BVI s position paper on the proposal for an EU-Regulation on European Long-Term Investment Funds dated 26 June 2013

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1 Frankfurt am Main 11 October 2013 BVI s position paper on the proposal for an EU-Regulation on European Long-Term Investment Funds dated 26 June 2013 Reference: COM(2013) 462 final, 2013/0214 (COD) General assessment and key issues BVI 1 greatly welcomes the Commission s initiative on creating a uniform regime for European Long- Term Investment Funds (ELTIFs). We share the Commission s appraisal that facilitation of investments with long-term perspective should benefit both the European economy in its search for reliable sources of financing and institutional investors striving for stable returns. In these terms, we observe a growing appetite for long-term investments in infrastructure and other tangible assets such as real estate on the part of insurance companies and providers of pension schemes. In times of low interest rates, these investors are looking for alternatives to their traditional engagements in bond markets which provide comparably constant yields to cover their ongoing obligations. Against this background, we also support the notion of allowing retail investments in ELTIFs. We believe that ELTIFs could reasonably enlarge the diversification opportunities for retail investment portfolios in the current market environment. Retail investments in ELTIFs could also make significant contributions to the financing of the relevant portfolio undertakings. Therefore, it is important to ensure that the ELTIF framework is sufficiently attractive to stimulate retail engagements in long-term assets. Besides the genuine retail market, it should be noted that many entities such as professional organisations managing pension schemes, health funds, municipalities, churches, foundations and business federations do not qualify as professional investors according to the MiFID criteria and thus would otherwise be excluded from investing in the new fund category. It appears that the need for pooled investment vehicles such as ELTIFs is particularly evident with regard to these small and midsized institutions which generally lack sufficient resources and expertise in order to make direct investments in e.g. infrastructure projects. Therefore, inclusion of these entities in the potential group of ELTIF investors should also benefit the European economy by broadening the accessible base for capital supply. Moreover, the envisaged introduction of an EU passport for retail distribution of ELTIFs would to a certain extent close the gap between UCITS offering retail investment opportunities in securities markets and AIFs which are set up as alternative investment vehicles for professional investors. Hence, granting of retail access to investments in long-term assets via ELTIFs appears a consequent step in the evolution of the European rulebook for investment funds. 1 BVI represents the interests of the German investment fund and asset management industry. Its 75 members currently handle assets of more than EUR 2.0 trillion in both investment funds and mandates. BVI enforces improvements for fundinvestors and promotes equal treatment for all investors in the financial markets. BVI`s investor education programmes support students and citizens to improve their financial knowledge. BVI`s members directly and indirectly manage the capital of 50 million private clients in 21 million households. BVI s ID number in the EU register of interest representatives is For more information, please visit

2 Page 2 of 10 of the BVI s position paper dated 11 October 2013 Nonetheless and despite the overall positive evaluation of the initiative, the relevant proposal features a number of shortcomings which might put into question the general market acceptance of ELTIFs. In particular, we would like to point out the following: Closed-ended nature of ELTIFs: We fear that the proposed rules on the end of life and interdiction of capital payouts prior to that date might undermine the feasibility and the success prospects of ELTIFs as future investment products of choice. As regards the end of life, it is unrealistic to assume that ELTIF managers will be in a position to anticipate the exact time point for winding-up the ELTIF investments and redeeming fund units or shares at the initiation of a fund. Effectively, this would place with the ELTIF manager the responsibility to predict the development of qualifying portfolio undertakings and general market conditions in 15 to 30 years time. This is obviously an impossible task especially when taking into account that the end of life of an ELTIF needs to be fixed in the fund rules or instruments of incorporation at the ELTIF s launch and before commencing of the subscription period let alone conducting investments on behalf of the ELTIF. According to Article 11 of the proposed Regulation, the ELTIF portfolio may not be pre-financed by the appointed manager, but must be conceived as a blind pool. Hence, it is very clear that at the time of stipulating the end of life of an ELTIF, the manager will have no knowledge of the qualified portfolio undertakings and therefore will not be able to make reliable statements on the adequate timeline for their development. Accordingly, in order to ensure practicability of the ELTIF framework and to avoid potential detriments for investors, it is essential to allow for more flexibility as regards the end of the ELTIF s life. In our opinion, the ELTIF manager should be entitled to prolong or shorten the prefixed end of life in situations clearly admitted in the fund rules or instruments of incorporation as part of its managerial discretion. Modification of the end date in other cases should also be possible subject to the investors consent (for further details, cf. our comments under II.7 below). Under the same conditions, ELTIF managers should be allowed to sell selected investments prior to the end of the ELTIF s life without the need to reinvest the proceeds into new assets. Such premature asset disposals should be recognised in Article 15 as a reason for ceasing to apply the ELTIF investment limits and should legitimise distribution of sale proceeds to investors even if such distribution encompasses the original commitments of capital. In this context, it must be emphasized that the suggested amendments entail no potential detriments for the long-term financing prospects of qualifying portfolio undertakings. The conditions of such financing are separate from any disposal activities by ELTIFs which target secondary market buyers. Hence, the long-term nature and specific terms of funding granted to qualifying portfolio undertakings will not be impacted by the mere substitution of the interest holder.

