Following its August 2022 consultation on the broader retail distribution of interests in a Long Term Asset Fund (LTAF), the FCA published its Policy Statement PS23/7 including final Handbook rules on 29 June 2023.
These changes take effect straight away on 3 July 2023 (and for the existing handful of LTAFs, there is a 12 month transitional period which will require compliance by 3 July 2024, or sooner if fund documents are updated).
As anticipated, units in an LTAF are to be recategorised from Non-Mass Market Investments (NMMI) to Restricted Mass Market Investments (RMMI). This extends the LTAF’s investor base to include restricted retail investors such as self-select defined contribution (DC) pension schemes and Self-Invested Personal Pensions (SIPPs) (up to 10% of their investable assets and subject to certain conditions being met).
Therefore eligible investors in an LTAF from now on include:
- professional investors
- certified and self-certified sophisticated retail investors
- certified high-net worth investors
- DC pension schemes (whether by way of a professional investor, using a unit-linked insurance wrapper or being self-selected)
- SIPPs
On top of the ability for pension scheme trustees to be able to exempt the performance-based element of investment management fees from an 0.75% cap on annual changes, this puts the LTAF firmly on the roadmap as a fund structure for UK AIFMs that choose an FCA-authorised vehicle and seek to access DC pension wealth.
In this briefing, we examine the updates to the LTAF regime under the Policy Statement. We also take another look at 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). This includes weighing the LTAF against other UK authorised vehicles on offer alongside it: 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.
Distribution categorisation
The LTAF was initially launched as a Non-Mainstream Pooled Investment (NMPI), being a sub-category of the high-risk investment NMMI category. The FCA decided that the RMMI was a more appropriate category for the LTAF (and in so doing, distinguishing the LTAF from the QIS, that is to remain a NMPI), noting the LTAF’s strict regulatory requirements - including strong governance and disclosure rules, the requirement for it to employ a prudent spread of risk, and for it to be managed by a full-scope UK AIFM.
Investors to have a sound understanding of risks of investing in an LTAF
Recategorisation to RMMI means that firms marketing LTAFs to retail investors will need to:
- provide risk warnings and summaries: in the final rules these focus more on liquidity risk (the FCA opined that the version consulted on overemphasised investment risk and could mislead potential LTAF investors)
- conduct an appropriateness assessment for all retail investors (although note that the LTAF is not subject to the 24 hour cooling off period that applies for other RMMI products); advised clients will be subject to a suitability assessment instead of an appropriateness assessment
- require unadvised retail investors to confirm that their exposure to investments subject to the RMMI rules (including LTAFs) is limited to 10% of their investable assets. This involves a declaration that the investor has not in the last 12 months (and will not in the next 12 months) invest more than 10% of their net assets in RMMIs. Net assets for these purposes does not include someone’s primary residence, pension or rights under qualifying insurance contracts
A firm will also have to consider the Consumer Duty’s rules and guidance, including under the consumer understanding outcome, when developing their approach. Included in the Policy Statement is an FCA request for views (by 10 August 2023) on whether or not the Financial Services Compensation Scheme should apply to investments in an LTAF.
Retail investor protection rules
There are additional rules to provide further protection for mass market retail investors – and which only apply to LTAFs open to mass market retail investors. They do not apply to LTAFs (or classes of units) for the newly-defined ‘limited protection LTAF class,’ being those LTAF only intended for professional, certified HNWI, certified sophisticated, or self-certified sophisticated investors. For LTAFs that are not ‘limited protection LTAFs’ the following rules apply:
- full engagement with unitholders about any proposed fundamental or significant changes to the fund, including rules on change events relating to feeder LTAFs
- arrangements for the conduct of unitholder meetings
- arrangements for the register of unitholders
- restrictions on what types of payments and charges can be taken from LTAF unit classes made available to retail clients
- regular investor updates to be provided in the event of a suspension of dealing
Broadening pension scheme distribution
The rules introduce some fine-tuning of how the pension scheme coverage will operate in practice.
