The UK's new Long-Term Asset Fund – what do you need to know?
The FCA has recently published its consultation on the creation of the "long-term asset fund" ("LTAF"), a new authorised fund regime in the UK for investing in long-term investment assets/productive finance (such as venture capital, private equity, private debt, real estate and infrastructure).
The LTAF is an intriguing proposition. It is the first proposed change to the UK's fund regime after Brexit and there are a number of convergences: retail investors and asset classes that have to date been considered suitable only for institutional/professional investors; an open-ended fund investing in illiquid assets; and regulated funds and liquidity management tools that have historically been available only to their unregulated counterparts.
An L-what?
LTAF. Not to be confused with the ELTIF (the European Long-Term Investment Fund, which has had limited take-up) or the LTIF (the UK's Long-Term Investment Fund, which was derived from the EU's ELTIF regime).
Regulation
A LTAF will need to be authorised by the FCA and will have its own chapter of rules within the FCA handbook (COLL 15).
LTAFs will be alternative investment funds and only firms authorised as full-scope UK alternative investment fund managers (AIFM) with the appropriate permission will be permitted to manage LTAFs.
In line with the requirements for AIFMs operating UK authorised funds, the AIFM of a LTAF must ensure that at least one quarter of the members of its governing body are independent natural persons. If the governing body comprises fewer than eight members, the AIFM must instead ensure that at least two of its members are independent natural persons.
The FCA will seek to authorise LTAFs in between 1 to 6 months and it is encouraging those applying for authorisation to engage with it directly prior to submission of the application.
We expect that early applications will require a number of discussions with the FCA around various topics, particularly the liquidity management tools that the LTAF wishes to be available.
A LTAF will need to appoint a depositary.
What legal form can a LTAF take?
A LTAF can be an ICVC (an investment company with variable capital), an AUT (an authorised unit trust scheme) or an ACS (an authorised contractual scheme, which can take the form of a co-ownership scheme or a limited partnership scheme).
It should be noted, however, that an ACS LTAF will require a minimum investment of £1 million from a non-professional investor.
Who can invest?
The main objective of the LTAF regime is "[t]o encourage UK pension funds to direct more of their half a trillion pounds of capital towards [the UK's] economic recovery" and "to enable investors, particularly Defined Contribution (DC) pension schemes, to more confidently invest in illiquid assets (such as venture capital and infrastructure) than they can using existing fund structures".
DC pension schemes are expected to rise to over £1 trillion in assets by 2030.
In addition to professional investors, however, it is proposed that a LTAF may be marketed to "certified sophisticated investors" and (following a preliminary assessment of suitability conducted by the firm promoting the investment) "self-certified sophisticated investors" and that these investors may invest in a LTAF.
A "certified sophisticated investor" is a person who meets the requirements set out in article 23 of the Promotion of Collective Investment Schemes Order, in article 50 of the Financial Promotions Order or in COBS 4.12.7 R.
A "self-certified sophisticated investor" is a person who meets the requirements set out in article 23A of the Promotion of Collective Investment Schemes Order, in article 50A of the Financial Promotions Order or in COBS 4.12.8 R.
A LTAF may be available to other retail investors in accordance with COBS 4.12, although the FCA's view is that the promotion of a LTAF to "a retail client who is not a certified sophisticated investor or a self-certified sophisticated investor is unlikely to be appropriate or in the client’s best interests".
The "retailisation" offered by the LTAF is pretty limited, although in the consultation, the FCA does ask questions about whether, and how, it can safely permit future wider retail access to LTAFs.
Investment powers
The LTAF's manager must ensure that, taking account of the investment objectives, policy and strategy of the LTAF, the scheme property of the LTAF aims to provide a prudent spread of risk. This is the standard expected of a UCITS or a Non-UCITS Retail Scheme (NURS). A Qualifying Investment Scheme (QIS) simply has to have a spread of risk. The FCA proposes that LTAFs should have 24 months to achieve a prudent spread of risk.
The investment strategy of a LTAF must be to invest mainly in long-term illiquid assets. The FCA would expect LTAFs to invest mainly (more than 50% of the value of the scheme property) in unlisted securities and other long-term assets such as interests in immovables or other collective investment schemes investing in such securities or long-term assets. However, a LTAF could have a strategy of investing mainly in a mix of unlisted assets and listed but illiquid assets.
