The LTAF – A New Type of FCA Authorised Fund
The UK has a new type of FCA authorised fund, the long-term asset fund (LTAF), which will invest mainly in long-term, illiquid assets. The LTAF, as an authorised fund structure, must comply with FCA rules which include a number of structural safeguards appropriate to the nature of the underlying assets. The FCA’s final rules on broadening retail access are expected imminently. The LTAF has generated considerable interest, particularly from the defined contribution (DC) pension scheme market, where there has been recent positive news on the price cap rules.
Advantages of the LTAF
The LTAF is a welcome additional fund vehicle for the UK market for investment in long-term illiquid assets and, in comparison to other UK fund vehicles for such assets, has the benefit of safeguards contained in the FCA rules and FCA scrutiny and oversight at the approval stage and ongoing.
DC pension schemes, larger charities, as well as some sophisticated or high net worth investors are likely to be the target market for the LTAF.
For the government, the hope is that the LTAF will provide investors an alternative route to returns, as well as supporting economic growth and the transition to a low carbon economy. As it allows investors access to illiquid assets such as infrastructure and real estate, the LTAF has the potential to help with significant issues around net zero.
FCA rules for the LTAF
The FCA rules incorporate many existing requirements for authorised funds but are tailored to reflect the type of assets which the LTAF will hold, and the liquidity issues associated with long term assets.
There is a high-level requirement that the LTAF’s investment strategy must be to invest mainly in assets which are both illiquid and long-term, or alternatively, in other funds that invests in assets of this nature.
The LTAF can borrow up to 30% of its net asset value, and it has an extensive range of investment powers and liquidity tools that are worth highlighting. The manager of the LTAF is required to ensure that the scheme property aims to provide a prudent spread of risk. The range of permitted investments is broad and includes listed and unlisted shares and bonds, commodities, real estate, loans, funds, including alternative investment strategies such as private equity and private debt (both regulated and unregulated), and funds of funds.
The LTAF rules in relation to dealing and liquidity management are specific to the LTAF, meaning that the LTAF will look quite different to other FCA authorised funds. For example, dealing – while it can be set at longer intervals – is not permitted more frequently than monthly. Investment can either be on a subscription basis or a commitment basis. Investors will have to give at least 90 days’ notice to redeem and managers of LTAFs can include significantly longer redemption notice periods.
There are a number of other permitted liquidity management tools, such as initial lock in periods and minimum holding periods, deferral of redemptions, limits or caps on the number of units that can be redeemed, and side pockets.
To be taxed as an FCA authorised fund, the LTAF must meet the genuine diversity of ownership (GDO), and the usual GDO provisions apply. In addition, the LTAF is able to meet the GDO where at least 70 per cent of the units or shares in the LTAF are held by one or more relevant investors. Relevant investors are a UK or foreign regulated insurer which is not a close company and the trustee, an AUT, OEIC or overseas equivalent which meets the GDO condition, or an administrator or manager of a pension scheme (excluding SIPPs or SSAS).
The FCA rules contain specific additional governance requirements for the LTAF. The manager must be a full-scope alternative investment fund manager with the knowledge, skills and experience needed to understand the LTAF, the assets it will hold and associated risks. Further, the manager must employ sufficient personnel with relevant skills, knowledge and experience, and will not be able to rely on a delegated portfolio manager to meet these requirements. Finally, in addition to half-yearly and annual reports required for all authorised funds, the LTAF must issue quarterly reports to investors.
Latest industry developments
Helpful guidance on investing in less liquid assets has been provided by The Productive Finance Working Group, with information on available UK fund structures including a guide on the LTAF and a model instrument for an LTAF structured as an OEIC. Managers and investors may find this a valuable resource, and it should facilitate greater interest in such investments and increased take up of the LTAF.
The original distribution market for the LTAF was quite narrow as the LTAF was to be categorised for marketing purposes in the same way as unregulated collective investment schemes. However, the FCA has listened to industry feedback and has proposed allowing limited distribution of the LTAF to retail investors. As proposed the LTAF would be classified as a restricted mass market investment (RMMI). Retail investors who receive advice would be able to invest in an LTAF subject to receiving the new risk warning and risk summary, and provided suitability requirements are met. As regards direct offers, retail investors are able to invest up to 10 per cent of their investable assets into an LTAF or other RMMI products provided that they certify that this is the case (so called “restricted investors”). Firms will need to take reasonable steps to satisfy themselves that investors meet the requirements, and the investors must meet an appropriateness test. The FCA has stated that it will publish the final marketing rules for the LTAF early in 2023, so imminently.
DC pension schemes are a key part of the target market for the LTAF. The original FCA LTAF rules amended the permitted links rules by removing the 35% limit for LTAF linked funds that form part of the default arrangement of a qualifying scheme. Although helpful, there was concern that this was overly restrictive and that investors in a long‑term unit‑linked product who had either professional support or guidance should be able to invest in an LTAF. The FCA has proposed, as part of the consultation on broadening retail access, to permit the broadening of the distribution of LTAFs in qualifying schemes beyond the default arrangement, to self‑select options, subject to certain safeguards.
The Department for Work and Pensions has also recently confirmed that trustees and managers of DC pension schemes will be able to exclude certain performance-based fees from their charge cap calculations where this is in the best interests of their members, with such measures taking effect from as early as April 2023. This should give DC pension schemes more flexibility to invest in funds investing in illiquid assets which typically utilise such fees, making the LTAF more commercially attractive for both the LTAF managers and a key part of the target market.
Grania Baird is Partner and Leon Chng is Associate at Farrer & Co.
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