The updated European Long-Term Investment Funds Regulation (ELTIF 2.0) has opened up new opportunities for investment firms to provide retail and professional investors with access to illiquid, long-term assets from 10 January 2024. Eligible investments include debt and equity instruments in unlisted companies and, real assets such as infrastructure. For investors, it’s a chance to diversify and access potentially higher returning assets previously restricted to institutional limited partners. At the same time, investment firms can deliver differentiated value that will help attract new clients and grow wallet share.
The primary purpose behind the ELTIF rules is to facilitate the raising and channeling of capital towards long-term investments in the ‘real economy’ (for example, into transport, real estate, and social infrastructure projects focusing on energy, hospitals, and social housing). A significant advantage of ELTIFs is they can be marketed to retail investors across the EU using a marketing passport. In contrast, other alternative investment funds (AIFs) only benefit from the marketing passport when marketing to professional investors.
The possibilities for investment firms are alluring, but ELTIFs are no slam dunk. The asset illiquidity and longer investment horizons will be a new experience for many retail savers. It will be crucial to educate investors used to public markets offering daily liquidity about the risks of long-term illiquid assets, and the restrictions they will face on redeeming units. As will ensuring investment firms have the operational procedures, people and technology to support new and more varied asset types, fund structures and investor needs.
The European Securities and Markets Authority recently published a long-awaited proposal[1] for the technical standards for this ELTIF regulation. These standards require ELTIF funds to hold more liquid assets if they offer frequent redemptions. Specifically, if an ELTIF has a redemption notice period of less than 6 months, it must ensure at least 40% of assets are liquid.
ELTIF operational impacts
Mixing illiquid assets with a regulated, retail-eligible vehicle brings liquidity management to the fore. As a note from EY observed, asset managers will have to balance investor returns and liquidity to satisfy redemptions from retail investors. “They will also be required to perform liquidity modeling for the fund to plan for (re-)investment and perform liquidity stress testing programs.”
Retail eligibility will be accompanied by greater regulatory scrutiny, raising the compliance bar for alternative asset managers more used to dealing with professional investors.
Pricing and valuations of non-listed, illiquid instruments pose a particular challenge, often requiring expert third-party inputs. According to the EY article, most fund accounting systems are designed either to account for liquid UCITS-eligible instruments or illiquid assets. “Fund accountants will therefore be required to find effective methods to aggregate liquid and illiquid assets when performing the calculation of the net asset value (NAV)[2].”
Firms then must report the portfolio positions and performance with the requisite accuracy and frequency to meet investors’ transparency expectations. The volume and oversight required to protect less-informed retail clients will add to the strain wherever areas of operational inefficiencies exist.
The right people
Robust operational procedures must be allied to teams with the right skill sets. These span data management, reconciliations, valuations, performance validation, client servicing and compliance.
Where the appropriate skills aren’t readily available in-house (and you can question whether such tasks should be a core competency for investment firms), managed service outsourcing can offer the necessary expertise, often at a lower cost of ownership.
Technology infrastructure
Many front-, middle- and back-office systems used across the investment management industry need to properly support the range of assets that can fit within an ELTIF. Most are either designed to support mainstream liquid asset classes or specialise in a limited subset of illiquid instruments.
As many underlying assets have unique characteristics. Managing and accounting for the idiosyncrasies of all the different assets’ cash flows and fee calculations, and producing accurate, timely, automated reports is complex. However, an infrastructure not built to handle that complexity will result in significant manual intervention.
A true multi-asset class infrastructure will instead allow firms to benefit from seamless workflows and automation, while giving them the flexibility to grow into new types of investments. And that applies across the technology stack, from portfolio management, accounting and reporting to portals that deliver the transparency investors demand today.
[1] European Securities and Markets Authority proposal, December 2023. Available from: https://www.esma.europa.eu/press-news/esma-news/esma-finalises-technical-standards-under-revised-eltif-regulation
[2] Finster, N. May 2023. “The road to ELTIF 2.0 is paved with operational challenges for the industry” Retrieved from: https://www.ey.com/en_lu/wealth-asset-management/the-road-to-eltif-2-0-is-paved-with-operational-challenges-for-t