- Self-select DC scheme exposure limit: the exposure limit for self-select DC scheme investors is the higher of 10% of the consumer’s pension value within that scheme or the exposure deemed appropriate within the default arrangement of the same qualifying scheme when investing in the same LTAF
- Non-advised investors: the FCA has expanded distribution to include non-advised investors in long term unit-linked products including non-workplace schemes and non-qualifying workplace schemes
- 35% illiquid assets limit: the final rules remove the 35% restrictions on illiquid assets within unit-linked fund structures within the default arrangement of a qualifying scheme, in line with the policy intent of the consultation (and the LTAF exemption)
- LTAF classified as a non-standard asset when used within a SIPP: this means that the relevant SIPP will have to hold additional capital, in order to provide additional protection for consumers and given the LTAF 90 day notice period
- Notification of Illiquidity: consumers with exposure to LTAFs in self-selected pensions or SIPPs should receive a notification alerting them to the illiquid nature of their holdings as they approach retirement age
Fund-of-funds exposure limits
The Policy Statement introduces some changes to the investment restrictions applicable to NURS investing in an LTAF. A NURS Fund of Alternative Investment Funds (NURS FAIF) can invest up to 35% of the value of its scheme property into a single LTAF, but only more than 50% of its scheme property in LTAFs where the NURS FAIF operates limited redemption arrangements (i.e. less frequently than twice a month and in accordance with COLL) to manage the liquidity mismatch. The NURS FAIF must be satisfied that the liquidity, redemption policies and dealing arrangements of any LTAF(s) (along with other assets) in which the NURS FAIF invests allows it to meet its redemption obligations.
The LTAF: Key features
| Vehicle | Overview | Key points of interest | Vehicle Regulation |
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Long Term Asset Fund: an FCA- authorised open-ended fund vehicle An LTAF is based on a QIS (see below) and can invest in a range of permitted investments, including real estate and loans. |
The investment strategy of an LTAF must be to invest mainly in long-term illiquid assets. The EU legislation on the ELTIF (see below) has been repealed in the UK (under the Financial Services and Markets Act 2023), given the lack of take-up in the UK and the option of the UK-specific LTAF. The borrowing limit of an LTAF is 30% of NAV. |
LTAFs are intended for:
DC pension schemes have the option to invest in funds featuring carried interest or performance fees. |
Only full-scope UK AIFMs can act as AFMs of LTAFs, and they must demonstrate to the FCA that they possess the necessary expertise and skills for their proposed investment strategies (whether or not they intend to delegate). An LTAF cannot offer redemptions more frequently than once a month and is subject to a mandatory notice period of at least 90 days for redemptions. |
Comparing the LTAF with related EU vehicles
| Vehicle | Overview | Key points of interest | Vehicle Regulation |
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European Long-Term Investment Fund: an EU-regulated closed-ended fund (with the option to be semi open-ended) The ELTIF is a collective investment framework for both professional and retail investors looking to invest in long-term illiquid assets such as real estate and infrastructure projects. |
Available since December 2015, a European Long-Term Investment Fund (ELTIF) is a collective investment framework for both professional and retail investors looking to invest in long-term assets. A review of the ELTIF Regulation was finalised in March 2023 and the amending regulation (the introduction of the ‘ELTIF 2’) entered into force on 9 April 2023 and applies 9 months later (i.e. from 10 January 2024). Under the amended Regulation, ELTIFs solely marketed to institutional investors can borrow up to 100% of the net asset value of the ELTIF (and up to 50% for ELTIFs marketed to retail investors). |
Helpfully, the amending Regulation reduces barriers for retail investors (by removing the €10,000 initial investment requirement and 10% exposure threshold for retail investors with portfolios below €500,000) and aligns the suitability test with that of the Markets in Financial Instruments Directive II. There is also clear differentiation between ELTIFs to be marketed exclusively to professional investors and those that are marketed to retail investors. For instance, provisions on diversification and concentration are disapplied for ELTIFs marketed only to professional investors. The ELTIF marketing passport extends to both retail and professional investors. |
