How to rebuild Ukrainian economy after war? Some thoughts on the role of EuSEF, EuVECA and ELTIF
Introduction
The war in Ukraine has profoundly changed our perspective on human dignity, democracy and the rule of law. What seemed to be unconditional, became rather ephemeral. Courageous Ukrainian people, guided by the President Volodymyr Zelensky, fight every single minute to protect the basic values of the mankind, as depicted in the Charter of Fundamental Rights of the European Union.
Since the war has ravaged Ukrainian territory, affecting millions of people, animals, public services and businesses, it is time to reflect upon the ways to rebuild Ukrainian economy when the long-awaited and well-deserved victory is proclaimed.
Numerous international initiatives can be cited in this respect, such as the 925 million USD mobilized support from the World Bank. However, not all of the allocated funds are grants, i.e. some of them are paid as loans that should be repaid in due time. This is notably the case for collected funds during the Stand Up for Ukraine campaign, whereby out of 10.1 billion USD 5.5 billion USD are issued as loans. We can also cite in this respect a 4 billion EUR credit line of the European Investment Bank aimed at helping EU Member States to bear the costs related to hosting and integrating Ukrainian refugees within their respective jurisdictions.
In this contribution, we would like to look at other opportunities to help Ukraine to rebuild its economy, that is by exploring the potential of European social entrepreneurship funds (“EuSEF”), European venture capital funds (“EuVECA”) and European long-term investment funds (“ELTIF”).
I. EuSEF, EuVECA and ELTIF: setting the scene
EuSEF, EuVECA and ELTIF represent a special type of alternative investment fund (“AIF”). The managers of AIF (alternative investment fund manager or “AIFM”) are regulated by the Alternative Investment Fund Managers Directive (“AIFMD”).
An AIF is a collective investment undertaking that has no restrictions, at EU law level, on its investment strategies and eligible assets. Nevertheless, national rules transposing the AIFMD may impose additional limits or requirements. As such, it is predominantly oriented towards professional investors who are considered to have enough knowledge and experience to invest in non-traditional investment funds. However, national regulatory authorities may allow AIF to be marketed to retail investors within their territory.
Yet, the specificity of EuSEF, EuVECA and ELTIF reside in the fact that their regulation is based both on Manager and Product regulatory approach, contrary to classical AIFs whereby only AIF´s managers and not the funds themselves are regulated at EU level. This brings an additional layer of security for the fund’s investors. To illustrate: ELTIF Regulation states that ELTIF are open to both professional and retail investors and details the measures aimed at protecting (especially) the latter category.
According to art. 3(1)(d)(ii) and (iii) of the EuSEF Regulation, EuSEF invest in those companies that have as its primary objective “the achievement of measurable, positive social impacts”. These impacts consist of providing “services or goods to vulnerable or marginalized, disadvantaged or excluded persons” or using “a method of production of goods or services that embodies its social objectives”. The investment strategy of EuSEF can thus be resumed as “positive social impact finance”. To illustrate, Phitrust Partenaires, a EuSEF managed by the French fund manager, invested in the company that offers different educational resources via microSD card to the people that do not have internet access in Western Africa.
According to Recital (1) of EuVECA Regulation, EuVECA funds should provide financing “to undertakings that are generally very small, that are in the initial stages of their corporate existence and that display a strong potential for growth and expansion”. The additional benefit of using EuVECA funds to finance corporate operations is that these funds “provide … valuable expertise and knowledge, business contacts, brand equity and strategic advice”. EuVECA funds promote “economic growth, contribute to the creation of jobs and capital mobilization, foster the establishment and expansion of innovative undertakings, increase their investment in research and development and foster entrepreneurship, innovation and competitiveness”. The European Investment Fund and the European Commission have already used this fund structure as regards centrally managed EU funds in order to increase capital investments (InnovFin programme).
According to Recital (1) of the ELTIF Regulation, ELTIF is designed to “provide finance of lasting duration to various infrastructure projects, unlisted companies, or listed small and medium-sized enterprises that issue equity or debt instruments for which there is no readily identifiable buyer”. To illustrate, the first two ELTIF authorized by the French Financial Markets Authority in 2016 invested 1.2 billion EUR in long-term infrastructure projects and have a life span of 25 years.
The European Commission has issued its proposal for an amendment of the Regulation 2015/760 on 25 November 2021 in order to make ELTIF more flexible and attractive for investors., with the Council adopting its position to improve ELTIF Regulation on 24 May 2022. The idea behind this proposal, which has seen light before the onset of the war in Ukraine, was based on the aspirations of the Capital Markets Union, Sustainable Finance Strategy and post-pandemic (Covid-19) recovery strategies. No doubt that the situation in Ukraine may call for further adjustments regarding this type of investment.
II. EuSEF, EuVECA and ELTIF: how can they benefit Ukrainian economy?
According to an E&Y study, as of 17 June 2022, there were only 57 ELTIF established in four EU jurisdictions (Italy, France, Spain and Luxembourg). Yet, it is highly likely that we will see a growing number of these funds, as well as of EuSEF and EuVECA, being established in the EU following the onset of the Russian invasion.
