European Context
In recent years, we have witnessed efforts at the EU level to further develop the single market of capital (CMU) with the aim of facilitating cross-border investments and unlocking access to capital. More recently, in a specialist report to the EU Council, Mr. Enrico Letta noted that in the EU there are 33 trillion euros in private savings, mainly held in currency and deposit accounts.
In recent years, we have witnessed efforts at the EU level to further develop the single market of capital with the aim of facilitating cross-border investments and unlocking access to capital.
In the grand plan of CMU, the European long-term investment fund (ELTIF), as provided under the revised ELTIF Regulation (applicable since 10 January 2024), was portrayed as a cornerstone, enabling AIFMs to market ELTIF/AIFs in the EEA with passports to both retail and professional investors.
However, the public disagreements between ESMA and the EU Commission (EC) on the regulatory technical standards (RTS) under the revised ELTIF Regulation have caused confusion for the market, and created doubt and uncertainty on whether an ELTIF is a suitable vehicle to structure evergreen funds. These EU bodies appear to have divergent views mainly on the liquidity management of an ELTIF, the last episode in this EU saga being ESMA’s final opinion on the ELTIF RTS, published on 19 April 2024, in which several of the improvements proposed by the EC have been rejected. It is unsure at this point whether the EC will endorse this final proposal or reject it entirely, thus entertaining uncertainty.
While these key points have not been clarified, the obvious question is: how can the exorbitant amount of savings in the EU be unlocked and invested in the real economy?
ELTIF 2.0 is expected to play its part. However, considering the ESMA/EC disagreement, managers have been one step ahead in expanding their investor base and piercing into the retail shield by using a more practical solution – the Part II funds.
Ascending Trend
As the professional investor market has matured over the last decade, managers have been looking at the potential of retail investors, while setting up in the last 2–3 years Luxembourg evergreen vehicles, to target both professional and retail (high net worth) investors altogether, by replicating a model that was successful in the US, where similar funds are structured as REITs or BDCs.
Luxembourg regulated AIFs known as Part II Funds, which (i) may accept subscriptions by any types of investors, (ii) offer flexible liquidity terms and, not to be neglected, (iii) are able to invest in all types of assets with limited investment and leverage restrictions. Sizeable players (such as Apollo, ARES, Blackstone, EQT, KKR etc.) have already launched their Part II product, proposing a variety of investment strategies to a wide base of investors. In the course of 2022, only 10 Part IIs were officially established, while in 2023, this number almost tripled.
Part II funds are not a new product – they may be traced back to the law of 25 August 1983 on undertakings for collective investments. Through the past decades, multiple Part IIs were launched, and the vehicle has since gained the trust of many regulators around the world.
Nevertheless, the Luxembourg investment funds toolbox was recently modernized in July 2023, creating more corporate structuring options for forming a Part II fund (including as a société en commandite spéciale, the homologue of the US/UK limited partnership, to which the alternative managers got accustomed in the context of Luxembourg unregulated AIFs).
Liquidity
As a common line, we note that the recent Part IIs were launched as “evergreen” vehicles with similar terms: (i) accepting only fully funded subscriptions, generally on a monthly basis and at NAV, (ii) seasoning a portfolio of warehoused assets in order to absorb cash inflows and (iii) offering some liquidity to investors by allowing redemptions, generally on a monthly or quarterly basis at NAV.
Marketing
Part IIs benefit from the AIFMD marketing passport in the EEA for professional investors as well as some semi-professional investors. Unlike the ELTIF product, Part IIs cannot be marketed to retail investors with this passport, but the fact that they are regulated by a trusted regulator (CSSF) and their longstanding existence eases registration with certain regulators in the EEA (e.g. Germany) and beyond (Asia, Middle East). For certain countries, the setting up of a parallel fund (e.g. France) is necessary, whilst other countries may be penetrated via local feeders.
Compromise
So far, Part II funds have been preferred by many managers to launch European funds that are as similar as possible to their US sister vehicles.
ELTIF’s advantage over a domestic AIF is that it provides the benefit of an EU-wide marketing passport for all investors; however, its investment limitations and asset eligibility requirements, as well as the uncertainty around its liquidity restrictions, force managers to make a choice between benefiting from this passport and keeping the flexibility they need to be authentic to their strategy. So far, Part II funds have been preferred by many managers to launch European funds that are as similar as possible to their US sister vehicles.