Our response to the LTAF proposals

On 25 June 2021, we submitted our detailed response to the FCA’s CP21/12 "A new authorised fund regime for investing in long term assets", welcoming the proposals for the Long Term Asset Fund (LTAF), which we consider struck the correct balance between investor opportunity and investor protection. This CP has been prepared following FCA’s engagement with the Productive Finance Working Group convened jointly by the FCA, Bank of England and HM Treasury, in which we have participated as the sole legal services provider representative.

Our response can be found here. We will be reporting again when the FCA publishes its Policy Statement and final rules for the new fund vehicle.

The LTAF is a potentially important new authorised vehicle, which should allow retail investors better access to illiquid assets while, at the same time, providing an appropriate degree of investor protection.

The idea of the LTAF was first put forward by the Investment Association in its Vision 2020 report of June 2019 and, critically, soon gained political backing. In November 2020, the UK’s Chancellor of the Exchequer made a commitment, in his Statement to the House of Commons that the UK’s first Long Term Asset Fund would be “up and running within a year”. The broader importance of such a scheme is recognised in the CP, which states “an ability to invest in illiquid assets, through appropriately designed and managed investment vehicles, is also important to supporting economic growth and the transition to a low carbon economy”.

The draft proposals should also be viewed in the context of HM Treasury’s recent Call for Input on its “Review of the UK Funds Regime” as the LTAF will form an important part of that future regime. Our response to the Call for Input is here.

Some key overview points from the FCA’s proposals are as follows:

• Fund liquidity is a key focus, with a recognition of the importance of matching a fund’s liquidity profile to that of its underlying assets.
• A move to (potentially much) less frequent liquidity opportunities for investors will require substantial operational changes.
• There is a clear focus on suitability for the “default” option of defined contribution pension schemes.
• Distribution of the LTAF will initially be restricted to professional and sophisticated retail investors within an “enabling” regime.

On the more detailed draft proposals:

• LTAFs will be established as a new category of authorised fund by way of a new chapter in the COLL sourcebook.
• Only a full-scope authorised UK AIFM may manage an LTAF, and there will be specific rules about undertaking due diligence on the LTAF’s investments (and disclosing how that will be done).
• Distribution to retail investors will be limited – perhaps (see below) beyond those investors as may currently invest in a QIS using the non-mainstream pooled investments (NMPI) rules, but the draft rules have been cast specifically to avoid hurdles to broader distribution if this is deemed appropriate in future.
• Strong governance is a priority. Independent representation on the governing body of the LTAF’s authorised fund manager (AFM) will be required (as for other authorised funds) and the manager must allocate responsibility for compliance to an approved person. There will also be a specific duty to assess and report on valuation, due diligence, conflicts of interest and liquidity management.
• Disclosure is also key and additional, LTAF-specific requirements will be created, with specific quarterly reporting obligations on key items. Specific disclosures for funds identifying as “sustainable, responsible or delivering some form of impact” are not specifically proposed yet, could be considered.
• Investment powers of an LTAF are to be broad, based on the QIS, with few restrictions on eligibility.
  • There must however be a “prudent” spread of risk – equivalent to a UCITS/NURS and a higher standard than the mere “spread of risk” applicable to a QIS. There will however be aa 24 month “ramp-up” period.
  • Investment in loans will be expressly permitted, subject to some limitations.
  • Funds-of-funds and investment into funds more generally is expressly envisaged and the prescriptive limits placed on other fund types are proposed to be replaced by a principle of avoiding “circular” investment.
  • Fund borrowing limits are to be set at 30% - a lower limit than is available to a QIS (100%) – but there is to be no limit on borrowing made by underlying investments.
• Valuations are noted as being important even where there is no prospect of redemption, and must be done externally unless a manager can demonstrate it has he “competence and experience” to handle these internally.
• As to liquidity, the FCA notes that they do not expect any LTAF to offer daily dealing. Further, they state “We do not propose setting detailed requirements as to how LTAFs should manage their liquidity, but to allow managers to choose liquidity tools that are appropriate to their investment strategy”. Further:
  • It is clearly envisaged that notice periods beyond 180 days may be applied.
  • Liquidity management tools such as long notice periods, deferrals and suspensions are permitted, but must be used with care (particularly suspensions, which are for “exceptional circumstances” only).
  • Whilst the prospect of a fully closed-ended, illiquid vehicle is not expressly envisaged, it would appear that something close to that model would be possible, in the form of a fund with clearly disclosed, but extremely limited liquidity although a truly closed-ended model would require certain amendments to primary legislation.
• Performance fees are clearly permitted, subject to disclosure requirements. There is also a direct cross-reference to possible changes to the charge cap and the related DWP consultation.

