ELTIF Regulation regulatory technical standards (RTS): Important detail in the ESMA consultation

The Amending Regulation provides: “The life of an ELTIF shall be consistent with the long-term nature of the ELTIF and shall be compatible with the life-cycles of each of the individual assets of the ELTIF….” The RTS include some issues that the ELTIF manager has to consider for this compatibility test, including the liquidity profile of the individual assets and of the ELTIF’s portfolio on a weighted basis, the ELTIF’s stated investment objective and (if relevant) redemption policy, cash management needs and expected cash flow and liabilities, the possibility to roll over or terminate the economic exposure of the ELTIF to its individual assets, and the availability of reliable, sound, and updated asset valuations.

An ELTIF manager must have a redemption policy available to investors that is “sound, well-documented and consistent with the ELTIF’s investment strategy and the liquidity profile of the ELTIF throughout the life of the ELTIF.” The redemption policy must be consistent with the valuation frequency. The RTS set out a minimum list of elements that the policy is to cover.

A minimum number of X years (subject to stakeholder feedback) is to be specified in the RTS, during which an ELTIF manager cannot grant redemptions (and having considered the time necessary to complete the investment of the ELTIF’s capital contributions and whether this period takes place in accordance with the valuation procedures and redemption policy of the ELTIF). That said, the ELTIF manager can differ from the stated minimum holding period, depending on the type, investment strategy, and liquidity profile of its ELTIF. The relevant criteria that the manager must take into account to justify a shortened lock-up period include (broadly): the long-term nature and investment strategy of the ELTIF and the underlying assets classes/their life-cycle position and liquidity profile; the investor base (including the aggregate concentration of retail investors and, if the ELTIF is solely marketed to professional investors, their concentration); the ELTIF’s liquidity profile, portfolio composition, and diversification; the extent to which the ELTIF lends or borrows cash, grants loans, and enters into securities lending or borrowing or repurchase transactions (or other agreements that pose similar economic risks), and the investment time frame of the ELTIF’s eligible assets. Although this provision is designed for the beginning of the life of the ELTIF, managers may also choose to implement lock-up periods, applying the same criteria, for subsequent investors.

Redemptions can occur no more frequently than quarterly (to ensure consistency with the valuation frequency and availability for illiquid funds), although again this can be modified where the ELTIF manager can justify it for a specific ELTIF. The manager has to take various factors into account to provide for a higher frequency of redemptions: portfolio composition, the ELTIF’s assets (including any Undertakings for the Collective Investment in Transferable Securities (UCITS) holding), life, liquidity profile, and documented process for valuation, as well as consideration of market conditions and material events that may impact the ELTIF’s ability to implement its redemption policy.

At least 45% of the ELTIF’s capital cannot be used to meet redemption requests during the life of the ELTIF. When determining the exact percentage (up to 55% and subject to change between assessment and the applicable redemption date) of an ELTIF’s capital that can be subject to redemption, an ELTIF manager must take into account the life cycle of the ELTIF assets and the ELTIF’s life, assessed in accordance with the redemption policy and valuation procedures. Specific additional criteria include the ELTIF’s liquidity profile, its assets and liabilities and risk of liquidity mismatches, the position in the life of the ELTIF, planned and expected frequencies of redemptions, and the ELTIF’s financial performance.

A mandatory redemption notice period of Y months is to apply for each investor’s redemption requests, with shorter notice periods to be allowed in certain circumstances or under certain conditions. ESMA suggests two options (with accompanying calculations) where an ELTIF can have shorter notice periods, as follows: (i) the ELTIF holds a minimum proportion of liquid assets in order to offer redemptions, with the notice period reduced accordingly; or (ii) a limit on the maximum redemption amounts based on the 45% UCITS holdings, depending on the length of the notice period and frequency of redemptions. The detail on this common standard is not included in the RTS, given that the headline options are subject to feedback in the consultative period.

LMTs are to be mandated, in order to protect investors (particularly those who do not request to redeem and remain in the fund) and to mitigate any potential risk to financial stability driven by issues related to first mover advantage. The proposed RTS provide that an ELTIF manager must implement at least one anti-dilution mechanism (in addition to notice periods): anti-dilution levies, swing pricing, or redemption fees. An ELTIF manager can implement redemption gates, but only in exceptional circumstances such as in stressed market conditions where numerous redemption requests could be received at the same time and/or where asset sales to meet redemption requests would require an asset sale at a highly discounted priced (noting there may be retail investors and to reduce the probability of the suspension of the ELTIF), and where justified having regard to the interests of the investors. The intention is to incorporate these LMTs by reference to those proposed in the AIFMD II Annex V list; noting that the ELTIF manager, as an EU AIFM, will be subject to the AIFMD liquidity risk management requirements (including investor disclosures, liquidity stress tests, and regulatory reporting) alongside the ELTIF rules. The AIFMD II updates for liquidity management for open-ended funds will also feed through to those ELTIFs that offer redemption (see our recent AIFMD II client alert for more). These provisions are to be set out in the prospectus/constitutional documents of the ELTIF.

The ELTIF manager’s matching policy (if it chooses to have one) has to be “sound, appropriate and calibrated,” ensure fair treatment of investors, and include conflicts of interest provisions. The ELTIF manager must set out the policy in the prospectus/constitutional documents of the ELTIF, including the procedures, format, process, and timing description of the matching mechanism, the frequency/periodicity and duration of the matching window, the dealing dates, deadlines for submission of purchase and exit requests, settlement and payout period, and how undue risks for the ELTIF are to be avoided. It must also highlight the differences with the redemption policy. Pro rata conditions apply, and the execution price is expected to be net asset value-based and aligned with the ELTIF valuation dates, but it can be determined otherwise (and if not net asset value-based, on the basis that there is fair treatment of all investors and the matching mechanism is then implemented outside the valuation dates to avoid any arbitrage). The ELTIF manager must also provide and update details on its matching mechanism in the ELTIF prospectus (or key information document of the ELTIF) or via a website link and must comply with the AIFMD marketing rules. This principles-based mechanism allows additional liquidity during the ramp-up period of the ELTIF as well as alongside redemptions during the ELTIF’s investment period. It does not negate secondary transactions of units or shares at the investor level.

An ELTIF manager must have completed its valuation process in these circumstances within a period of six months (starting at least one year before the end of the ELTIF’s life) when providing a schedule of valuation on request from its national competent authority (NCA).

Minimum information is to be provided at the time of an ELTIF’s authorisation, including on the ELTIF’s redemption policy, processes, systems, and persons responsible; how an adequate balance of assets and liabilities will be maintained; procedures to prevent redemptions causing dilution effects for investors; valuation procedures of the ELTIF; the manager’s liquidity stress tests (and methodologies and parameters used); and description and procedures for implementation of available LMTs, as well as their calibration and activation. The ELTIF manager must give the ELTIF’s NCA prior notice of any material changes to this information or other elements that affect its redemption policy — or, where this is not possible, notice within 10 days from the date the ELTIF manager knew of/should have known of the respective material change. ESMA state that in principle there should be no duplication in information to be provided under AIFMD and the ELTIF rules.

In addition, during the life of an ELTIF, with its Article 24 AIFMD annual reports (or on request by the ELTIF’s NCA), the ELTIF manager must also provide updated information on asset valuations (and how this has proved to be substantial and reliable, to ensure redemptions in accordance with the ELTIF’s policy and any dilution effects for its existing investors), if and how an LMT has been activated to manage redemption requests, and any updates on liquidity stress tests. An ELTIF manager must also inform the ELTIF’s NCA (and provide an explanation) if it cannot grant redemptions under its policy.