Update Investment Funds No. 35

ELTIF 2.0: BaFin's future administrative practice in view of the ELTIF amendment

A. Background to the ELTIF amendment

Regulation (EU) 2015/760 of April 29, 2015 (hereinafter "ELTIF Regulation") created a uniform legal framework for European long-term investment funds (hereinafter "ELTIFs") throughout Europe. In legal terms, ELTIFs are classified as alternative investment funds (hereinafter "AIFs") within the meaning of the German Investment Code (Kapitalanlagengesetzbuch, hereinafter "KAGB") that are domiciled in the European Union. ELTIFs are intended to enable professional investors, but also retail investors in particular, to invest in infrastructure projects, unlisted companies or listed small and medium-sized enterprises, thereby contributing to the financing of the European Union's real economy.

Despite a recent upward trend, ELTIFs have so far experienced relatively low acceptance: for 2021, the European Commission estimated the net assets of existing ELTIFs at just EUR 2.4 billion (see recital (1) of Regulation (EU) 2023/606). According to a study conducted by Scope Fund Analysis GmbH in March 2023, the total volume of assets managed in the form of ELTIFs amounted to around EUR 11.3 billion at the end of 2022. By comparison, total assets under management in the form of AIFs in Europe amounted to around EUR 7.1 trillion in 2022, according to statista.

In order to ensure greater acceptance of the ELTIF and at the same time take up the positive market signal of 2021 and 2022, the European Parliament and the Council of the European Union have adopted Regulation (EU) 2023/606 amending the ELTIF Regulation (hereinafter "ELTIF amendment"), which will apply from January 10, 2024.

The ELTIF amendment is intended to remove regulatory hurdles, which were originally intended to protect investors in particular, and make investing in ELTIFs accessible to a broad range of (retail) investors. We already reported on the main changes resulting from the ELTIF amendment in our Investment Fund Update No. 31 dated January 13, 2023.

B. Administrative practice of BaFin

On October 20, 2023, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, hereinafter "BaFin") held a workshop on "ELTIF 2.0" (hereinafter "ELTIF 2.0 Workshop") with the industry associations. As part of this workshop, BaFin presented its future administrative practice for the supervision of the issuance and distribution of ELTIFs under the future applicable standards regime of the ELTIF Regulation as amended by the ELTIF amendment (hereinafter "ELTIF Regulation (as amended)"). The main points of this administrative practice are presented below.

I. Extension of a KVG license to the management of ELTIFs

A German alternative investment fund manager (Kapitalverwaltungsgesellschaft, hereinafter "KVG") that already has a license from BaFin to manage AIFs does not generally need to apply to BaFin for an extension of its license to manage ELTIFs, as ELTIFs are AIFs within the meaning of the KAGB. If the KVG license is only limited to certain types of AIF, for example open-ended or closed-ended AIF, this restriction also applies to the management of ELTIFs.

As part of the ELTIF 2.0 workshop, BaFin clarified that an ELTIF which, in accordance with Art. 18 (2) ELTIF Regulation (as amended) – in deviation from the rule set out in Art. 18 (1) ELTIF Regulation (as amended) – provides for the possibility of redemption by investors during the term of the ELTIF, is to be classified as an open-ended AIF. Therefore, if a KVG only has a license limited to closed-ended AIFs under the KAGB, but intends to manage such an open-ended ELTIF in the future, the KVG in question must apply to BaFin to extend its license to include the management of open-ended AIFs.

II. Distribution of units in ELTIFs by financial investment brokers pursuant to section 34f GewO

According to BaFin, financial investment brokers within the meaning of section 34f of the German Trade Regulation Act (Gewerbeordnung, hereinafter "GewO") are permitted to distribute units in ELTIFs.

Since ELTIFs for which the possibility of unit redemption during the term is provided for in accordance with Art. 18 (2) ELTIF Regulation (as amended), which provide for the possibility of unit redemption during the term, are classified by BaFin as open-ended AIFs (cf. in this respect the explanations above under I.), a financial investment intermediary requires a license for the distribution of units in such an ELTIF in accordance with section 34f (1) no. 1 GewO for the distribution of units in open-ended investment funds.

