- What are ELTIFs?
ELTIF stands for European Long-Term Investment Funds and refers to the new type of fund introduced in 2015 to enable small and professional investors to make long-term investments in the EU’s real economy. The regulatory framework is provided by Regulation (EU) 2015/760 of 29 April 2015 (hereinafter: ELTIF Regulation) and, after initially moderate success of the ELTIF, revised by Regulation (EU) 2023/606 of 2023. The new regulation should remove practical obstacles from the first regulation and give ELTIFs new relevance.
The ELTIF is intended to enable small investors in particular to invest better and more variedly in illiquid assets. This is only possible to a limited extent within the German regulatory area due to requirements regarding the scope, structures and possible (to be combined) investment objects.
ELTIFs offer the opportunity to invest in private equity, private debt and other funds (other ELTIF, EuVECA, EuSEF, etc.), but also in real estate, infrastructure projects and other tangible assets. The interesting thing about this is the possibility of combining different investment objects with each other. For example, thematic funds such as “Care and Health”, which then invest in nursing homes, shares of medical technology companies and kindergarten operators, are conceivable. An ELTIF must invest at least 55% of its capital in the illiquid assets listed in the ELTIF Regulation. With regard to diversification, an investment asset may not exceed 20% of the capital of the ELTIF.
- Is an ELTIF a closed-end fund under German law?
First of all, it should be noted that the ELTIF Regulation itself does not specify any standard for the openness or closedness of a fund. Therefore, the national regulations continue to apply. Pursuant to Sections 338a, 1 (4) No. 4 KAGB in conjunction with Article 1 (2) sentence 1 Delegated Regulation (EU) No. 694/2014[1], AIFs are open if the shares of the fund can be sold back or returned to the fund by the shareholder before the start of the liquidation or start-up phase. All AIFs that do not meet this definition are to be categorized as closed in accordance with Section 1 (5) KAGB, Art. 1 (3) Delegated Regulation (EU) No. 694/2014. [2]
It is questionable in which of the categories ELTIFs are to be classified. According to Art. 18 para. 1 ELTIF Regulation, redemptions of shares are generally not provided for before the end of the term. According to the above-mentioned standards, ELTIFs are therefore generally to be categorised as closed-end investment vehicles. This also corresponds to the fundamental illiquidity of the typical assets of the ELTIF.
- ELTIF and the closed-end special fund
Funds can take on several legal forms in Germany. These include the investment limited partnership, the investment stock corporation and the special fund. The structure of the special funds was subject to some restrictions in Germany. According to section 139 KAGB, a structure as a closed-end special fund was only permissible for special AIFs and thus semi- or professional investors, which is why special funds in the public sector could only be structured as open-ended funds. However, due to the revision of the ELTIF Regulation, these national restrictions are superimposed by the European Regulation. German restrictions regarding the structure of the funds, such as the prohibition of structuring them as closed-end special funds, do not apply to ELTIFs. This means that ELTIFs can also be launched as a closed-end special fund in the form of a public AIF, in which private investors can then also invest.
This offers long-awaited opportunities for the German fund industry. The background to this is that the special fund as a fund form has significant advantages over the conventional corporate forms of funds – investment limited partnerships and investment stock corporations.
An investment limited partnership is a partnership and an investment in it can therefore be cumbersome and complicated, especially from abroad, have an unfavourable tax effect and pose challenges with regard to the settlement. The establishment and maintenance of such a limited partnership requires considerable costs and effort, for example for the drafting of the articles of association, for regular company resolutions and meetings, as well as the entry and exit of the limited partners in the commercial register, etc. Furthermore, shares in a limited partnership are not depositable. An investment stock corporation is relatively expensive to set up compared to the special fund and represents a significant additional expense due to compliance with the regulations on stock corporations.
Shares in special funds, on the other hand, can be booked in the customer’s custody account with the bank. This is a decisive advantage with regard to distribution to retail investors, as it opens up bank sales and runs in the same way as the securities business. Furthermore, the special fund enjoys a shielding effect under insolvency law. Even if the administrator should go bankrupt, the assets are not affected. Finally, the final withholding tax applies to special funds, which can be more favourable in relation to personal taxation in the case of shares in a limited partnership. Furthermore, as a special fund, ELTIFs receive a European passport due to their European nature, which has great advantages for European sales. German funds with distribution to small investors can thus open up a large new market that has so far remained rather closed to them due to German restrictions on foreign investors.
- Closed and still tradable
Closed structures, with no redemption options, are known to be well suited for investments in tangible assets with a long-term investment horizon. At the same time, there is a need for a liquid product, especially among private investors. If investors have the opportunity to redeem their share in the ELTIF at least once before the end of the term, then, as described above, it is an open ELTIF pursuant to Sections 338a, 1 (4) No. 4 KAGB in conjunction with Article 1 (2) sentence 1 Delegated Regulation (EU) No. 694/2014. In order to avoid an open structure, but at the same time enable returns, a different solution is needed.
According to Art. 19 para. 2a Regulation (EU), “liquidity window mechanisms” are the possibility for the capital management company to provide investors with a platform through which the applications of departing investors are compared with applications from potential new investors. In this way, there is no return to the capital management company, but the shares are sold on the secondary market. [3]
- ELTIF with crypto fund shares
By structuring them as special funds, ELTIFs can now also be structured with shares in the form of crypto tokens. The German legislator has explicitly created this possibility only for shares in special funds (Section 95 (1) sentence 1 KAGB in conjunction with the Ordinance on Crypto Fund Shares). These crypto fund shares are electronic share certificates that are registered in a crypto securities register. In accordance with § 3 sentence 1 KryptoFAV, the register maintains the depositary of the fund. This form of participation makes it possible for the first time to transfer shares in special funds directly via a blockchain. [4]
- Result
All in all, it can be said that the new ELTIF Regulation means that public AIFs can now also be launched as closed-end special funds for the first time. Ultimately, the ELTIF will provide retail investors with significantly more investment opportunities in illiquid assets such as private equity, infrastructure and real estate. For the fund industry, the greater freedom of design with regard to fund products and the Europe-wide distribution passport offer a great opportunity to expand its investor base.
[1] BaFin FAQ on the ELTIF Regulation of 01.02.2024, case number WA 51-Wp 2154-2023/0001.
[2] BaFin FAQ on the ELTIF Regulation of 01.02.2024, case number WA 51-Wp 2154-2023/0001.
[3] BaFin FAQ on the ELTIF Regulation of 01.02.2024, case number WA 51-Wp 2154-2023/0001.
[4] Heidbüchel, CF 2023, 197, 200.