Subject to the above, LTAFs will have wide investment flexibility. The FCA plans to enable LTAFs to invest in a range of long-term illiquid assets, with few restrictions on eligible investments.
Like a QIS, a LTAF may invest in certain specified investments under the Regulated Activities Order, as well as certain types of immovable assets and commodities. Unlike a QIS, however, a LTAF will be permitted to invest in loans (with some restrictions) including investment in direct lending as part of a lending syndicate.
A LTAF will be able to invest in certain other collective investment schemes (CIS) without the restrictions faced by a QIS where managers have to establish that a CIS will not invest more than 15% of its assets into other CIS.
Borrowing
The maximum level of borrowing will be 30% of a LTAF's net assets, which is in contrast to 10% for a NURS and 100% for a QIS.
The FCA does not intend to set specific limits on the aggregate borrowing of underlying investments.
Valuation
The AIFM of a LTAF will have to appoint an "external valuer" (in accordance with AIFMD rules) unless it can demonstrate that it has the competence and experience to value assets of the type in which the LTAF invests. The FCA suggests that it will be for the depositary, during the authorisation application process, and on an ongoing basis, to assess the manager's competence to value the scheme's assets.
As with a NURS, the LTAF's assets will have to be valued at least monthly.
The UK's AIFMD rules provide "[i]rrespective of any contractual arrangements that provide otherwise, an external valuer is liable to the AIFM of an AIF in respect of which the external valuer is appointed for any losses suffered by the AIFM as a result of the external valuer's negligence or intentional failure to perform its tasks".
This provision has hindered the appointment of external valuers by AIFs and, given the nature of the LTAF's assets and the potential liability involved, we do not expect many external valuers to throw their hats into the ring.
Liquidity management
Rather than being prescriptive or prohibitive, the FCA, thankfully, is proposing to allow managers to work with their advisers to choose the liquidity tools that are appropriate to their investment strategy.
The FCA refers to notice periods on redemptions and subscriptions, the ability to defer redemptions, and the ability to limit the amount of the fund that could be redeemed at any dealing point but notes that a LTAF should not expect to use, nor rely on, suspension as a means of managing fund liquidity in the normal course of events.
The draft rules also refer to minimum holding periods, in kind redemptions, dilution levies or adjustments to sales and redemptions of units and the use of side-pockets.
The FCA expressly notes that some funds may choose to have long notice periods, potentially in excess of the 90‑180 days it recently proposed for property funds.
It should also be noted that the FCA states that "managers may need to make additional agreements with [DC] investors to deal with liquidity events".
Crucially, LTAFs need to be open-ended. The draft rules provide: "The maximum period between dealing days for a long-term asset fund will depend on the reasonable expectations of the target investor group and the particular investment objectives and policy of the scheme. For instance, for a scheme aiming to invest in large infrastructure projects, the expectation would be that it is reasonable to have a longer period between dealing days for liquidity reasons".
The full range of liquidity management tools appears to be available in order to structure the LTAF's terms properly. Clients who manage hybrid funds, hedge funds or other open-ended unregulated funds have had to deal with the issues arising from investing in illiquid assets for years and we would be well placed to advise here.
At the end of the day, however, the AIFM will need to convince the FCA that its desired liquidity management tools are appropriate during the authorisation process.
Fee disclosure
As there may be complex charging structures, the LTAF will have fee disclosure requirements equivalent to those for a UCITS or a NURS, including the requirement to provide examples of how any performance fee will operate. The FCA is likely to require full disclosure of all costs and charges incurred directly or indirectly by the LTAF.
Reporting
There will be three reporting requirements for the LTAF. As with other authorised funds, investor reports will be required on a six-month and yearly basis. In addition, the LTAF will be required to produce a quarterly report providing investors with details on investments, transactions and any other significant developments. It is proposed that the quarterly update reports should be produced within 20 business days of the quarter end.
Conclusion
The FCA will look to publish a final policy statement and final handbook rules later in 2021.
The LTAF might not be a private equity fund for the masses but it is still an intriguing proposition.
