Broadening retail access to LTAFs – the FCA’s proposals

On 1 August 2022, the FCA published a consultation paper, CP 22/14, "Broadening retail access to the long-term asset fund" (the CP).

What’s the background to the CP?

As we reported last year, the FCA launched the new Long-Term Asset Fund (LTAF) with effect from November 2021.

The LTAF is a category of authorised open ended fund specifically designed to facilitate investment in long term, less liquid asset classes such as venture capital, private equity, private debt, real estate and infrastructure. The liquidity profile of such assets is not suitable for open ended funds that offer daily dealing and the LTAF must deal no more frequently than monthly with not less than 90 day notice periods.

At the time that the LTAF rules were first introduced, the FCA was of the view that wider access for retail investors should be considered within its broader review of the financial promotions regime for “high risk investments”.

This work has since progressed and, at the same time as it published the CP, it set out new rules under policy statement PS 22/10 “Strengthening our financial promotion rules for high risk investments and firms approving financial promotions” (the PS).

Given the FCA’s original decision - as a first step - to categorise LTAF as a non-mainstream pooled investment (NMPI), distribution of LTAFs was restricted to professional investors (such as DC pension schemes), certified sophisticated retail investors and certified high net worth individuals rather than to retail investors more broadly.

However, the FCA noted at the time “we remain open to potentially further broadening the base of investors who can access the LTAF in a controlled way” and confirmed it would consult in 2022 on the broadening the base of retail investors who can access the LTAF.

The CP makes good on that promise and makes a number of proposals on which the FCA seeks the views of stakeholders.

The consultation period closes on 10 October 2022.

For our summary of the rules on LTAFs on which the FCA consulted in 2021, see our article here.

The CP was 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.

What is the FCA proposing to change?

Proposals to broaden retail investment coverage

As mentioned above, the LTAF was initially categorised as an NMPI, and so would be included in the Non Mass Market Investments (NMMI) product category under the proposed new financial promotions regime proposed in the PS.

This currently puts the LTAF alongside the Qualified Investor Scheme (QIS), which is restricted to professional investors and “sophisticated retail” investors but does not reflect the fact that the LTAF has a higher level of investor protection and governance than the QIS .

Given this additional level of protection , the FCA considers that “there are sufficient controls to ensure that those retail investors [to whom we propose LTAFs can be promoted] are made aware of the risks and are assessed as being well placed to deal with them. We therefore think it is appropriate to allow retail access to the LTAF in a controlled way and as part of a diversified investment portfolio”.

• Recategorise the LTAF as a Restricted mass market investments product

  To broaden the investor base of LTAFs, the CP sets out proposals to recategorise the LTAF as a “restricted mass market investment" or “RMMI” (in line with the FCA’s rules under PS22/10), rather than being a NMMI.

  This would mean that, as well as the high net worth and certified sophisticated retail investors which already have access to LTAFs under their current classification as an NMPI (and now NMMI), all retail investors will be able to invest up to 10% of their investable assets into LTAFs (or other RMMI products) in aggregate.

  Classification as an RMMI would also enable LTAFs to be generally mass‑marketed. If a firm wanted to move beyond general mass marketing and the prospective investor does not receive a personal recommendation, then the Direct Offer Financial Promotion (DOFP) rules apply - see the PS for detailed guidance on how firms should apply the DOFP rules.

• Risk warnings

  The CP proposes a specific risk warning for the LTAF, which would include specific references to the investment being “high risk” in relation to investment horizon, liquidity and redemptions - the rules around how such a risk warning must be displayed are aligned with the new RMMI requirements introduced under the PS (see COBS 4.12A and COBS 4 Annex 1R).

  The CP provides further information about the warnings and risk summary template that the FCA is putting forward.

• Amending rules around NURS FAIFs

  The CP proposes to amend the FCA rules governing Non‑UCITS Retail Schemes (NURS) which are set up as funds of alternative investment funds (NURS FAIFs) to allow investment up to 35% of net asset value into units of a single LTAF and up to 50% in aggregate in LTAFs.

  The FCA is looking to apply an upper investment limit of 50% of a FAIF into LTAFs in order to stay under the threshold for the Funds with Inherently Illiquid Assets (FIIA) rules but welcomes views on this point as to
  whether an upper limit should be set and, if so, what that limit should be.

  In light of the level of investor protection already inherent in the rules for LTAFs, the FCA proposes to switch off the so-called “enhanced due diligence” rules under COLL 5.7.9R(1) and (2) for FAIFs investing into units of LTAFs

• Fund regulation rule changes

  The FCA’s proposals would require firms marketing LTAFs to restricted investors to disclose in their prospectus how the manager will manage the fund where liquidity issues arise.

