What is a Long Term Asset Fund?

The LTAF is an open-ended fund, authorised by the FCA, and can be structured as any of the following:

• an Authorised Contractual Scheme (ACS)
• an Investment Company with Variable Capital (ICVC) or
• an Authorised Unit Trust Scheme (AUT).

All authorised funds have to be open-ended, so investors have the right to redeem their investment at a price ‘related to’ net assets although the frequency at which such right may be exercised is not set out in legislation or in the FCA rules.

For the time being, at least, fully closed-end LTAFs are not feasible. The rules do not set an upper limit to the LTAFs’ dealing cycles and redemption frequencies, although we anticipate most LTAFs will have redemption windows on at least an annual basis.

The FCA added a new chapter 15 into its Collective Investment Schemes sourcebook (COLL), which contains the specific rules on LTAFs.

COLL 15 can be found here.

First of all, it’s important to note that the FCA expects an LTAF’s investment strategy to be to invest “at least 50%” of the scheme’s property in assets that are illiquid and need to be held over the longer term.

This, though, is very much a baseline - the rules allow an LTAF to have a strategy of investing much more than this in illiquid assets, provided its fund-level liquidity arrangements are properly aligned with the liquidity in the underlying assets.

The rules in COLL 15.6 set out the LTAF’s investment and borrowing powers and include:

a) Eligible investments

An LTAF can invest in any assets or investments to which it is dedicated, including those within articles 74 - 86 and 89 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001.

This, though, is subject to:

• any restrictions in COLL; and
• any limitations set out in the instrument constituting the scheme and/or the LTAF’s prospectus.

This means that an LTAF is permitted to invest in a wide range of financial instruments, the most important of which include:

• deposits
• rights under contracts for insurance and under a pension scheme
• shares
• instruments creating or acknowledging indebtedness (bonds etc)
• government and public securities
• units in a collective investment scheme
• options, futures, contracts for difference
• emission allowances
• interests in real property
• interests in loans (subject to certain conditions)
• precious metals (gold, silver and platinum); and
• commodities traded on a recognised investment exchange or recognised overseas investment exchange.

b) Investment in other funds (‘second schemes’)

An LTAF can invest in a second scheme which is a regulated collective investment scheme.

It can also invest in an unregulated scheme under certain circumstances. These require the LTAF manager to have taken reasonable care to determine that:

• the second scheme is subject to an independent annual audit;
• the NAV calculation of each of the second schemes, and the maintenance of their auditing records, is kept segregated from the investment management function; and
• the second scheme is prohibited from investing in the LTAF (or, if there is no prohibition, the LTAF manager must be satisfied, on reasonable enquiry, that neither the second scheme nor any scheme in which it invests, will make an investment in the LTAF).

Investment in second schemes which are not regulated schemes, qualified investor schemes or other LTAFs is generally permitted although where such investment exceeds 20% in aggregate the LTAF manager must conduct appropriate due diligence prior to investment and on an ongoing basis.

c) Prudent spread of risk (PSOR)

The fund must aim to provide a ‘prudent spread of risk’ (PSOR).

The concept isn’t defined in the FCA rules but the FCA expects the industry (and the courts, if necessary) to apply a natural meaning to it.

The PSOR requirement applies from launch so the LTAF’s initial portfolio must be compiled on a PSOR basis from the outset. This includes any period during which the fund’s portfolio is “ramping-up” to fulfil its full investment objective and policy.

d) Feeder funds

An LTAF can invest as a feeder fund into a qualifying master LTAF – the master fund itself doesn’t need to be an LTAF (in fact, it doesn’t even need to be an authorised fund) and also doesn’t need to be a UK-domiciled fund.

The master fund could, therefore, be an existing fund and - subject to ensuring the feeder fund can operate as an LTAF and that there are no local limitations on the master fund having an LTAF feeder - this is a particularly attractive option for many managers who wish to gain access to the UK DC market using their existing fund range.

e) Derivatives

An LTAF can invest using derivatives though this is subject to a number of provisions in the FCA rules related to delivery of the underlying, cover and valuation.

The LTAF manager must also ensure that a risk management process is in place and that this enables it to monitor and measure the risk of the LTAF’s derivatives positions, as well as their contribution to the overall risk profile of the LTAF.

The LTAF manager must conduct the monitoring and measurement “as frequently as is appropriate”.