3 Page 3 of 10 of the BVI s position paper dated 11 October 2013 Uniform product rules for retail and professional funds: Specific features for ELTIFs aimed at retail or professional investors, respectively, might enhance acceptance by either investor category. The Commission s proposal comprises many elements applicable to ELTIFs in general which aim at protecting the interests of non-sophisticated investors. This pertains in particular to the requirement to issue a prospectus under Article 21 and the facilities ensuring contacts with investors under Article 23. These protective measures might inhibit business relationships with professional investors and thus should apply solely to ELTIFs intended for retail distribution (for further details, cf. our comments under II.9 and 10 below). Some further features of the proposed ELTIF regime such as diversification rules, concentration limits and restrictions on borrowing of cash should be deemed not compulsory for professional investment products. Hence, we recommend allowing ELTIFs which are marketed exclusively to professional investors to disapply or modify the provisions in Articles 12 to 14 of the proposed Regulation subject to the investors consent. Such additional flexibility in the product design should further enhance the professional investors willingness to engage in the set-up and funding of ELTIFs. Lastly, it is important to bear in mind that institutional investors such as insurance undertakings and pension funds are subject to sector-specific restrictions on permitted investments deriving from the Solvency regime and investment regulations at national level. As it stands, the capital requirements foreseen under Solvency II render long-term engagements rather unattractive. Thus, in order to stimulate greater long-term commitments by institutional investors, it is necessary to back up the ELTIF initiative by a review of the capital requirements and investment restrictions applicable to investments in long-term assets. We are aware that the Commission has already approached EIOPA on this issue and would like to express our full support for further measures to be undertaken in this regard. As regards the retail market side, we are afraid that the current ELTIF concept might have only little attraction for retail investors due to the strict provisions on the end of life and interdiction of redemptions before that date. The market experience in Germany shows very clearly that only few retail investors are prepared to invest in vehicles where the invested capital is tied up for 15, 20 or 30 years. Admission to trading on secondary markets cannot be considered an adequate substitute for the exclusion of direct redemptions. In the German market for closedended funds, secondary trading generally entails significant discounts from the market value due to the illiquidity of the portfolio assets and limited trading activities. There is no reason to assume that secondary trading of ELTIF shares will take place in different circumstances. Moreover, it must be taken into account that due to ELTIFs being conceived as blind pools (cf. our remarks above) retail investors subscribing to participation in ELTIFs will not be able to fully assess the details of their investments. Hence, in order to ensure that ELTIFs will offer attractive investment opportunities for retail investors, it is in our view indispensable to allow from the outset for limited redemptions of units or shares. Such redemptions could be subject to restricting mechanisms such as initial lock-up periods, announcement periods for redemptions, redemption fees, gating or queuing and should be accompanied by commensurate measures of liquidity management. For instance,

4 Page 4 of 10 of the BVI s position paper dated 11 October 2013 ELTIFs offering redemption opportunities in certain intervals could be required to maintain a certain level of minimum liquidity. In any case, it is not appropriate to postpone the discussion on possible redemptions to the regular review three years after the entry into force of the Regulation as proposed in Article 30(a). By following this reluctant approach, the EU legislator might miss the opportunity of establishing ELTIFs as successful investment products in the retail market. Detailed comments In detail, we would like to issue comments and suggest improvements in relation to the following elements of the Commission s proposal: 1. Multiple approval of the AIFM (Article 4(2) of the proposed Regulation) Under the Commission s proposal, an authorised AIFM shall apply to the competent authority of the ELTIF