  The FCA also proposes to increase protections for retail fund investors by aligning the LTAF more closely with the rules for NURS and UCITS, no doubt to reflect the proposed greater level of retail access. For example, the FCA proposes introducing more specific rules on notification of fund changes, conduct of unitholder meetings, unitholder registration, fees and fund suspension

Broadening pensions scheme coverage

The CP also contains proposals to amend the permitted links rules for unit linked products to extend the distribution of LTAFs and other illiquid assets to members of Defined Contribution (DC) pension schemes.

These changes would

• permit wider distribution of LTAFs via self select options in qualifying schemes, subject to similar protections to those that currently apply to default arrangements
• extend distribution of LTAFs where investors in a long term, unit linked product have appropriate professional support on fund selection and
• give equivalent status to that currently afforded to LTAFs via the permitted links rules to other illiquid assets where the unit linked product is part of the default arrangement of a qualifying scheme

The existing 20%/35% cap on illiquid investments within any unit linked fund has long made it difficult for firms trying to market funds that invest in illiquid assets to DC schemes.

The permitted links rules were changed by the FCA to remove the 35% limit for LTAF linked funds that form part of the default arrangement of a qualifying scheme. However, requirements on insurers to provide risk warnings and ensure that the fund is suitable for the ultimate investors were retained.

So that the proposals applied only to default arrangements, conditional permitted LTAFs were introduced and made available only in relation to default arrangements – this meant that an LTAF was not available to retail investors investing outside a qualifying scheme’s default arrangement.

Investment in LTAFs via unit-linked funds above the 35% limit at the moment applies only in respect of default arrangements in qualifying schemes, such that investment in LTAFs is not currently available to either self-select options available to members of a qualifying scheme or for workplace pensions that are not a qualifying scheme or for non-workplace personal pensions.

The 35% limit continues to apply for the other investments that a default arrangement may make in other conditional permitted links.

In light of feedback to its previous work, the FCA has now decided to consult on

• broadening distribution of LTAFs in qualifying schemes to self‑select options, subject to guidance which states that the insurer must satisfy itself that protections are in place to prevent investors from over‑exposing themselves to the LTAF‑linked fund and
• extending the distribution of the LTAF more widely where investors in a long‑term unit‑linked product have appropriate professional support on fund selection. This change would cover investors both in non‑workplace pensions and in workplace pensions that are not qualifying schemes. Such investments would only be possible outside qualifying schemes for advised investors, but the FCA notes that it is “open to suggestions that ensure an equivalent level of consumer protection as part of the consultation process”.

What does Simmons think?

We support the FCA’s proposals as a proportionate way of expanding retail access to the LTAF in the broader context of the FCA’s revised retail financial promotions regime. Although we regard the proposals as a significant step towards the democratisation of private assets, we would also hope (despite the FCA’s silence on the issue) to see further progress made by HMRC in developing the ISA regime to allow investment in the LTAF as part of a “long-term ISA”.

The asset classes in which an LTAF may invest offer important sources of long term investment diversification. Rather than being reserved for investment by so-called “sophisticated” retail or those with significant investment portfolios, the proposals will allow access for the mass retail market with appropriate safeguards so that, importantly, retail investors will be warned about the risks and will not be able to invest more than 10% of their investable assets.

In moving the LTAF towards greater retail distribution, the (perhaps, inevitable) pay-off is an increase in detailed regulation to put the LTAF on a par with other retail vehicles, the NURS and UCITS. This brings with it more meaningful “democratisation” of private assets together with a level of prescription that might not be as attractive for products that are aimed solely at DC or the professional investor.

The FCA has not proposed the option of establishing either a “retail LTAF” or a “professionals LTAF”, as we see with the EU ELTIF regime. If a vehicle is intended as a “Professionals only” offering aimed only at DC, on the proposals as they stand, it will have to adopt a level of prescription that is arguably more suited to a retail product. This seems an issue that might warrant further consideration.

The proposed categorisation of LTAFs as “high risk” is interesting – even though LTAFs could be invested in less risky assets than, for example, a daily-dealing listed equities fund, the fact that LTAFs will deal less often seems, in the FCA’s mind, to trump the portfolio risk. Again, a point worth watching as the proposals are developed in light of feedback.

The proposals also use the concept of the “restricted investor”, allowing full access (with appropriate safeguards) to retail rather than just through high net worth and private wealth networks. Again, we support the more meaningful “democratisation” of private assets which this should produce.

The key to making the proposals work for retail distributors, though, is to make the process of certification and delivery of relevant risk warnings work as smoothly as possible, using technology where possible to streamline that process.

That said, in respect of the use of risk warnings and the 10% self-certification as a restricted investor, the devil will be in the detail – how will (or, indeed, can?) these proposals be assimilated into the sales and distribution process using technology to enhance the investor “journey” in a way that does not detract from the importance of key messages.

What happens next?

The consultation closes on 10 October 2022.

The FCA will consider replies received and intends to publish final rules ‘early in 2023’.

We understand that the FCA is also intending to publish a paper on pricing for LTAF to encourage certainty among investors and product providers as to how FCA expect LTAF to price.