February 15, 2024

A deep dive into the redemption challenges and liquidity matching opportunities in democratizing private assets

On December 19, 2023, ESMA unveiled its final report proposing Level 2 Regulatory Technical Standards (RTS) for ELTIF 2.0, specifically for the fund’s redemption policy, matching mechanism, and cost disclosure, as mandated by the amended regulation. The report has been submitted to the European Commission for endorsement before proceeding to the European Parliament and Council for final approval.

Now the question is: what do the draft RTS reveal about the potential of ELTIF 2.0? Let’s delve into the key contents of the report and its implications for ELTIF managers and investors.

The key components of the Draft RTS for ETLIF 2.0

1. Minimum Holding Period: A Crucial Consideration

The manager of an ELTIF plays a pivotal role in determining the minimum holding period. This decision-making process involves careful consideration of multiple criteria, including the investment strategy, underlying asset classes, investor basis (retail or professional), liquidity profile, valuation of assets (timing included), lending and borrowings, and the portfolio composition. Crucially, the manager must demonstrate to the competent regulator the appropriateness of the minimum holding period duration and its compatibility with the ELTIF’s valuation procedures and redemption policy.

2. Redemption Frequency, Notice Period and Liquidity Management Tools: Striking a Balance

ESMA mandates a quarterly maximum redemption frequency, with the ELTIF manager allowed to deviate under justified circumstances. Redemptions require a minimum notice period of 12 months, although a shorter notice period is possible if calibrated based on a minimum of liquid assets and subject to mandatory redemption gates. Justification is necessary for ELTIFs marketed to retail investors, while professionals are exempted.

The redemption price must accurately reflect the fair value of the underlying assets, rejecting an estimate of the Net Asset Value (NAV) as an acceptable measure. ELTIFs, also being Alternative Investment Funds (AIFs), adhere to the Article 19 requirements of the AIFMD concerning redemption price and valuation dates.

ELTIF managers must select and implement at least one anti-dilution Liquidity Management Tool (LMT), such as anti-dilution levies, swing pricing, or redemption fees. Alternatively, other LMTs can be chosen with adequate justification. Professional investor-focused ELTIFs may be exempted from using any LMTs.

3. Liquidity Matching Mechanism: A New Dimension

ESMA introduces a disclosure framework for the constitutive documents of the ELTIF, specifying the format, process, and timing of the matching mechanism. This includes details on the matching window, dealing dates, submission deadlines for purchase and exit requests, settlement and pay-out periods, safeguards against arbitrage, execution price determination rules, costs for unit transfers, and pro rata conditions for matching different requests. The approach to the matching mechanism, a novel concept in EU fund regulation, is principle-based: here they lay some of the greatest market opportunities, but it adds also complexity.

Future Outlook: Navigating Challenges and Embracing Opportunities

It is clear the effort made by ESMA to strike a balance between prescription and flexibility in the draft RTS. The proposed provisions affirm the viability of ELTIF 2.0 for professional investors, yet present challenges when targeting retail investors.

Stricter conditions on redemption rights and redemption prices may hinder ELTIFs, with regulation surpassing current market standards, as in the case of Luxembourg Part II funds.

The liquidity matching mechanism introduced in ELTIF 2.0 presents a significant opportunity for democratizing access to private assets, benefiting both investors and asset managers. By enhancing liquidity and accessibility, it opens new avenues for participation and growth in the asset class. Fund platforms and transfer agents will play a key role in making this opportunity a reality by facilitating efficient transactions and ensuring smooth operations.

The effectiveness of ELTIF 2.0 may be compromised if open-ended or semi-liquid ELTIFs become rare, incurring high operating costs to meet stringent regulatory requirements. On one side, ELTIF managers will need to adopt efficient operating models to seize the opportunities of the new regulation. On the other side, with ESMA’s cautious stance reflecting global concerns on liquidity and systemic risks, ELTIF success hinges also on national regulators’ sensible application.

The Commission has now three months (extendible by one) to adopt the draft RTS; once adopted, the European Parliament and Council have 3 months to scrutinize them. Considering some industry concern, amendments may be advocated for, still within a tight-timeline process, also in in view of the European elections this year.

Empowering ELTIF Managers: Adepa’s Comprehensive Support for Evolving Market Dynamics

As ELTIFs gear up for the regulatory changes brought about by ELTIF 2.0, Adepa extends its support to ensure that ELTIF managers are well-equipped to navigate compliance and operational requirements, and excel in an evolving market.

Leveraging its expertise in Super ManCo, Adepa provides decades of experience and market recognition in third-party AIFM services, providing comprehensive support to asset managers in establishing, governing, and operating investment funds of all types through to its Luxembourg-based flagship Management Company and AIFM.

Additionally, Adepa’s Fund Administration services, backed by long-established best practices and cutting-edge technology, ensure top-quality valuation, accounting, and reporting for funds investing in diverse asset classes across different jurisdictions, ensuring the highest level of valuation standards both for liquid and illiquid assets, to fully satisfy the challenges arising from the new regulation.

Furthermore, its Investor Services deliver innovative  and fully compliant solutions, combining expertise, processes, and technology to adeptly manage the full investor journey, from digital onboarding, to transaction execution and control and investors’ register data maintenance. Adepa’s service platform is ready to enable managers to overcome the challenges of semi-liquid, open-ended alternative investment funds, capitalizing at the same time on the opportunities presented by the liquidity matching mechanisms.

These services are tailored to all types of ELTIFs, both open-ended and closed-ended, with illiquid or semi-liquid investment strategies, targeting both professional and retail investors. With its global model and strong European footprint, Adepa is perfectly positioned to support both local and cross-border initiatives, managing already different vehicles eligible for ELTIF in various domiciles (Part II, SIF, RAIF, FILPE, FIA).

Intrigued to unlock the full potential of ELTIF 2.0? Contact our experts today to discover more on our extensive support and embark on a journey towards operational excellence and market success!

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