for approval each time it intends to launch a new ELTIF. This manager s approval is to a certain extent based on the AIFM license, but requires provision of specific information directly to the competent authority of the fund. In our opinion, such additional approval required on each occasion of launching a new fund is overly burdensome and provides no added value to the already granted AIFM license. The information items to be submitted to the competent authority of the ELTIF already form part of the AIFM authorisation under Article 7 AIFMD and hence are known to the competent authority of the AIFM. If material changes to the conditions for initial authorisation occur in the course of launching new ELTIF vehicles, such changes must be notified to the competent authorities of the AIFM prior to their implementation in accordance with Article 10 AIFMD. Therefore, we believe that the requirement of an additional approval of the AIFM by the competent authority of the ELTIF should be altogether waived. For the purpose of authorising an ELTIF, the only relevant piece of information should be whether the AIFM is authorised to manage AIFs investing in assets which are eligible for the ELTIF portfolio. The competent authorities of the ELTIF should be able to ask for the respective attestation from the competent authorities of the AIFM as part of the ELTIF authorisation process. 2. Use of financial derivative instruments (Article 8(2)(d) of the proposed Regulation) The admission of financial derivative instruments for the purpose of hedging duration and exchange risks is not sufficient for the purpose of effective risk management in ELTIF portfolios. Risks inherent in the eligible investments under Article 9 such as commodity price and commodity supply risks in relation to manufacturing companies should also be capable of hedging through derivatives. Hence, the use of financial derivative instruments should be generally allowed subject to the condition that it serves the sole purpose of hedging the portfolio risks of an ELTIF.

5 Page 5 of 10 of the BVI s position paper dated 11 October Eligible investment assets (Article 9 of the proposed Regulation) It is unclear to us which cases the Commission had in mind when allowing instruments as defined in Article 9(a)(iii) to qualify as eligible investments. According to this provision, ELTIF should also be able to invest in shares of major listed companies, provided that such companies hold a majority stake in a qualified portfolio undertaking and issue shares in exchange for equity or quasi-equity interests in such an undertaking. This appears to be in conflict with the general policy on ELTIFs eligible investment assets which is focused on participations in undertakings without access to the liquidity of secondary markets (cf. recital 16 of the proposed Regulation). On another note, we welcome in principle that ELTIFs shall be able to grant loans to qualifying portfolio undertakings under Article 9(c). Our members see a significant demand for such loans in the market, especially as regards SMEs or for funding project developments which may be later available for ELTIF investments via equity or debt instruments ( bridge financing ). On the other hand, however, it should not be overlooked that provision of loans represents a core banking activity and thus could result in ELTIFs being perceived as engaging in shadow banking. Therefore, in order to avoid future irritations in this respect, the EU Regulation on ELTIFs should explicitly clarify that loans granted by ELTIFs in the context of their investment activities do not fall under the CRD/CRR regime and especially, do not imply the necessity for AIFM managing ELTIFs to apply for a banking license or to comply with the capital requirements for credit institutions. 4. Qualifying portfolio undertakings (Article 10(2) of the proposed Regulation) Project companies established for the purpose of financing and holding interests in infrastructure or real estate by several investors might qualify as AIF under the broad definition in Article 4(1)(a) AIFMD. Given that ELTIF investments in other collective investment undertakings shall be limited to units or shares of another ELTIFs, EuVECAs or EuSEFs according to Article 9(d), ELTIFs might be prevented from acquiring eligible investment assets via project companies. In our view, this result would unduly restrict the investment opportunities for ELTIFs especially with regard to large infrastructure or building projects requiring financing by more than one party. In order to remedy this situation, we suggest that the derogation in Article 10(2) extends also to collective investment undertakings excluded under Article 10(1) if such collective investment undertakings have the exclusive purpose of finance qualifying portfolio undertakings or investing in real assets. 