• European Securities Market Authority (ESMA) submitted draft ELTIF 2.0 Regulatory Technical Standards (RTS) to the European Commission in December 2023.
• European Commission has informed ESMA it will only adopt the RTS once certain amendments have been made.
• European Commission requires material changes to the RTS proposals relating to the redemption policy including abandoning the 12-month minimum redemption notice period.
• European Commission requires amendments to ESMA proposals relating to the liquidity-related requirements linked to notice periods, the use of liquidity management tools and redemption gates.
• If ESMA does not respond, the European Commission can proceed to adopt the RTS as amended.

Introduction and background

Regulation (EU) 2023/606 amending the ELTIF Regulation (ELTIF 2.0)¹ mandated ESMA² to develop regulatory technical standards (RTS) to determine the following:

• the criteria for establishing the use of financial derivative instruments for hedging purposes;
• the circumstances in which the life of an ELTIF is considered compatible with the life-cycles of each of the individual assets, as well as different features of the redemption policy of the ELTIF;
• the circumstances for the use of the matching mechanism, i.e., the possibility of full or partial matching (before the end of the life of the ELTIF) of transfer requests of units or shares of the ELTIF by exiting ELTIF investors willing to transfer their units and potential investors willing to acquire these units;
• the criteria to be used for certain elements of the itemised schedule for the orderly disposal of the ELTIF assets; and
• the disclosure obligations on costs and the format to be used for this purpose.

On 19 December 2023, ESMA sent its Final Report³ that includes the draft RTS to the European Commission (EU Commission). For a summary on the key points of the draft RTS, please refer to our OnPoint ELTIF 2.0 RTS: ESMA adopts a conservative approach toward open-ended ELTIFs.

However, on 6 March 2024, the EU Commission wrote to ESMA⁴ informing it that it would only adopt the RTS once certain amendments have been made. The EU Commission suggested that ESMA should take a more “proportionate approach” and that the RTS should take into consideration the variety of ELTIFs and their investment strategies. In particular, the EU Commission sets out amendments to the provisions of the draft RTS relating to the requirements to grant redemption rights to investors in an ELTIF.

ESMA has until 17 April 2024 to consider the amendments from the EU Commission. If ESMA does not respond to the EU Commission, the EU Commission can proceed to adopt the RTS, in which case, it is possible that the RTS will be adopted by mid-May 2024.

In this OnPoint, we look at the EU Commission’s proposed amendments to the draft RTS in relation to the redemption policy, the notice period to request the redemption of units, the liquidity requirements and the use of liquidity management tools (LMT) and redemption gates.

Material changes to the redemption policy subject to consent of the ELTIF’s competent supervisory authority

The draft RTS submitted by ESMA to the EU Commission require the ELTIF manager to inform the ELTIF’s competent supervisory authority as soon as practically possible, and not later than within three business days of any material change affecting the redemption policy. The EU Commission considers that material changes should be notified to the competent authorities before they occur unless such material changes are beyond the control of the manager of the ELTIF. The EU Commission’s view is that the ELTIF manager should not have the capacity to materially change, at its own initiative, the redemption frequency without prior consent of the competent supervisory authority. The EU Commission states that this provision should be deleted, or alternatively, the draft RTS should be amended in a manner that would not be construed as limiting the competences of the competent supervisory authority.

Abandon of the 12-month minimum redemption notice period

The draft RTS required that the redemption notice period must at least be 12 months, except in certain cases where the notice period can be calibrated based on the minimum liquid assets contained in the portfolio and subject to mandatory redemption gates (i.e., the maximum percentage of assets that redemption can represent). The EU Commission considers that this one-size-fits-all approach does not take into account the different investment strategies, type of assets, leverage profiles and other factual specific circumstances pertaining to ELTIFs. The EU Commission’s view is that the draft RTS should be amended to remove the minimum 12-month redemption notice period.

