The UK Long-Term Asset Fund has arrived
Published on 1st Dec 2021
The authorised fund vehicle aims to ease access for institutional and other investors to illiquid asset classes, such as private equity and venture capital
Managers, investors and all those in tune with the UK’s asset management industry were greeted recently with the news that the Financial Conduct Authority (FCA) had finalised the rules for the new UK Long-Term Asset Fund (LTAF), initially consulted on in May 2021.
Targeted at institutional investors, particularly defined contribution (DC) pension schemes, as well as sophisticated and certified high-net-worth investors, the introduction of the LTAF may be a welcome development for parties seeking to unlock the investment potential of long-term illiquid asset classes within a structurally sound environment and appropriately designed vehicles.
The government highlighted in August, in an open letter to UK institutional investors calling for an "Investment Big Bang", the need to remove barriers to DC pension schemes including illiquid assets in their default investment strategies. The FCA has since accommodated many of the industry’s responses to its consultation on the scope of the long-term asset fund regime. Investment managers are now entitled, since 15 November 2021, to apply for authorisation of LTAFs, the regulator has confirmed.
The hope within government is that the new fund regime will assist economic recovery from some of the effects of Brexit and the Covid-19 pandemic by tapping into the vast sums held by UK pension funds more habitually invested in liquid assets, such as listed equities and bonds, and instead encouraging long-term horizon investment in higher risk, illiquid assets such as venture capital, private equity, private debt, real estate and infrastructure.
As these types of illiquid investment typically take longer to sell, the FCA’s published guidelines for the LTAF look to match how long it takes for a fund to sell these assets with the frequency and timing by which investors may redeem their holdings in a fund – all while retaining the characteristics of an open-ended vehicle.
The new LTAF, therefore, is a novel concept for funds professionals in the UK, moving against the conventional wisdom that long-term assets should only be held using closed-ended vehicle structures such as, for private funds, limited partnerships and, for listed funds, investment trusts. It aims to break down the real or "perceived barriers" important investor groups may feel towards these categories of investment, thereby creating new opportunities for improved returns and helping the UK to compete globally.
This was noted by Nikhil Rathi, chief executive of the FCA, who said: “We are supporting fresh collaborative thinking designed to improve the effectiveness of UK markets while protecting standards … If this innovative fund structure, created by our rules, is taken up by the asset management industry, it may provide alternative routes to returns for investors, while supporting economic growth and the transition to a low carbon economy.”
What does the LTAF look like?
The LTAF is an FCA-authorised fund that promotes long-term investment while maintaining appropriate safeguards and hallmarks of strong governance. Rather than locking away capital for specific periods, as is the case with most forms of investment funds focusing on long-term illiquid assets, LTAFs are open-ended funds. However, the nature of the illiquid assets intended to be held by the new structure dictates that LTAFs are not open-ended in the traditional and fluid sense. For this reason, LTAF managers are permitted to allow redemptions no more frequently than monthly. Furthermore, LTAFs have an obligatory 90-day notice period built into redemption provisions to provide managers with an element of liquidity management and fund security. This aspect of the new regime is certain to pose logistical challenges for some investors, such as DC schemes that generally prefer short-term access to committed funds, but has been deemed necessary by the FCA in order to enable schemes to better manage redemption flows (and is still a significant divergence from the terms of liquidity the managers of this kind of asset will be used to).
The range of FCA-authorised fund vehicles available to managers looking to establish an LTAF will be unit trusts, open-ended investment companies or authorised contractual schemes (ACS). Given the tax transparency of ACS, these structures may be the most favourable for those looking to pitch to DC investors.
Regarding governance, LTAFs are to be subject to the same non-mainstream pooled investment rules as qualified investment schemes. This means that they can, for the time being, only be marketed to professional clients and certain retail clients that pass assessments of appropriateness or suitability. The FCA does recognise though that with the additional protections in place, less sophisticated retail investors could be given the opportunity to participate in the regime in the future.
The guidelines also specify the necessary management mechanics for overseeing the regime. Authorised fund managers (AFMs) managing an LTAF will be required to be full-scope UK alternative investment fund managers holding the regulatory permission to manage an authorised alternative investment fund with the "appropriate knowledge, skills and experience of managing assets in the proposed asset class and be able to demonstrate this as part of the authorisation process." These firms must designate a senior manager within their staff with the responsibility of ensuring that the LTAF is managed in the best interests of investors and, in addition, must appoint at least two independent directors as per the requirements for all AFMs in the FCA's Collective Investment Schemes sourcebook.
Alongside strong governance, effective disclosure for LTAF products is demanded under the new regime. The FCA recognises that LTAFs, by their nature, may involve complex investment, charging methodologies and liquidity management strategies unfamiliar to most investors and so clear disclosure using plain language will be key to establishing a regime that investors can trust and in which they can place confidence.
The prospectus of an LTAF, for instance, will need to include worked examples to explain the fund's dealing processes and how such processes will apply to unitholders in practice. Disclosures on the due diligence process will also be included, covering how and why investments will be chosen by the fund in line with its investment strategy. Managers of an LTAF, depending on their internal competencies, will have the option to either use an internal or external valuer, thereby providing flexibility for different sizes of firm. For AFMs that choose to value in-house, the fund's depositary will have to make a determination that the AFM has the resources necessary to apply these processes effectively.
Finally, the new regime also lays down specifics relating to investment powers and borrowing restrictions for LTAFs. These rules follow the existing template applied to qualified investor schemes (QIS) but with some important differences. For instance, LTAFs should invest at least 50% of their holdings in assets deemed long term and illiquid. In following its investment strategy, an LTAF should also aim to provide a "prudent spread of risk" rather than simply a spread of risk as delineated for QIS. Only 30% of an LTAF's net asset value may be borrowed. This compares with a 100% comparative limit for QIS.
Osborne Clarke comment
While managers have been expressing interest in the new structure, it remains to be seen how many will actually take up the opportunity to launch an LTAF in the first wave this month, and, in particular, the profile of sponsors who are willing to support the associated liquidity requirements.
The appetite of pension schemes to invest in LTAFs is likely to depend on charges, particularly in light of the charge cap on pension funds. The rules for authorised funds do not contain any caps on fees, and the FCA is allowing the market to decide the appropriate structure and amount of any performance fees.
Moreover, changes to the charge cap are on the cards, which could have ramifications for LTAF take-up. The government announced in the Autumn Budget that it intends to consult later this year on amending the charge cap, considering options to amend its scope so it can better accommodate performance fees.