An ELTIF is subject to AIFMD. The aim of the amendments is to make ELTIFs more appealing to investors, in particular retail investors; minimise restrictions and reduce barriers; and provide more flexibility and accessibility to the regime and more favourable redemption options. The Level 2 RTS under consultation will repeal, replace and consolidate the original ELTIF RTS of December 2017. They include details on an ELTIF’s redemption policy, liquidity management tools, and circumstances for the use of secondary market matching, information to be disclosed to investors and to the member state regulators, use of hedging derivatives, and on disclosure of costs (including a requirement to disclose an overall ratio of the costs to the capital of the ELTIF). |
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Luxembourg Undertakings for Collective Investment (UCIs – Part II) Part II UCIs are subject to the provisions of the second part of the Luxembourg 2010 law transposing the UCITS Directive. |
A Part II UCI must invest capital based on the principle of risk spreading and the 2010 law and other Commission de Surveillance du Secteur Financier (CSSF) regulations provide for specific restrictions. There are no restrictions with respect to eligible assets (unlike in the case of UCITS). Borrowings of up to 25% of net assets are allowed without any restrictions. |
A Part II UCI can be marketed to professional investors in the EEA under the AIFMD passport and can be offered to retail investors in Luxembourg. It should be noted, however, that a number of EU jurisdictions allow Part II UCIs to be marketed to their retail investors under applicable private placement regimes. There are various safeguards in place when a Part II UCI is marketed to retail investors. |
A Part II UCI is subject to AIFMD. The risk diversification requirements are defined by IML Circular 91/75 and 02/80 — the requirements are less stringent than the ones applicable to UCITs. A Part II UCI can’t invest more than 20% of its net assets in securities issued by a single issuer. |
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Undertakings for Collective Investments in Transferable Securities (UCITS): an EU regulated open-ended fund UCITS are subject to the provisions of the EU UCITS Directive. |
A UCITS must invest capital collected from the public in transferable securities based on the principle of risk spreading. A UCITS cannot invest in real estate or other physical assets. The basic rule is that UCITS are not permitted to borrow, although member states can authorise limited borrowing. |
UCITS can be marketed to all EU investors (including retail clients). A UCITS has various investment restrictions, for instance on investment in property, investment limits, and risk spread and on redemptions, suspensions, and pricing. There is a UK UCITS regime. |
Subject to the regulation of the UCITS Directive (which includes conditions on the authorisation of the UCITS management company). The UCITS regime is separate from that of AIFMD. |
Comparing the LTAF with related UK vehicles
| Vehicle | Overview | Key points of interest | Vehicle Regulation |
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Non-UCITS Retail Scheme (NURS): an FCA- authorised open-ended fund vehicle Subject to some limitations, a NURS can invest in real estate and unregulated schemes. |
The NURS appeals to those wanting to access the broad retail market. It comes with more regulatory compliance than for either the QIS or LTAF. A NURS also has a borrowing limit of 10%. |
NURS can be marketed to UK investors (including retail clients). |
A NURS is subject to AIFMD. A NURS has several investment restrictions, for instance on investment in property, investment limits, and risk spread, and on redemptions, suspensions, and pricing. |
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Qualified Investor Scheme (QIS): an FCA- authorised open-ended fund vehicle A QIS can invest in a range of permitted investments, including real estate. |
Institutional investors prefer the QIS (the less regulated alternative to the NURS). As stated above, the LTAF offers a broader investor base than the QIS. The borrowing limit of a QIS is 100%. However, the QIS is subject to various restrictions in its investment strategy and powers. |
QIS are intended only for professional clients and for retail clients who are sophisticated investors. FCA guidance states that the promotion of units in a QIS to a retail client who is not a certified sophisticated or a self-certified sophisticated investor is unlikely to be appropriate or in the client’s best interests. |
A QIS is subject to AIFMD. |
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 other recent topical briefings: Private Fund Managers and Retail Investment in the UK and EU: Comparing the UK’s Long Term Asset Fund, ELTIF Regulation regulatory technical standards (RTS): Important detail in the ESMA consultation and Horizon Scan for Private Investment Funds: Key Recent and Expected Funds, Regulatory and Tax Developments to Look Out For.
To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.
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Andrew Henderson
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