(2), first sub-paragraph, point (d) of the ELTIF Regulation.
Key contacts
Disclaimer
The articles published on this website, current at the dates of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.