Private Fund Managers and Retail Investment in the UK and EU: Comparing the UK’s Long Term Asset Fund

The UK Financial Conduct Authority (FCA) has just announced its first authorisation of a Long Term Asset Fund (LTAF). We have written about the FCA’s increased focus on continuing access by retail investors to wholesale or private funds, whilst ensuring that managers have proper regard for the vulnerability of those investors. This policy focus has arisen in part in the context of the new financial promotion rules, as covered in our previous alerts The Remaining New Financial Promotion Rules for UK Private Fund Managers: Less Than a Month Away and New Risk Warning Rules for UK Private Fund Managers: Action Required, and the consumer duty covered in both The UK Consumer Duty: Next Steps For Private Fund Managers and The UK Consumer Duty: The FCA’s Reminder for Private Fund Managers. In addition, development of the LTAF, in a similar vein to its EU counterpart, the European Long-Term Investment Fund (ELTIF), is an important further step towards the ‘retailisation’ of investments that would otherwise be available only to professional investors. The LTAF, like the ELTIF, offers managers of private funds a distinct and more tailored way of accessing retail investors.

Whereas the FCA rules on financial promotion focus on direct retail access to private funds, the LTAF provides a form of indirect access via an authorised open-ended fund vehicle. The use of a fund vehicle authorised by the FCA, in contrast to a private fund vehicle such as an unregulated limited partnership, which does not itself have to be FCA-authorised (although its manager typically does, as an alternative investment fund manager [AIFM]), is typical for retail investors.

In this briefing, we put the LTAF under the spotlight, including examining how its key features compare with European competitor vehicles — the ELTIF, Luxembourg Undertakings for Collective Investment (UCIs – Part II), and EU Undertakings for Collective Investments in Transferable Securities (UCITS). We also weigh the LTAF against other UK authorised vehicles on offer alongside the LTAF: a non-UCITS retail scheme (NURS) and a qualified investor scheme (QIS). The LTAF, QIS, and NURS are regulated by the FCA, must adhere to detailed FCA regulatory requirements, and follow the FCA principles for business.

Introducing the LTAF

Available since November 2021, the LTAF is an open-ended authorised fund structure that can invest in a full range of illiquid asset classes. With news of the first LTAF FCA authorisation on 9 March 2023 and several other firms reportedly having formally applied to launch one (and many more exploring a launch), LTAFs are now a reality. The uncompetitive six-month FCA authorisation timescale (which compares negatively with other UK authorised vehicles) may well be outweighed by the UK government’s focus on a broader distribution of the LTAF. Along with the revamped ELTIF (covered in ELTIF Reform: A Milestone in the Development of an EU Private Fund Structure for Accessing Wholesale Markets), we would expect the number of LTAF launches to increase as managers targeting retail investors become more convinced of its benefits.