New approach on liquidity requirements in connection with standardised notice periods requirements

ELTIF 2.0⁵ requires that the redemption policy of an ELTIF ensures that the overall amount of redemptions within any given period is limited to a percentage of liquid assets⁶ and that this percentage shall be aligned to the liquidity management and investment strategy disclosed by the ELTIF manager.

In the draft RTS, ESMA took the approach to adopt the standardised notice period requirements in relation to the minimum liquid assets held by the relevant ELTIF. The EU Commission considers this approach fails to sufficiently take into account the individual situation of each ELTIF and “would inevitably ill-fit ELTIFs pursuing well-established and legitimate investment strategies”. As an illustration, the EU Commission pointed out that an ELTIF with a quarterly redemption frequency and a 2% gate would limit the redemptions up to 8% each year, but the draft RTS proposed by ESMA would force this ELTIF to maintain at least 40% of the ELTIF’s portfolio in liquid assets. However, as the same time, ELTIF 2.0 requires an ELTIF to invest at least 55% of its portfolio in eligible investment assets.⁷ The EU Commission states, “that setting out standardised requirements that may not be suited to the individual situation of the ELTIF could discentivise the use of ELTIFs and would defeat the objectives of the ELTIF Regulation”.

The EU Commission’s view is that the liquidity-related requirements linked to notice periods requirements set out in the draft RTS should be amended. The EU Commission proposes the ELTIF manager should be granted the choice to proportionately and carefully calibrate the maximum percentage of redemptions upon either (i) the redemption frequency and the extended notice period, or (ii) the redemption frequency and the minimum percentage of liquid assets held by the relevant ELTIF.

No strict obligation of having at least one anti-dilution LMT – case-by-case approach recommended

To ensure fair treatment of investors in an ELTIF and to avoid dilution of remaining investors in the ELTIF that may be driven by first mover advantage-related issues, the draft RTS proposes that at least one anti-dilution LMT (e.g., swing pricing or redemption fees) be selected and implemented. The EU Commission is of the view that the provision is amended on the basis that it can be construed as “disentivising or limiting the possibility for ELTIF managers to implement different liquidity management tools”. The EU Commission also took the view that by imposing this additional requirement, ESMA went beyond the scope of its mandate, which is limited to providing technical guidance.

Use of redemption gates not limited to specific cases

ESMA sets out in the draft RTS that gates should be imposed “in certain specific circumstances”, including situations where redemption gates are needed to mitigate any potential risk to financial stability and, in stressed market conditions, “where numerous or voluminous redemption requests could be received by the manager of the ELTIF at the same redemption point and where the sale of assets to meet those requests is either impossible or implies a sale at a highly discounted price”.

The EU Commission considered that ESMA went beyond the scope of its mandate by imposing conditions for the activation of redemption gates.

Conclusion

ESMA’s conservative approach in the draft RTS towards open-ended ELTIFs reflects the general concerns from regulators and supervisory authorities globally related to liquidity and systemic risks. However, the requirements for granting redemption rights to investors in the draft RTS did not sufficiently consider the variety of ELTIFs and the need to create open-ended or semi-liquid ELTIFs (if ELTIF 2.0 is to achieve its ultimate objective of providing retail investors in the EU with an access to the alternative asset classes). The EU Commission’s amendments to the draft RTS provide for a more bespoke approach, which is a positive signal for the development of ELTIF.

1. For a summary of ELTIF 2.0, please refer to our OnPoint “ELTIF 2.0: retailization of private funds – the gateway to heaven or a storm in a teacup?”.
2. European Securities Market Authority, the financial markets regulator and supervisor of the EU.
3. The Final Report is available here.
4. The EU Commission letter to ESMA is available here.
5. Article 18.2(d) of ELTIF 2.0.
6. Liquid assets are assets which fall within the scope of article 50(1) of Directive 2009/65/EC.
7. Article 13(1) of ELTIF 2.0.