In addition the FCA have commented:

• There is no need to expressly permit the use of intermediate holding companies – if the fund prospectus permits their use and they meet the criteria on eligibility that already apply then that is sufficient.
• There will be no change to the rules relating to the registration of “non-custodial” assets in the name of the depositary.
• They will not at this stage commit to apply the one month authorisation service standard timeframe applicable to a QIS to an LTAF, but early engagement with the FCA is encouraged and this will be reviewed after one year.

Permitted Links – perhaps the most important target investor base for the LTAF has been identified as the DC pension schemes and there is discussion in the CP around how the LTAF might be integrated within the regulatory framework for investment by DC schemes in unit-linked long-term insurance products via amendments to the so-called “permitted links” rules. Those rules have been the subject recent change (PS 20/4) to address barriers to retail access to longer-term assets through unit-linked funds and the FCA looks in the CP to further address how those rules might be made to work better (and to clarify how those rules actually do work in one or two aspects).

Take up of the LTAF by default DC schemes will be critical to the success of the new vehicle and so this aspect of the CP will be of particular interest to respondents.

The proposals include lifting the 35% limit on illiquid investments where an LTAF forms part of the default arrangement of a pension scheme and relying instead on the insurer to provide risk warnings and to assess suitability for the underlying investors. Also proposed is a rule change (and associated guidance) to ensure that investments in LTAFs do not count towards calculation of the 35% limit itself, relying instead on the trustees of an occupational scheme (or the operator of a workplace scheme (the insurer or SIPP provider) to decide the proportion of the default arrangement that should be allocated to illiquid assets (including the LTAF).

Distribution – as mentioned, the FCA is seemingly open to arguments for opening up access to the LTAF beyond those who can currently access a QIS through the NMPI rules – broadly certified and self-certified sophisticated investors. The FCA acknowledges that there are concerns around how those rules (and associated guidance) operate in practice at present and has asked to understand those concerns from the industry in greater detail.

It has set out a number of options that they are considering for how retail access with appropriate investor protection might look. These include:

• reliance being placed on the “appropriateness” assessment regime that accompanies the promotion of other “complex” financial instruments;
• treating the LTAF as a “non-readily-realisable security (NRRS) rather than an NMPI (involving certification that the investor has not invested more than 10% of their net assets in NRRS in the previous 12 months and will not do so for the following 12 months);
• co-investment with institutional investors - placing reliance on the fact that an LTAF has a proportion of investment from institutional investors before it can be promoted to retail (hence benefitting from the intensive due diligence undertaken by institutional investors); and
• investment by retail through a Fund of Alternative Investment Funds (FAIF) which in turn invests in LTAFs.

These are interesting options – some (it has to be said) with limitations but it is clear that the FCA is open to discussion around how some form of retail access beyond current NMPI rules might be achieved with appropriate safeguards.

The Simmons view

Simmons & Simmons has long supported the development of a suitable regime which enables much broader access to long-term and productive capital vehicles.

We are actively represented on both the Steering Committee and Technical Expert Group of the Bank of England / HMT / FCA Productive Finance Working Group and have actively engaged with our clients on this topic, informing our responses to both the HM Treasury consultation on the tax treatment of asset holding companies (see our response here) and to its wider Call for Input on the future of the UK’s funds regime (please see here).

Whilst there is undoubtedly much to consider in the detail, and DC schemes will need to consider as a practical matter how to manage the relatively low liquidity and potentially higher charging structures offered by the LTAF as part of the wider default portfolio we welcome the proposals in the CP. The overarching approach of creating an “enabling regime” is the right one, and the adoption of principles rather than strict rules is appropriate given the breadth and nature of the underlying asset classes. The prospect of potentially very long notice periods and highly restricted liquidity is potentially very interesting for the traditional closed-end fund market.

Regulatory reform, of course, is not the end of the story.

As importantly, DC pension scheme trustees and other operators will need to be persuaded that investment for their default arrangements in the LTAF is not merely permitted but is also positively beneficial for their underlying investors notwithstanding higher associated costs which are attendant on this type of investment.

Getting the tax treatment right for LTAFs and, if permitted, any vehicles through which they invest and hold assets, will also be a crucial aspect if the regime is going to be successfully adopted by managers and investors. This will include resolving the question of the VAT treatment of management and related services provided by managers to LTAFs.