Travers Smith's Alternative Insights: Retailisation

Travers Smith's Alternative Insights: Retailisation

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A regular briefing for the alternative asset management industry. 

The many alternative fund managers looking at high net worth (HNW) investors as a source of capital have had mixed news over the last year.  Policymakers are grappling with competing priorities: they want to facilitate the flow of capital to long term investments, but they also want to protect investors who may not be able to bear the risks and illiquidity inherent in those investments.  So, while the market continues to tap wealth management firms and private banks, regulators are both helping and hindering those efforts. 

There is still no market consensus on the best structure to use to address the HNW market.  The three main candidates are: feeders into institutional funds, evergreen semi-liquid funds, and the (soon to be improved) European Long Term Investment Fund (or ELTIF).

The feeder is without a doubt the most straightforward and well-established way for managers to access HNWs without disturbing their existing institutional offering, and remains the most prevalent.  The growth of these feeders is expected to continue.

However, a number of managers have established bespoke evergreen, semi-liquid products that generally co-invest with their institutional funds.  There are vehicles, mostly in Luxembourg, that work for such structures, and this is certainly also a growing part of the market. 

But the most interesting development is the forthcoming reform of the ELTIF regime, a structure offering a full retail passport for qualifying funds.  After a very slow start, the market had already started to use the ELTIF even before this latest round of changes, but uptake is certainly expected to increase now that some of the uncertainties have been clarified and some of the restrictions have been swept away.

Among the improved features of the reformed ELTIF are greater freedom to invest in underlying companies and assets that are outside the EU, and removal of some investor eligibility requirements – although the requirement for a suitability test remains. 

However, one big outstanding question for the future of the ELTIF is whether regulators will allow it to be used in place of an evergreen structure.  Although the ELTIF is required to have a fixed term, ELTIFs with 60+ year terms have been approved under the current regime and representations will no doubt be made that the final technical rules should allow that continue.  That would be significant because the ELTIF does allow some liquidity to be offered before the end of the life of the ELTIF – although no redemptions are permitted in the first five years, and stringent rules are expected to apply after that – and continuous issuance is also permitted.  

If ELTIFs can be (virtually) evergreen and (partially) open ended, there is a possibility that the structures targeting HNWs will converge around the ELTIF rulebook – especially as the full EU retail passport is so useful, even if most managers will not want to distribute to truly retail investors. The passport obviates the need to navigate national rules on distribution to HNWs on a country-by-country basis.

But it is true that, even after the latest round of reforms, the ELTIF rules are still more restrictive and complex than those that apply to other structures: as well as the ban on redemptions for the first five years, which may be unpalatable to some wealth managers, investment restrictions are still tighter than other available structures, making it impossible to completely replicate some traditional alternative strategies.  Moreover, although funds of funds are now permitted, these can only invest in other EU funds that make eligible investments, and master-feeder structures can only invest in underlying ELTIFs.

It is therefore too early to tell how ubiquitous the ELTIF will become among alternatives managers, but these changes do represent an important step in the right direction. 

On the other hand, the mood music on the regulatory front is less encouraging. 

While the UK regulator continues to urge firms to get to grips with its new – very demanding, and increasingly criticised – "consumer duty", the European Commission is expected to unveil its long awaited Retail Investment Strategy, part of its ongoing Capital Market Union initiative, in the coming months.

At the time of its 2021 consultation, the Commission's principal aim seemed to be to encourage greater retail investor participation in the capital markets, including making further efforts to unlock capital to be directed into the EU real economy.

More recently, the emphasis appears to have changed; now the focus seems to be on investor protection, including (yet more) transparency and reporting, and new initiatives to promote fairness and good investor outcomes (for example, value for money provided by asset managers' fees). 

In particular, it has been widely reported that the Commission is mulling a ban on commissions payable by fund managers to distributors, in an echo of the UK's 2017 Retail Distribution Review.  This is currently being described more loosely as a ban on "inducements", which would have even wider implications: inducements is a term that includes a wide range of payments and non-monetary benefits received from, or paid to, regulated firms.  Left-of-centre Members of the European Parliament are likely to seize on these measures with relish: their ideas for greater investor protection have been developed in the crucible of the negotiations on revisions to the AIFMD.   

Those AIFMD negotiations also failed to deliver one potential win for those targeting HNW investors: a proposal by some MEPs to extend the passport to so-called "semi-professional" investors did not survive and was quietly dropped. 

Retailisation will continue in the years ahead, whatever changes we see in the regulatory framework, and improvements to the ELTIF structure are welcome and will help.  But addressing the retail market has always added significant cost and complexity to distribution and this will continue to be the case. For many managers, it will likely be a price worth paying but requires careful thought and planning.

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A series of regular briefings for the alternative asset management industry.

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