European Long Term Investment Funds – A Missed Opportunity?
By Simon Burns
Posted: 19th January 2015 08:54A brief look at the history of financial shocks shows the prominent role often played by market participants seeking to gain significant returns in a short time frame. For example, speculative behaviour by Dutch investors in the 17th Century resulted in what became known as 'Tulip mania'. Demand for the national flower’s bulbs grew to such levels that there were moments when they could be sold for many times the annual income of a skilled worker of the time. Unsurprisingly, this bubble was destined to burst.
This distorted market had convinced all and sundry that the price of the commodity could only rise, despite its limited intrinsic value. Short-term investors going long inevitably had their fingers burnt.
Fast forward to the close of the 20th Century, and the collapse of the "dot-com" bubble illustrated these dynamics at play once more. The must-have asset on this occasion was online companies, with seemingly limitless demand in the market resulting in the value of NASDAQ companies – the exchange on which the majority of their shares were traded – peaking in March 2000 at roughly US$6.7tn. The rise was ultimately unsustainable, and the necessary realignment severe. The same market hit a low of US$1.6tn by October 2002(1).
Today, we are again operating in a post-crisis environment. The effects of the great recession of 2007-8 and the subsequent Eurozone crisis of 2011-12 have been documented at length and do not require repetition here. Of particular interest however is a proposal of the European Commission, the European Union's ("EU") executive body, to counter the prevalence of short-term and nefarious behaviour in financial markets: the European Long Term Investment Fund ("ELTIF").
This initiative was born out of a high-level call for evidence by the Commission in early 2013; the Green Paper on the Long Term Financing of the European economy ("Green Paper")(2). By this point, the die had been cast within the political class, at least in Brussels; short term investments breed volatility while patient capital, investing for the long term, represents the desirable alternative that should be encouraged. The content of the Green Paper reflected this viewpoint:
“They (long-term investments) enable companies and governments to produce more with fewer resources, responding to new economic, social and environmental challenges, facilitating the transition to a more sustainable economy and raising the productive and industrial capacity of the economy”(3)
A new vehicle designed specifically to facilitate long term investments was the result, the intention being that an ELTIF would slot neatly into the existing European regulatory framework for investment funds.
At present this is dominated largely by Undertakings for Collective Investments in Transferrable Securities ("UCITS") - retail funds - and Alternative Investment Funds ("AIFs") - hedge, private equity, and real estate funds for professional investors - as regulated under the Alternative Investment Fund Managers Directive ("AIFMD").
The political momentum behind the initiative resulted in an agreement being reached between the co-legislators in Brussels – the European Parliament and the Council of Ministers – in November 2014 on the content of the regulation. Often, the final cut of a piece of European legislation represents a significant departure from the initial proposal, with the demands of different stakeholders eventually hammered out into a workable compromise. On this occasion however, the output of the EU’s legislative machinery was remarkably similar to the raw material placed into it.
As stated in the original proposal, prospective fund managers must be fully authorised under the AIMFD, and will have to adhere to a number of additional criterion governing assets eligible for investment, as well as diversification and concentration provisions.
Authorised ELTIFs will be able to invest in a wide range of assets including infrastructure, real estate, debt and equity instruments in companies, intellectual property, European Venture Capital Funds (“EuVECAs”), European Social Entrepreneurship Funds (“EuSEFs”) and other ELTIFs. At least 70 per cent of an ELTIF’s capital must be invested in these assets.
The principal carrot on offer to would-be ELTIF managers comes in two forms. First, as with the AIFMD a marketing passport will be available upon authorisation, meaning the manager of a fund authorised by say, the UK’s Financial Conduct Authority (“FCA”), would not have to register with the Autorité des Marchés Financiers (“AMF”) in France if it wished to market the fund to French investors. However, unlike the AIFMD the marketing passport under the ELTIF regulation encompasses both professional and retail investors, thus enabling access to potentially larger pools of capital.
Second, ELTIFs will be in a position to engage in credit origination. The extent to which this will become standard practice for authorised funds remains to be seen, but if does at least present the option of additional diversification of revenue streams for managers.
The fundamental question remains however: given the operating requirements that will be placed upon an ELTIF fund manager, can we expect take-up of the new vehicle to be widespread? The Impact Assessment(4) (“IA”) that accompanied the European Commission’s original proposal back in 2013, states that “potential investors in long-term assets are currently deprived of an appropriate investment vehicle”, hence the need for this new initiative.
Potential investors in this context naturally include both professional and retail as per the definition found in the Markets in Financial Instruments Directive (“MIFID”). However, given that professional investors already have access to a suitable vehicle in the form of the AIF, the only investors that could not otherwise tap the market for long-term investments are retail.
Anecdotal evidence suggests that demand in this part of the market for such investment products is limited and perhaps justifiably so. Pure retail investors may typically be seeking opportunities that offer ready access to their capital, rather than investments with only limited redemption rights.
Also, there is a broader question surrounding the desirability of introducing another, optional, regime for investment funds into the European regulatory framework. Take-up of the voluntary European Venture Capital Fund (“EuVECA”) tag has thus far been limited despite widespread political backing of the initiative; is the ELTIF destined for a similar fate?
The Commission’s IA for the ELTIF again speaks of how the new fund structure will help build new “economies of scale” in the market for long term investments, but it could be argued that the present course of action will only serve to introduce further fragmentation. Resolving the teething problems still evident in the AIFMD framework could arguably have been a more fruitful course of action.
Taken together, it appears that the Commission may well have missed an opportunity to launch the ELTIF as a state-of-the-art vehicle for long-investment in Europe. This is not to say the situation may not change further down the line; officials will hope this precedes any speculative and irrational rise in the price of tulips, online companies or real estate.
Simon Burns, Public Affairs Manager, British Private Equity and Venture Capital Association (BVCA)
Simon Burns has worked on the Public Affairs Team at the BVCA since April 2012. Prior to that, he also spent time at both a public affairs and a communications consultancy firm. Simon holds an undergraduate degree from the University of Liverpool in Politics and Environmental Studies, and a postgraduate degree from Maastricht University (Netherlands) in European Studies, with a specialisation in European Policy and Administration.
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(1) Gaither C and Chmielewski DC (2006) Fears of Dot-Com Crash Version 2.0 in Los Angeles Times - http://articles.latimes.com/2006/jul/16/business/fi-overheat16
(2) European Commission (2013) Green Paper: Long Term Financing of the European Economy - http://eur-lex.europa.eu/resource.html?uri=cellar:9df9914f-6c89-48da-9c53-d9d6be7099fb.0009.03/DOC_1&format=PDF
(3) Ibid, p.2
(4) European Commission (2013) Staff Working Document Impact Assessment accompanying the document: Proposal for a Regulation of the European Parliament and of the Council on European Long-Term Investment Funds - http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52013SC0230&from=EN