The FCA’s Final Rules For LTAFs: Distribution To Mass Market Retail Investors

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

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 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.