5. Borrowing of cash (Article 14 of the proposed Regulation) The condition in Article 14(e) should be deleted as it might seriously impede efficient financing of the ELTIF investments. The prohibition of encumbrance as regards the portfolio assets would effectively restrict the borrowing opportunities for ELTIFs to short-term credit lines. However, such short-term credits are of no use for the purpose of acquiring a participation in long-term assets as presumed in Article 14(b). Given that ELTIFs must be expected to engage in the development of their portfolio assets such as infrastructure or property, development finance secured on the assets is essential to the whole economics of the fund. Moreover,

6 Page 6 of 10 of the BVI s position paper dated 11 October 2013 encumbrance of real assets is common practice and helps to reduce financing costs in the currently operating funds which invest e.g. in real estate. In order to protect the interests of retail investors, it could be envisaged to make such encumbrance conditional upon consent by the depositary if an ELTIF is marketed to the retail public 2. Furthermore, we believe that borrowing taking place at the level of the qualifying portfolio undertaking should not be taken into account when calculating the 30% limit under Article 14(a) provided that the ELTIF does not have to bear potential losses resulting from such borrowing beyond the total amount of its investment. This approach has been recognised under the AIFMD regime for AIFs investing in private equity 3. We would welcome a respective clarification also with regard to the borrowing by ELTIFs. 6. Application of diversification rules (Article 15(1) of the proposed Regulation) In our view, ELTIFs must not be required to comply with the diversification rules laid down in Article 12 on an ongoing basis. Unlike UCITS and AIFs investing in financial instruments, ELTIFs are not in the position to easily dispose of their assets in case of an identified breach of an investment limit as a result of market movements. It is simply not possible to sell off parts of a tower block or fractions of a railway project in order to restore compliance with Article 12. Therefore, only active violations of investment limits resulting from new acquisitions or disposals of portfolio assets should be relevant for determining whether the diversification rules applicable in accordance with Article 15(1) are observed. Moreover, the portfolio composition and diversification rules should generally cease to apply in case an ELTIF sells selected portfolio assets and distributes the sales proceeds to investors prior to the end of its life. The possibilities of ELTIF managers to generate positive returns for investors would be seriously curtailed if ELTIFs were prevented from seizing early sales opportunities by the strict rules on the end of life under Article 16(1) and (2) (cf. our remarks below). It is obviously very difficult to stipulate at the outset of an investment whether advantageous market conditions for disposal will occur in 13, 15 or 17 years ahead. Under the Commission s proposal, an ELTIF running for, say, 17 years would be able to partially dispose of its assets after 15 years only if it finds substitute investments eligible under Article 9 to be acquired and held for the remaining two years of the fund s lifetime. Given the long-term character of eligible investment assets, such substitute investments should not be feasible in most cases. It must be clear that early disposals of participations in qualified portfolio undertakings amount to secondary sales to other investors and thus would not withdraw or diminish the long-term financing available at the undertaking s level. On the other hand, an effective ban on early disinvestments might significantly impair the appeal of ELTIFs as the investment vehicle of choice for fund managers and sophisticated investors. Therefore, ELTIF managers should be given the flexibility of selling selected investments prior to the end of the ELTIF s life in situations laid down in the fund rules or instruments of 2 This would correspond with the current standards under German law, cf. 260 para. 3 No. 2, 264 para. 3 No. 2 of the German Capital Investment Code (Kapitalanlagegesetzbuch KAGB). 3 Cf. Article 6(3) second sentence of the EU Regulation 231/2013 (AIFMD Level 2 Regulation).