These funds can invest in companies and projects that are based both in the EU and third countries. As such, they can invest in the rebuilding of Ukrainian houses, setting forth different infrastructure projects and many other areas that allow Ukrainian people to have appropriate living conditions. Ukrainian government has already recommended that all new buildings should have bomb shelters and improved energy supply systems.
Currently, mobile houses and empty train carriages are in place to provide a temporary “home” for those people who lost their houses due to the Russian invasion in the suburbs of Kiev. As an example, direct and indirect economic losses in Boutcha, a sadly famous suburb of Kiev, due to unprecedented levels of civil casualties, are estimated at 449 million EUR. More than half of that loss is linked to the destroyed residential buildings and social infrastructure.
As regards the situation in Kiev, 390 buildings are damaged, 222 of which are residential skyscrapers. According to Vitali Klithschko, mayor of Kiev, the overall costs of renovation is estimated at more than 70 million EUR.
We should also think about people who became disabled or lost their jobs due to the war. These citizens will need to be provided with a social housing that corresponds to their particular needs (e.g. wheelchair accesses).
All these examples highlight the importance of financing that can be brought into Ukrainian economy by the three types of discussed investment funds.
In addition, the investments can be made in those services that promote education, research innovation and social wellbeing. Some examples may include:
- developing inclusive educational system in Ukraine whereby all children can benefit from distance learning (which includes providing free laptops and Wi-Fi to those not able to pay for it themselves);
- offering free English language classes for children and adults who want to study or work abroad;
- financing research on the advanced medical practices in times of war, developing medical equipment that can function without energy;
- setting forth private psychological clinics that can provide their services to all those dealing with war-induced anxiety and post-stress traumatic disorder;
- creating animal shelters where abandoned animals can have a good quality of life; and
- investing in the development of different environment and energy-saving projects.
We have mentioned previously that EuVECA provide not only capital, but also expertise, strategic advice and network opportunities for target companies. Unfortunately, the war has put a stop on numerous business initiatives in Ukraine as people and businesses need to focus on fulfilling strategic goals, i.e. defending the country and providing vital social services. Once the war is over, Ukrainian entrepreneurs will need to level up to catch up with the latest developments, such as digitalization and sustainability. As such, they will benefit from the advice and business contacts supplied by the managers of EuVECA.
The above-mentioned investment funds have medium- and long-term investment strategy. This means that investors have limited ability to withdraw their capital from the fund before the end of the investment period. When such withdrawal is possible, the process of capital redemption is rigorously written down. This should be compared to hedge funds (another type of AIF), whereby investors can withdraw their funds at a short notice following a simple procedure. As a result, investments made by EuSEF, EuVECA and ELTIF will provide a steady capital flow to Ukrainian economy, thus allowing Ukrainian people to not only rebuild the economy but also benefit from additional job opportunities linked to these long-term projects.
Investors can take advantage from investment opportunities that have a relatively small risk of being affected by market fluctuations due to a time horizon of this type of investment. They can also increase the diversification of investment portfolios via investing in non-traditional assets (Ukrainian companies that operate in socially important areas of activity). In addition, with regard to ELTIF, investors are exposed to lesser risks as compared to traditional private equity funds.
Special incentives to invest in these types of AIFs are set forth in national tax laws. For example, according to Belgian law, the tax treatment of ELTIF does not depend on the distribution obligation, as it is the case for other investment companies (SICAV RDT). The distribution obligation implies that funds must distribute at least 90% of their net annual income as dividends. The reduction in the amount of dividends paid increases in turn the amount of capital gains of the fund that are tax exempt. It would be interesting to follow the developments in this area closely, as countries may provide additional tax relief on the investment in such funds.
Finally, it should be also noted that the ESMA has issued its Public Statement on Actions to manage the impact of the Russian invasion of Ukraine on investment fund portfolios on 16 May 2022 with a view to clarify the obligations of fund managers “to manage investment funds in the best interest of investors”. Such statement aims also at promoting adequate valuation of assets and liquidity management approaches -including, specifically, the possible use of side pockets-. We suggest that further steps should be taken regarding the disclosure obligations of fund managers in order to provide sufficient safeguards for fund investors (both before and during their investment in the fund) to account for potential impacts of the Russian invasion on the funds’ portfolios.
III. Conclusion
The darkness brought about by the Russian invasion is driven out by courage of Ukrainian people and vast international support. Whilst many international initiatives are aimed at providing help “on the spot”, it is also necessary to think about the medium-term and long-term solutions that Europe can offer in this context.
In the respect, we suggest that EuSEF, EuVECA and ELTIF represent interesting solutions that deserve to be explored further. These funds can finance the development of socially important projects and services and promote increased research opportunities in Ukraine. Ukrainian entrepreneurs will also benefit from the expertise and professional network of EU fund managers. In return, investors will profit from medium- and long-term investment opportunities, which have a small dependence on market volatility; they will also achieve the diversification of their portfolios by investing in non-traditional assets. Last but not least, investors can really make a difference by supporting the economy and development of Ukraine thus taking a holistic approach to money-maximizing strategies.
We suggest that EU and national policymakers should think about further ways of making these investment vehicles attractive enough for investors, e.g. increasing the disclosure obligations of fund managers and providing tax relief on the investments in EuSEF, EuVECA and ELTIF.