An LTAF can borrow up to 30% of its NAV. This includes borrowing for liquidity management purposes, which is seen as an important investor protection.

This borrowing limit applies at the level of the LTAF, and does not prevent underlying assets from being further leveraged.

The LTAF manager must take reasonable care to ensure that arrangements are in place to allow borrowings to be closed out if they would take the scheme over this limit.

For these purposes, ‘borrowing’ includes “any arrangement (including a combination of derivatives) designed to achieve a temporary injection of money into the scheme property in the expectation that the sum will be repaid”.

There is no requirement as to the purpose for which the borrowing is entered into. So, borrowing could be for liquidity, for efficient portfolio management or for investment purposes.

Investors in UK authorised funds must be entitled to redeem their investment at a price “related to” NAV calculated in accordance with the scheme. It is clear therefore that LTAFs need to be open-ended in terms of allowing redemptions although their frequency is not prescribed in law or regulation other than that redemptions can be no more frequent than monthly.

In its LTAF rules, the FCA has tried to find the right balance between:
(a) allowing investors greater access to illiquid assets; and
(b) ensuring that an appropriate level of investor protection is provided.

This includes allowing investors to redeem their investments within an acceptable timeframe.

An LTAF manager must align the redemption policy with the liquidity of the underlying assets and demonstrate this, both during the fund authorisation process and on an ongoing basis. This is an important feature of the LTAF as a properly aligned fund will allow investors to understand the liquidity profile of their investment and to accommodate it within their own liquidity requirements.

The LTAF manager can employ a range of mechanisms to support the efficient management of the fund’s portfolio and to ensure fair treatment for all investors (whether looking to redeem or remain in the LTAF).

These mechanisms (which will be set out in the prospectus) can include:

• lock-up periods
• side pockets
• gates (at either investor or fund level)
• extended notice periods and
• suspension of dealing.

Under the FCA rules:

• an LTAF must be open for redemption no more frequently than monthly; and
• all redemptions must apply a notice period of at least 90 days.

That said, it is expected that many LTAFs will deal less frequently than monthly and/or have a notice period longer than 90 days.

To ensure that LTAFs offer an appropriate degree of consumer protection, the authorised fund manager of an LTAF must be a full-scope UK AIFM.

Note that an LTAF manager must have FCA permission for “managing an authorised AIF” – firms that currently only have FCA permission for managing an unauthorised AIF will need to seek a variation of permission (VoP), which can take up to six months to obtain.

In particular, the FCA rules require that:

• a senior manager at the LTAF manager is responsible for overseeing that the LTAF is managed in the best interests of investors;
• the LTAF manager carries out an annual assessment of value of the LTAF - this is a feature of all authorised funds and is designed to focus on whether payments charged to the fund are justified in the context of the overall value delivered to investors;
• the LTAF manager must also carry out an annual assessment of how the LTAF is being managed in accordance with investors’ best interests - this requires the LTAF manager to assess and report on at least four additional aspects of the operation of the LTAF:
  • valuation;
  • due diligence;
  • conflicts of interest; and
  • liquidity management;
• the LTAF manager’s governing body must include at least two independent people (or, where the governing body is made up of more than 8 individuals, at least 25% must be independent); and
• the members of the governing body must also:
  • possess the collective knowledge, skills and experience to be able to understand the activities of the manager and the risks involved;
  • commit sufficient time to perform their functions properly; and
  • act with honesty, integrity and independence of mind.

The authorisation process for LTAFs is the same as for other authorised fund applications – these requirements are set out at COLL 2.1.

Further information is available on the FCA’s website here.

The FCA is required to process applications for authorisation of authorised funds (other than UCITS) within six months, although we expect that in many cases the process may take less than the full period allowed. Where a new sub-fund is added to an existing LTAF umbrella, then the FCA has up to one month to process the application.

The FCA has encouraged firms which are considering making an authorisation application for an LTAF to engage with it prior to submitting an application.

The FCA’s Handbook notes that LTAFs are “only intended for investors that are, in general, prepared to accept a higher degree of risk in their investments or have a higher degree of experience and expertise than investors in a UCITS scheme or a non-UCITS retail scheme”.

When the concept of the LTAF was under consideration, it was primarily with defined contribution (DC) workplace pensions (and in particular the default segment) in mind - at least so far as initial investors were concerned. As a result, at their introduction, LTAFs were categorised as non-mainstream pooled investments (NMPIs).