7 Page 7 of 10 of the BVI s position paper dated 11 October 2013 incorporation as part of their managerial discretion. In other cases, early disposal of individual assets should be possible subject to the investors consent. If endorsed in the said manner, such premature sales should be recognised in Article 15 as a reason for ceasing to apply the investment limits laid down in Article 12(1). 7. Redemption policy/end of life of the ELTIF (Article 16(1)-(3) of the proposed Regulation) We believe that the provisions on the end of life of ELTIFs are too strict and might undermine the practicability and the success prospects of ELTIFs as future investment products. Indeed, as pointed out above, it is unrealistic to expect that ELTIF managers will be able to anticipate the exact time point for winding-up the ELTIF investments and redeeming fund units or shares at the launch of a fund. Effectively, this would place with the ELTIF manager the responsibility to predict a company s development and market conditions in 15 to 30 years time. This is obviously an impossible task especially when taking into account that the end of life of an ELTIF needs to be fixed in the fund rules or instruments of incorporation at the ELTIF s launch and before commencing of the subscription period let alone conducting investments on behalf of the ELTIF. According to Article 11 of the proposed Regulation, the ELTIF portfolio may not be pre-financed by the appointed manager due to the potential conflicts of interest, but must be conceived as a blind pool. Hence, it is very clear that at the time of stipulating the end of life of an ELTIF, the manager will have no knowledge of the qualified portfolio undertakings and therefore will not be able to make any statements on the precise timeline for their development. Nevertheless, under the approach proposed in Article 16(1) and (2), it appears that the end of the ELTIF s life should be stipulated in advance without any chances of subsequent changes. Hence, ELTIF managers might be forced to sell portfolio assets at the end of life without being able to adapt the predetermined lifetime in order to account for the specificities of the ELTIF s investments. Moreover, given the investor s right to request winding down of the ELTIF one year after the end of its life under Article 16(3), such sales could become mandatory even in potentially adverse market conditions or despite temporary setbacks at the portfolio company s level. In these situations, ELTIF managers would be bound to consciously realize reduced returns or even to produce losses for investors. Thus, the current concept entails a serious risk of ELTIFs being driven into unattractive performance results. In other words, the manager would be forced to act against the interests of the investor which is in blatant contradiction to his/her fiduciary duty. In order to tackle these deficiencies, we recommend allowing for more flexibility as regards the handling of the end of life of ELTIFs. In our opinion, the end of life could be fixed in the fund rules or instruments of incorporation of an ELTIF in line with the Commission s proposal, however not as an unchangeable date. The ELTIF manager should be entitled to prolong or shorten the end of life in situations clearly admitted in the fund rules or instruments of incorporation as part of its managerial discretion. Modification of the end date in other cases should be possible subject to the investors consent.

8 Page 8 of 10 of the BVI s position paper dated 11 October 2013 We would like to emphasize once again that the suggested amendments entail no potential detriments for the agreed long-term financing of qualifying portfolio undertakings. The terms of such financing, be it through equity or debt instruments, or provision of loans, are separate from any disposal activities by ELTIFs which target secondary market buyers. Hence, the long-term nature and specific terms of funding will not be impacted by the mere substitution of the interest holder. In this context, we would also like to suggest reconsidering whether the proposed approach which allows only ELTIFs with strictly closed-ended features is sufficiently attractive for the retail market. In our view, only few retail investors will be prepared to invest in vehicles where the invested capital is tied up for 15, 20 or 30 years (cf. our above explanations in relation to the key issues). Hence, in order to attract retail investors, it is in our view indispensable to allow for limited redemptions of units or shares which could be subject to restricting mechanisms such as initial lock-up periods and announcement periods for redemptions, redemption fees, gating or queuing and should be accompanied by commensurate measures of liquidity management (for further arguments, please refer to the key issues depicted under I. above). Lastly, it is in our view not appropriate to require that the life of the ELTIF covers the whole life cycle of each individual portfolio asset as proposed in Article 16(2). It must be noted that commercial real estate might have a life cycle of 50 years; the life cycle of infrastructure projects such as motorways might be even longer. It cannot be seriously expected from investors to commit their assets for half a century to ELTIFs without being offered proper exit opportunities during the funds lifetime. Therefore, the life of an ELTIF should be rather linked to the holding period after which it the qualifying portfolio assets are market-ready and can be disposed of with reasonable profits. The respective anticipations by the ELTIF manager should be disclosed in the ELTIF rules or instruments of incorporation. In this context, it could be envisaged to include in the ELTIF framework provision on the minimum lifetime in order to warrant the long-term nature of ELTIFs as investment products. 