In particular, if managers and DC pension scheme investors can work together to create a liquidity solution that is acceptable to the FCA, then the LTAF may well make a substantial amount of investment capital available to managers and give DC pension schemes much needed access to longer-term investments.
The LTAF is an intriguing proposition. It is the first proposed change to the UK's fund regime after Brexit and there are a number of convergences: retail investors and asset classes that have to date been considered suitable only for institutional/professional investors; an open-ended fund investing in illiquid assets; and regulated funds and liquidity management tools that have historically been available only to their unregulated counterparts.
An L-what?
LTAF. Not to be confused with the ELTIF (the European Long-Term Investment Fund, which has had limited take-up) or the LTIF (the UK's Long-Term Investment Fund, which was derived from the EU's ELTIF regime).
Regulation
A LTAF will need to be authorised by the FCA and will have its own chapter of rules within the FCA handbook (COLL 15).
LTAFs will be alternative investment funds and only firms authorised as full-scope UK alternative investment fund managers (AIFM) with the appropriate permission will be permitted to manage LTAFs.
In line with the requirements for AIFMs operating UK authorised funds, the AIFM of a LTAF must ensure that at least one quarter of the members of its governing body are independent natural persons. If the governing body comprises fewer than eight members, the AIFM must instead ensure that at least two of its members are independent natural persons.
The FCA will seek to authorise LTAFs in between 1 to 6 months and it is encouraging those applying for authorisation to engage with it directly prior to submission of the application.
We expect that early applications will require a number of discussions with the FCA around various topics, particularly the liquidity management tools that the LTAF wishes to be available.
A LTAF will need to appoint a depositary.
What legal form can a LTAF take?
A LTAF can be an ICVC (an investment company with variable capital), an AUT (an authorised unit trust scheme) or an ACS (an authorised contractual scheme, which can take the form of a co-ownership scheme or a limited partnership scheme).
It should be noted, however, that an ACS LTAF will require a minimum investment of £1 million from a non-professional investor.
Who can invest?
The main objective of the LTAF regime is "[t]o encourage UK pension funds to direct more of their half a trillion pounds of capital towards [the UK's] economic recovery" and "to enable investors, particularly Defined Contribution (DC) pension schemes, to more confidently invest in illiquid assets (such as venture capital and infrastructure) than they can using existing fund structures".
DC pension schemes are expected to rise to over £1 trillion in assets by 2030.
In addition to professional investors, however, it is proposed that a LTAF may be marketed to "certified sophisticated investors" and (following a preliminary assessment of suitability conducted by the firm promoting the investment) "self-certified sophisticated investors" and that these investors may invest in a LTAF.
A "certified sophisticated investor" is a person who meets the requirements set out in article 23 of the Promotion of Collective Investment Schemes Order, in article 50 of the Financial Promotions Order or in COBS 4.12.7 R.
A "self-certified sophisticated investor" is a person who meets the requirements set out in article 23A of the Promotion of Collective Investment Schemes Order, in article 50A of the Financial Promotions Order or in COBS 4.12.8 R.
A LTAF may be available to other retail investors in accordance with COBS 4.12, although the FCA's view is that the promotion of a LTAF to "a retail client who is not a certified sophisticated investor or a self-certified sophisticated investor is unlikely to be appropriate or in the client’s best interests".
The "retailisation" offered by the LTAF is pretty limited, although in the consultation, the FCA does ask questions about whether, and how, it can safely permit future wider retail access to LTAFs.
Investment powers
The LTAF's manager must ensure that, taking account of the investment objectives, policy and strategy of the LTAF, the scheme property of the LTAF aims to provide a prudent spread of risk. This is the standard expected of a UCITS or a Non-UCITS Retail Scheme (NURS). A Qualifying Investment Scheme (QIS) simply has to have a spread of risk. The FCA proposes that LTAFs should have 24 months to achieve a prudent spread of risk.
The investment strategy of a LTAF must be to invest mainly in long-term illiquid assets. The FCA would expect LTAFs to invest mainly (more than 50% of the value of the scheme property) in unlisted securities and other long-term assets such as interests in immovables or other collective investment schemes investing in such securities or long-term assets. However, a LTAF could have a strategy of investing mainly in a mix of unlisted assets and listed but illiquid assets.
