Retailisation: the evolving European regulatory environment

A regular briefing for the alternative asset management industry.

The "retailisation" of private markets poses conflicting challenges for European regulators. While they are keen to mobilise more long-term capital from individual investors – and to enable them to access the higher returns available for less liquid and more active investment strategies – they also have a mandate to protect those investors from harm. The resulting policies sometimes mean that rulebooks take two steps forward and one-and-a-half steps back. Some important recent developments suggest that the forward momentum is still winning – but only just.

The biggest EU regulatory initiative for alternative asset managers looking to access retail investors in recent years has been reform of the European Long Term Investment Fund (or ELTIF). This vehicle has been around since 2015, but restrictive (and, in places, unclear) rules hampered uptake. Recent reforms aiming to improve usability have been promising, but the market has been waiting for the all-important implementing measures before leaping in to the ELTIF structure (although some sponsors have launched ELTIFs in recent years as market positions have developed on some of the uncertainties inherent in the existing rules).

Now the pan-EU supervisor, ESMA, has published draft implementing rules for consultation. They can be seen as another baby-step forward.

The key issue for the private funds market – not fully answered by the new rules themselves, and left to these implementing measures to determine – was whether it would be possible to design an "evergreen, semi-liquid" ELTIF – in other words, one with a perpetual term and regular redemptions. This is possible with other EU structures, but the full EU retail passport (and, perhaps, recognised brand) offered by the ELTIF could make it a gamechanger.

ESMA's draft implementing rules are helpful on that key point. They strongly suggest that ELTIFs do not have to be tied to a single vintage of assets, and that they can offer redemptions provided there is appropriate management of the fund's liquidity position.

Unsurprisingly, strict rules will have to be followed before an ELTIF that permits redemptions will be authorised. While many of these rules are prudent and workable, some refinement would still be helpful. For example, ESMA proposes a three year lock up period before any redemptions are permitted, although this is not a hard-and-fast rule. That presumption may cause issues for vehicles that are continually fundraising, and those issues will need to be discussed with ESMA in the coming months. Similarly, some of the rules on the portion of liquid assets that must be held to meet redemption requests look overly restrictive and may be an unacceptable drag on returns.

There is some more work for the industry to do, but significant progress has already been made by Invest Europe and other industry associations in making the ELTIF a viable structure for the retail market.

The consultation runs until August, and final rules are expected by the end of the year. There is some more work for the industry to do, but significant progress has already been made by Invest Europe and other industry associations in making the ELTIF a viable structure for the retail market. Ultimately, the hope is that it could operate as a closed-ended fund that invests alongside institutional limited partnership-style funds on equivalent terms, or as an evergreen structure that enables high net worth investors to access private markets without giving up all liquidity.

Some (healthy) competition between Ireland and Luxembourg to become the hub for ELTIFs might also yield benefits for the market, especially since national interpretations will remain important.

So much for the steps forward. Also in May, the European Commission unveiled its long-awaited Retail Investment Package. This includes a draft Retail Investment Directive which is generally focussed on consumer protection and could create some challenges for alternative asset managers who are seeking to raise capital from individual investors – and even for some who are not. (Our full briefing on the package is available here.)

The European Commission's expressed aim for this package is to create safer and fairer conditions to grow retail investor participation in capital markets. However, the wide-ranging proposals are focused more on investor protection than on growth.

Although far from being the only concern in the comprehensive package, one point likely to elicit particular concern is the proposal to extend the existing (MiFID) ban on fees, commissions and other benefits ("inducements") paid by fund sponsors (or other "manufacturers" of fund products) to a wider range of distributors. While such a ban may be a worthy long-term objective, its premature introduction could make it more difficult for private assets to become established as a mainstream investment for the wealth management community.

It is still early days for these proposals (which also include some important proposals on "undue" costs and fees for alternative investment funds). They have been in gestation for some time and are quite contentious. The European Commission has already encountered some significant resistance to its earlier thinking and there is some scepticism in Brussels as to how much of the package will be politically palatable. It seems unlikely that the measures will be passed before the end of the term of the current European Commission and Parliament and therefore their final shape may depend on the outcome of the European Parliamentary elections in early June 2024. Final changes are unlikely to come into effect much before 2026. In the meantime, there is scope to shape the final form of the rules and industry engagement will be important.

In the end, the EU's co-legislators will need to strike a balance between giving impetus to the private markets – including by giving them easier access to wealthy individual investors – and protecting investors from unacceptable risks. That isn't easy, and there are political as well as technical challenges, but at least the legislators are trying.

Read Simon Witney Profile