knowledge 25 March 2015 |

ELTIFs and MMFs: A Tale of Two Regulations

ELTIFs

The proposed ELTIF Regulation seeks to create a new form of widely accessible fund vehicle which is designed to promote investment in companies and projects which require long-term or “patient” capital. ELTIFs are expected to be of interest to investors seeking longterm returns within a well-regulated structure including, in particular, pension administrators, insurance companies and other entities facing regular and recurrent liabilities. However, they are also open to retail investors, subject to certain conditions.

The proposed ELTIF Regulation lays down uniform rules on the authorisation, investment policies and operating conditions of EU alternative investment funds (AIFs) that are marketed as ELTIFs. In doing so, it builds on the Alternative Investment Fund Managers Directive (AIFMD) by permitting an EU AIF which is managed by an EU AIF Manager (AIFM) to be authorised as an ELTIF, and to use the ELTIF label and passport for marketing throughout the EU to both professional and retail investors.  

An ELTIF will be required to invest at least 70% of its capital in “eligible investment assets” which include: unlisted companies; listed companies with a market capitalisation of no more than €500,000,000 (Small Listed Companies); real assets with a value of at least €10,000,000; other ELTIFs; European Venture Capital Funds; and European Social Entrepreneurship Funds. It is worth noting that eligible investment assets may be located within the EU or in third countries. ELTIFs will also be subject to portfolio composition and diversification rules.  

The proposed ELTIF Regulation is a central element of the European Commission’s (Commission) project to establish a capital markets union and is expected to boost the availability of non-bank funding to certain types of projects and companies. While the new rules on ELTIFs are closely linked to AIFMD, there is a significant difference between the marketing passports available under the two regulatory frameworks.  

Specifically, while AIFMD permits an EU authorised AIFM to market to professional investors throughout the EU, the proposed ELTIF Regulation permits an AIFM managing an ELTIF to market the ELTIF’s units or shares to professional and retail investors.  

From an Irish perspective it is also noteworthy that the proposed ELTIF Regulation explicitly permits ELTIFs to originate loans to unlisted and to Small Listed Companies as well as prohibiting “gold plating”. Consequently, this will likely give rise to the Central Bank of Ireland revising its current approach to loan origination by investment funds. It remains to be seen whether this revision will focus exclusively on ELTIFs, or whether it will have a knock-on effect on the Central Bank’s overall framework for loan originating qualifying investor AIFs.  

MMFs

The Commission issued the proposed MMF Regulation in September 2013, within months of the proposed ELTIF Regulation. Its key purpose is to provide a regulatory framework for MMFs with a view to enhancing financial stability by preventing contagion risk and increasing investor protection. In order to achieve this purpose, the proposed Regulation contains a number of requirements which are generally designed to enhance the liquidity and stability of MMFs. More controversially, it also requires CNAV MMFs to maintain a 3% capital buffer, largely on the basis that these types of funds are an enhanced source of systemic risk, as compared with variable net asset value (VNAV) MMFs.

The proposed MMF Regulation made little progress in 2014. In particular, the Parliament’s Economic and Monetary Committee (ECON) confirmed, on the 10 March 2014, that it had postponed its vote on the proposed Regulation largely because of the lack of consensus regarding the 3% capital buffer.  

For its part, the Italian Presidency of the Council of the EU issued three compromise texts on the proposed Regulation, the third of which prohibits all CNAV funds with the exception of “small professional” CNAV MMFs. However, the Council did not vote on these texts and, according to a report issued by the Presidency on 17 December 2014 (Report), the proposed approach “has not met with sufficient support”. On a more positive note, there did appear to be widespread agreement among the Member States on setting aside further negotiation on the capital buffer itself.  

As compared with last year, 2015 is proving more positive, particularly from the perspective of the Parliament. Specifically, on 26 February 2015, ECON voted in favour of an amended version of its draft report on the proposed MMF Regulation paving the way for a plenary vote on that version which, as mentioned, is scheduled for 28 April 2015. Like the Italian Presidency’s third compromise text, ECON has abandoned the proposed 3% capital buffer for CNAV funds. Instead, it is proposing to permit low volatility net asset value (LVNAV) MMFs which will be allowed to display a constant net asset value per unit or share, provided specific conditions are fulfilled, including that the relevant assets have a residual maturity of less than 90 days. These LVNAV MMFs are to be permitted for an initial five year period, with the possibility of an extension.  

ECON is also proposing to ban all other CNAV funds with the exception of:  

• Public Debt CNAV MMFs – a CNAV MMF which invests 99.5% of its assets in public debt instruments (cash or government assets or reverse repurchase agreements secured with government debt) and, by 2020, at least 80% of its assets in EU public debt instruments.
• Retail CNAV MMFs – a CNAV MMF that is available for subscription only to charities, non-profit organisations, public authorities and public foundations.

Under ECON’s approach, the systemic and investor risks associated with LVNAV MMFs, Public Debt CNAV MMFs and Retail CNAV MMFs will be managed through liquidity fees and redemption gates.  

Despite the progress within the Parliament on the proposed MMF Regulation, there still appears to be considerable divergence between it and the Council particularly on the issue of CNAV funds. Nor, according to the Report, is there any real agreement on this issue within the Council itself.  

Attempts to find a resolution to the dilemma posed by CNAV funds are further complicated by the need to ensure that such a resolution is compatible with the approach adopted in the US last year, or face the threat of regulatory arbitrage. Specifically, on 23 July 2014, the US Securities and Exchange Commission announced new rules requiring certain CNAV MMFs marketed to institutional investors to become VNAV MMFs, while permitting MMFs marketed to retail investors and those which invest primarily in government debt to operate as CNAV funds. Due to the structure of the US market, the new rules only impacted on a minority of US CNAV funds.  

Judging from the Italian Presidency’s third compromise text and its Report, the Parliament and Council also diverge on other issues, both from each other and from the Commission. For example, the proposed Regulation only permits MMFs to invest in four categories of financial assets, namely, money market instruments, deposits with credit institutions, financial derivatives and reverse repurchase agreements. However, both ECON and the Council wish to extend these categories to include repurchase agreements. In contrast, while the Council also wishes to include units or shares in other MMFs in the list of eligible categories, ECON is proposing to specifically ban MMFs from investing in other MMFs. 

Overall, it appears that considerable work remains to be done before agreement is reached on the proposed MMF Regulation. According to the Latvian Presidency’s work programme, it intends to resume discussions on the proposed Regulation in the second half of its term, although it is still unclear whether or not it intends to use the Italian Presidency’s third compromise proposal as a basis for those discussions. Once the institutions agree their own proposals they must then reach agreement on the final form of the draft Regulation in the course of trilogue negotiations, following which the final text must be approved by both the Parliament and the Council, and published in the EU’s Official Journal.