Subject to the above, LTAFs will have wide investment flexibility. The FCA plans to enable LTAFs to invest in a range of long-term illiquid assets, with few restrictions on eligible investments.
Like a QIS, a LTAF may invest in certain specified investments under the Regulated Activities Order, as well as certain types of immovable assets and commodities. Unlike a QIS, however, a LTAF will be permitted to invest in loans (with some restrictions) including investment in direct lending as part of a lending syndicate.
A LTAF will be able to invest in certain other collective investment schemes (CIS) without the restrictions faced by a QIS where managers have to establish that a CIS will not invest more than 15% of its assets into other CIS.
Borrowing
The maximum level of borrowing will be 30% of a LTAF's net assets, which is in contrast to 10% for a NURS and 100% for a QIS.
The FCA does not intend to set specific limits on the aggregate borrowing of underlying investments.
Valuation
The AIFM of a LTAF will have to appoint an "external valuer" (in accordance with AIFMD rules) unless it can demonstrate that it has the competence and experience to value assets of the type in which the LTAF invests. The FCA suggests that it will be for the depositary, during the authorisation application process, and on an ongoing basis, to assess the manager's competence to value the scheme's assets.
As with a NURS, the LTAF's assets will have to be valued at least monthly.
The UK's AIFMD rules provide "[i]rrespective of any contractual arrangements that provide otherwise, an external valuer is liable to the AIFM of an AIF in respect of which the external valuer is appointed for any losses suffered by the AIFM as a result of the external valuer's negligence or intentional failure to perform its tasks".
This provision has hindered the appointment of external valuers by AIFs and, given the nature of the LTAF's assets and the potential liability involved, we do not expect many external valuers to throw their hats into the ring.
Liquidity management
Rather than being prescriptive or prohibitive, the FCA, thankfully, is proposing to allow managers to work with their advisers to choose the liquidity tools that are appropriate to their investment strategy.
The FCA refers to notice periods on redemptions and subscriptions, the ability to defer redemptions, and the ability to limit the amount of the fund that could be redeemed at any dealing point but notes that a LTAF should not expect to use, nor rely on, suspension as a means of managing fund liquidity in the normal course of events.
The draft rules also refer to minimum holding periods, in kind redemptions, dilution levies or adjustments to sales and redemptions of units and the use of side-pockets.
The FCA expressly notes that some funds may choose to have long notice periods, potentially in excess of the 90‑180 days it recently proposed for property funds.
It should also be noted that the FCA states that "managers may need to make additional agreements with [DC] investors to deal with liquidity events".
Crucially, LTAFs need to be open-ended. The draft rules provide: "The maximum period between dealing days for a long-term asset fund will depend on the reasonable expectations of the target investor group and the particular investment objectives and policy of the scheme. For instance, for a scheme aiming to invest in large infrastructure projects, the expectation would be that it is reasonable to have a longer period between dealing days for liquidity reasons".
The full range of liquidity management tools appears to be available in order to structure the LTAF's terms properly. Clients who manage hybrid funds, hedge funds or other open-ended unregulated funds have had to deal with the issues arising from investing in illiquid assets for years and we would be well placed to advise here.
At the end of the day, however, the AIFM will need to convince the FCA that its desired liquidity management tools are appropriate during the authorisation process.
Fee disclosure
As there may be complex charging structures, the LTAF will have fee disclosure requirements equivalent to those for a UCITS or a NURS, including the requirement to provide examples of how any performance fee will operate. The FCA is likely to require full disclosure of all costs and charges incurred directly or indirectly by the LTAF.
Reporting
There will be three reporting requirements for the LTAF. As with other authorised funds, investor reports will be required on a six-month and yearly basis. In addition, the LTAF will be required to produce a quarterly report providing investors with details on investments, transactions and any other significant developments. It is proposed that the quarterly update reports should be produced within 20 business days of the quarter end.
Conclusion
The FCA will look to publish a final policy statement and final handbook rules later in 2021.
The LTAF might not be a private equity fund for the masses but it is still an intriguing proposition.
In particular, if managers and DC pension scheme investors can work together to create a liquidity solution that is acceptable to the FCA, then the LTAF may well make a substantial amount of investment capital available to managers and give DC pension schemes much needed access to longer-term investments.