Key features of the LTAF

• At least 50% of the value of the scheme property is expected to be invested in long-term illiquid investments (i.e., unlisted securities, interests in immovables or indirect interests in such long-term assets via other collective investment schemes [CIS]). Investment by LTAFs is not strictly limited to assets commonly regarded as ‘productive finance’, and the rules do not attempt to define ‘productive finance’ or ‘illiquid assets’.
• Only full-scope UK AIFMs can act as authorised fund managers (AFMs) of LTAFs, and they must demonstrate to the FCA that they possess the necessary expertise for the proposed investment strategies (whether or not they intend to delegate).
• One of the main appeals is that LTAFs can be promoted to certified high-net-worth individuals, as well as sophisticated retail and professional investors and certain defined contribution (DC) pension schemes. This is set to be broadened — an August 2022 FCA consultation is proposing to extend the LTAF’s investor base to restricted retail investors (up to 10% of their investable assets, and subject to certain conditions being met). The proposals are aligned with the changes to the financial promotion rules for ‘high risk investments’. In addition, from Spring 2023 the government intends to exempt performance fees from an annual 0.75% cap on annual charges that can be levied on auto-enrolled pension savers, which will again broaden investment opportunities for DC pension schemes.
• To cater to regulatory concerns around liquidity mismatch, the final rules introduced new specified minimum standards that require LTAFs to permit redemptions no more frequently than monthly, and to have at least a 90-day notice period on redemption.
• The FCA rules on mandatory suspension of dealings where there is material uncertainty about the valuation of at least 20% of scheme property (that applied from September 2020 under the FCA Policy Statement PS19/24 on illiquid assets and open-ended funds) do not apply to LTAFs (or QIS). However, the AFM of the LTAF can, with the prior agreement of the depositary, and must without delay, if the depositary so requires, temporarily suspend dealings of units, where due to exceptional circumstances it is in the interest of all the unitholders.
• Investment powers are similar to those of the QIS — certain specified investments, including immovable assets and commodities. LTAFs can also invest in loans (with some restrictions; e.g., an LTAF cannot make loans to natural persons or to the AFM, depositary, or their associates).
• Various investment restrictions apply (mirrored on the QIS). For instance, the LTAF cannot invest more than 20% in QIS, other LTAFs or unregulated schemes unless the AFM has carried out due diligence and the CIS or other schemes comply with the relevant legal and regulatory requirements (on an ongoing basis). A principles-based requirement applies to the AFM to ensure that the scheme does not indirectly invest in itself (this is more flexible than the QIS restriction that no more than 15% of the fund value can be invested in underlying funds of unregulated CIS).
• The prescribed Senior Managers and Certification Regime (SMCR) governance responsibilities (namely, assessment of overall value, requirement for independent directors on AFM boards, and acting in investors’ best interests) will apply to AFMs of LTAFs. In addition, an AFM must appoint an approved person to assess and report on the LTAF’s investment valuations, due diligence, conflicts of interest, and liquidity management. We will need to monitor any changes to these requirements given that the SMCR is subject to review.
• In addition to the half yearly and annual reporting requirements for AFMs, an LTAF’s AFM must deliver quarterly updates to investors: to cover portfolio investments, including details of any transactions during the period (together with an explanation of how the transaction is consistent with the LTAF’s investment objectives, policy, and strategy) and any significant developments in the investments for which investors require reasonable notice.
• An AFM need not appoint an external valuer if the depositary has determined that the AFM has the resources and procedures for carrying out asset valuation. An external valuer is also required for an LTAFs that invest in other CIS or AIFs.
• The FCA notes that in some cases (i.e., real estate assets), it is not workable for the depositary to hold scheme property, and the authority intends to consult on changes (in line with the Alternative Investment Fund Managers Directive [AIFMD] ownership model. which has a carve-out for noncustodial assets, but with appropriate protection for retail investors). In the meantime, it will consider applications to modify or waive the LTAF custody requirements, but only if it is satisfied that any alternative custody mechanism provides sufficient protection for investors. Depositaries will not have a role in overseeing the value assessment.
• LTAFs must publish monthly valuations, regardless of their dealing policy.
• The AFM of the LTAF must ensure that the scheme property of the LTAF aims to provide a prudent spread of risk (a higher threshold than for the QIS spread of risk). There is no ramp-up period for this rule to apply.

The LTAF: Key features

Comparing the LTAF with related EU vehicles

Comparing the LTAF with related UK vehicles

Comment

The developments in the LTAF and the ELTIF in particular will, in our view, help shift the emphasis of discussions about private capital’s place in the retail investor market, away from costs alone and towards a more holistic consideration of the long-term returns and diversification benefits. There are various other investment structures that are used to accommodate wholesale clients investing in alternative assets. Examples include closed-ended listed investment companies, evergreen funds with fixed liquidity windows to align with the investment cycle of less liquid assets, and using aggregation feeders and dedicated funds to target high-net-worth investors. In addition, non-fund options include bespoke investment management arrangements. The details of these options are beyond the scope of this alert.

You may be interested in our other recent briefings for private fund managers: Horizon Scan for Private Investment Funds: Key Recent and Expected Funds, Regulatory and Tax Developments to Look Out For, and AIFMD II Gathers Momentum: The European Parliament Finalises Its Proposed Text

To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.