8. Distribution of income (Article 20(1) of the proposed Regulation) In line with our comments on the possibility of early sales and the corresponding payment of the proceeds to investors (cf. section II 6 above), we believe that the standards on income distribution under Article 20(1)(b) are too narrow. In order to provide a basis for effective portfolio management, ELTIF managers should be allowed to sell singular assets before the end of the ELTIF s life and to distribute not only capital appreciation, but all proceeds from realization of an investment. This possibility should arise in situations described in the fund rules or instruments of incorporation of an ELTIF or otherwise be subject to the investors consent. 9. ELTIF prospectus (Article 21 of the proposed Regulation) The necessity to produce an ELTIF prospectus going beyond the requirements of Article 23 AIFMD should be limited to funds intended for retail distribution. From the viewpoint of professional investors, a prospectus adhering to the standards of Article 21(3) and (4) has no additional value. A statement on the investment objectives and eligible categories of assets will be included in the description of the investment strategy required

9 Page 9 of 10 of the BVI s position paper dated 11 October 2013 under Article 23(1)(a) AIFMD. Similarly, information on the long-term nature, the end of life of an ELTIF and the status of redemption rights should be provided under Article 23(1)(h) and possibly Article 23(4) AIFMD. Further items such as the advice foreseen in Article 21(4)(f) are clearly appropriate only for retail investors. Furthermore, we advise against granting national authorities the discretion under Article 3(e) to request additional information to be included in the prospectus. Such additional information which may be easily justified on grounds of investor protection will result in fragmentation of the transparency rules and might significantly impede cross-border marketing of ELTIFs in case a prospectus complying with the standards of one Member State will not be recognised as adequate in others. 10. Facilities available to investors (Article 23 of the proposed Regulation) In view of the proposed set-up of ELTIFs as purely closed-ended vehicles, we see no need to install facilities for repurchasing or redeeming shares or units at the initiation of marketing, i.e. several years before first redemptions may take place. Aside from this function, dedicated facilities for making subscriptions or payments and informing potential investors should be required only with regard to retail distribution. Marketing to professional investors generally involves direct contacts with the ELTIF management company. Such direct business relationship between the ELTIF manager and professional investors renders intermediation by third parties superfluous as it provides an adequate basis to request or provide any kind of information or to perform the actions considered in Article Additional requirements for marketing to retail investors (Article 24 of the proposed Regulation) We see no reason to require that ELTIFs marketed to retail investors are not structured as partnerships (cf. Article 24(g) 4 ). In Germany, the most common legal structure for closed-ended funds distributed to the retail public is the so-called GmbH & Co. KG based on the private limited partnership. In our view, a general prohibition of partnerships is not necessary for reasons of effective investor protection. Rather, it should be required in general terms that the liability of retail investors in an ELTIF is limited to the amount of the capital commitment and does not involve additional contributions. The German experience shows that these material standards can also be fully realized in a partnership structure. In this context, we would like to endorse the general approach of the Commission s proposal to impose no limits on the legal forms available for the structuring of ELTIFs. In the current market practice, the structures of closed-ended investment funds are adapted to the national company laws and tax regimes. ELTIFs should be able to benefit from the same degree of freedom in order to offer investor a tax-efficient product wrapper aligned with the needs of a specific market. 4 This refers to the second subpoint of Article 24, which usually would be counted as (b).

10 Page 10 of 10 of the BVI s position paper dated 11 October 2013 Lastly, we would like to stress once again that some provisions proposed by the Commission for all ELTIFs are appropriate only in the context of retail distribution. This applies in particular to the requirement to issue a prospectus under Article 21 and the facilities ensuring contacts with investors under Article 23. A modification of the Commission s proposal in this respect should, however, not jeopardize the overall concept of ELTIFs as a product for institutional as well as retail investors.