The distribution of units or shares of an ELTIF to retail investors is also subject to certain special rules. In particular, in accordance with Art. 30 (1) ELTIF Regulation (as amended) may only be marketed to retail investors if a suitability assessment has been carried out in accordance with Art. 25 (2) of Directive 2014/65/EU ("MiFID II") and a suitability statement has been sent to the retail investor.

As part of the suitability assessment, the financial investment broker must obtain the necessary information about the retail investor's knowledge and experience in the investment field in relation to the specific type of product or service, their financial circumstances, including ability to bear losses, and their investment objectives, including risk tolerance, in order to be able to recommend ELTIFs to the retail investor that are suitable for them and, in particular, in line with their risk tolerance and ability to bear losses. Although the suitability assessment is an essential feature of investment advice, BaFin believes that it should also be possible under supervisory law to sell ELTIFs by way of investment brokerage.

III. Duration of an ELTIF

According to Art. 18 (1) ELTIF Regulation (as amended), a specific date for the end of the term of an ELTIF must be specified in the contractual terms and conditions or in the articles of association of an ELTIF. It is also possible to specify the right to extend the life of the ELTIF for a limited period and the conditions for exercising this right of extension.

In accordance with Art. 18 (3) ELTIF Regulation (as amended)., the term of an ELTIF must be appropriate in its long-term nature and compatible with the terms of the individual assets of the ELTIF.

The ELTIF Regulation (as amended). does not provide any concrete specifications for the duration of an ELTIF. However, BaFin agreed in the ELTIF 2.0 workshop that the existing administrative practice should continue to be applied to ELTIFs in the legal form of a (closed-end) German public investment limited partnership (Publikums-Investmentkommanditgesellschaft). This means that the sum of the term and extended term of such an ELTIF can be a maximum of 30 years.

For ELTIFs for which, in accordance with Art. 18 (2) ELTIF Regulation (as amended)., BaFin announces a high degree of flexibility with regard to the term. However, BaFin does not provide any specific details - it refers to the forthcoming publication of the revised draft regulatory technical standards for the ELTIF Regulation (hereinafter "RTS"; cf. in this respect the comments below under IV.) by the European Securities and Markets Authority (hereinafter "ESMA") and the associated specification of Art. 18 (3) ELTIF Regulation (as amended), among other things.

IV. Publication of the revised draft of the RTS

The first draft of the RTS on the ELTIF Regulation (as amended) was published by ESMA on May 23, 2023 and made available for consultation. According to BaFin, the revised draft of the RTS can be expected to be published in December 2023. Following approval by the Commission of the European Union, the RTS is expected to be adopted in March 2024.

In particular, the RTS should also contain specifications of the rules on the redemption of units or shares in ELTIFs and on the circumstances in which the term of an ELTIF is considered compatible with the term of individual assets in accordance with section 18 (3) of the ELTIF Regulation (as amended).

V. Minimum disclosure requirements in the terms and conditions of an ELTIF

Pursuant to section 338a KAGB, the KAGB is applicable to ELTIFs on a subsidiary basis insofar as the ELTIF Regulation (as amended) does not contain any special statutory provisions. This also applies insofar as the ELTIF Regulation (as amended) does not contain any requirements regarding the information required for the investment conditions of ELTIFs. BaFin intends to prepare overviews showing the minimum information that investment conditions must contain in accordance with the ELTIF Regulation (as amended) and the KAGB.

C. Conclusion

The lowering of regulatory hurdles associated with the amendment to the ELTIF Regulation and the de facto opening of this fund class to retail investors means that the upward trend in the number and volume of ELTIFs issued in 2021 and 2022 may be confirmed and new European sales markets may be opened up as a result. It remains to be seen whether and to what extent BaFin will continue to adapt its administrative practice to the regulatory changes and practical issues faced by fund houses and investors as a result of the amendment to the ELTIF Regulation.

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