This meant that only:

• professional clients
• certified and self-certified sophisticated investors and
• certified high net worth individuals

could invest in an LTAF.

That said, it was always the intention to expand the eligible investor base and, in August 2022, the FCA consulted on broadening access to retail clients, DC self-select, and SIPPs – see our summary of the consultation paper here.

The consultation period closed in October 2022 and final rules were published on 29 June 2023, in PS23/7.

This recategorised units in an LTAF as Restricted Mass Market Investments (RMMI), with the result that, provided the relevant investor protection measures are complied with, LTAFs are now accessible to the wider, mass retail market.

See also the section, Who can you market an LTAF to? below.

In addition, changes announced in the UK Government’s November 2023 Autumn Statement as part of its efforts to broaden retail investment into the LTAF have led, since April 2024, to the UK's Innovative Finance ISA (IF ISA) being able to hold Long Term Asset Funds (LTAFs). However, it is important to note that the IF ISA is not expected to be a major source of investors (and therefore capital) for the LTAF. As such, the industry continues to engage with the FCA to explore alternative ISA routes for investment into the LTAF.

a) Instrument/Deed

Whatever legal form an LTAF takes, its instrument must comply with certain content requirements set out in detail in COLL 15.3.6 (R).

The Productive Finance Working Group has produced a model instrument for an LTAF which is structured as an ICVC – model versions for use where the LTAF is an ACS or an AUT are expected to follow shortly.

b) Prospectus

The LTAF manager must ensure that a prospectus is drawn up and offered free of charge to any person eligible to invest in the LTAF prior to a purchase of any units in it.

The contents of the Prospectus are prescribed in the FCA rules (see COLL 15.4) and include information relating to the LTAF’s investment strategy, redemption terms, and charging structures.

The contents must be set out fairly, clearly and in plain language so they can be easily understood by investors.

c) Key Information Document (PRIIPs KID)

In addition to the prospectus, where an LTAF is made available to retail clients, the LTAF manager will currently need to prepare a PRIIPs KID, which must be provided to a retail investor in good time before he or she invests. (We are, though, waiting for the outcome of HMG’s consultation, which proposed replacing this requirement with a different framework for retail disclosure. The consultation period closed on 3 March 2023.)

d) Reports

The LTAF manager must prepare (i) an annual, (ii) a half-yearly and (iii) a quarter-yearly report on the fund, containing information specified in the relevant sections of COLL 15. Of these, only the annual report needs to be audited.

A copy of the latest report must be provided free of charge upon request to an eligible investor prior to investment.

As we mentioned in the section on eligible investors above, when LTAFs were introduced, they were categorised as non-mainstream pooled investments or ‘NMPIs’.

Marketing (or ‘promoting’) an NMPI to a retail client is generally banned under the FCA’s rules. But it is allowed if one of the exemptions set out in COBS 4.12B applies. These exemptions include where you are promoting to certified or self-certified sophisticated investors or certified high net worth individuals (HNWIs).

In August 2022 the FCA consulted in CP22/14 on re-categorising LTAFs as “restricted mass market investments” (RMMI), in line with new rules that the FCA introduced in February 2023, following publication of PS 22/10, “Strengthening our financial promotion rules for high risk investments”. Click on the relevant link for our summaries of CP22/14 and PS22/10.

The FCA published its final rules following CP22/14 on 29 June 2023, as part of PS23/7. (For our summary of PS23/7 see here.)

As was widely expected, the FCA decided to go ahead with the re-categorisation to RMMI, meaning that, in addition to sophisticated and HNWI investors, all retail investors will be able to invest up to a total of 10% of their investable assets into LTAFs or other RMMI products subject to going through the appropriate hurdles (i.e. the delivery of relevant risk warnings and making of an appropriateness assessment). Retail investors who invest based on a personal recommendation or advice would not be restricted to the limit of 10% of investable assets.

In March 2023, we advised on the launch of the first LTAF in the UK, which reflects our long-standing commitment to this important initiative. We also advised on the launch of the third LTAF in May 2023.

We have also actively engaged with our major asset manager clients on the LTAF. A significant number of our clients have expressed interest in setting up LTAFs and we anticipate that there will be significantly more on the market in the coming months.

We would be happy to speak to you about any aspect of setting up an LTAF.

Please contact David Williams, John Dooley, Charles Vermeylen or Dom Buxton in the first instance.