Groundhog Day for ELTIF 2.0

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Until the industry digitalizes and interest rates fall, renewed efforts by European regulators to open up alternative assets to retail investors are likely to have the same disappointing outcome as before, says Julien De Mayer

Sometimes I wonder what planet the regulators live on. This time, I’m thinking about the imminent launch of the European Long-Term Investment Fund (ELTIF) 2.0 on January 10, but also the series of regulations that are bringing retail-like regulatory belts and braces to the world of complex investments.

ELTIF 2.0’s predecessor, the original European Long-Term Investment Fund, arrived to much expectation in 2015. It was designed to help stimulate growth by channeling privately held, long-term finance into venture capital and private-equity funds that would back deserving projects and companies. But the idea failed to take off in the way regulators had hoped. Just 57 ELTIF funds have been launched in nearly eight years, raising some €2.4 billion across only four countries. This is a relative drop in the European fund ocean.

Rather than admit defeat, the European Commission has reworked ELTIF’s structure to set broader rules on marketing to retail investors and more flexible investment rules for managers. The idea is to make it easier for retail investors to get a piece of the long-term alternative asset action and thereby increase the amount of finance available. Will they be more successful in 2024 than they were in 2015? I’m not so sure. The problem? The lack of supporting infrastructure and the innate illiquidity of what, for good reason, is called ‘patient capital.’

As we will discuss at Aperture Capital’s event on January 16, when funds open up to retail investors, life gets more complicated for the fund service providers. There’s more communication, more compliance checks, more reporting – more management. Every single retail investor must be screened to ensure they are eligible to invest, for example; there’s know your customer (KYC) too, and anti-money-laundering requirements. And this data needs to be kept up-to-date. To do all this, the funds need the right tools at an affordable cost.

The more traditional fund administration service providers, however, still employ many manual processes, pushing up their costs and making it uneconomic for them to cater for many more investors. And while companies including fundcraft offer end-to-end, digital fund administration services that can be scaled efficiently and economically, they are few and far between.

But that’s not the only shadow hanging over ELTIF 2.0. Retail investors in Europe have little experience in long-term funds; their knowledge and understanding are low. While they may well be aware that long-term investments can deliver good returns, have they really grasped the additional risk associated with early-stage investing? Or the extended timeframe of five-plus years? And will they accept the opaque nature of the fund? Alternative asset investing is, after all, a long way away from stock picking.

On top of this, the timing is challenging. The sustained period of low interest rates that provided the impetus for long-term investing, with its higher risk but higher returns of 10-15 percent, is over – for now. Given the attractive interest rates on offer, the marginal potential gain of long-term investing, with the real increase in risk, higher associated costs and inherent illiquidity, is far less attractive today. Already, this is steering money away from equities and corporate funding toward lower-risk investments such as government bonds.

Taken together, it all points toward an environment that just doesn’t favor long-term alternative assets for retail investors. If the regulators really want to change that, they’ll need to do more than tweak eligibility criteria. Indeed, they’ll need to review much of the regulation and remove the gold plating – the burdensome rules that apply to everyone, but that address the threat to perhaps less than 0.1 percent of the market. For example, strict marketing rules can stop general partners – the people who help decide how capital is allocated within funds – discussing potential new funds with prospective clients to gauge likely demand. This leads to a catch-22 situation where funds aren’t launched because the market is difficult to read, and the market doesn’t form an opinion because it doesn’t have the knowledge.

Another example, this time intended to stop greenwashing, is the project by the European Securities and Markets Authority – now underway for 14 months and counting – to develop guidelines to name funds using environmental, social and governance-related investment criteria. While greenwashing is indeed pernicious, this approach has unnecessarily slowed the pipeline of much-needed funding for climate-transition efforts. There’s got to be another way to effectively tackle what boils down to mislabeling.

Such gold plating simply adds layers of expensive obligations without driving any form of value. But even a thorough review on its own won’t be enough.

Realistically, it’s going to be years before the market is ready. Interest rates will need to fall and we need a widespread digital transformation of the fund administrative services sector.

It would be remiss of me not to state that it will be critical to work with partners (like fundcraft) who enable digitization and best-in-class operating models, but even with the right partners it will take creativity and determination to manufacture and distribute the next generation of alternative investment funds.

Julien De Mayer is the founder and CEO of fundcraft, a Luxembourg-based fintech and regtech firm building digital infrastructure for asset managers.

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