There is continued focus across global asset management on allowing retail investors greater access to less liquid alternative investment funds. Nowhere has this focus been more intense than in the United Kingdom where industry stakeholders have been working fervently to mobilize the country’s Long-Term Asset Fund (LTAF).

We previously flagged the LTAF as a structure with huge potential for capital inflows but also noted that there were some very evident changes required if the LTAF was to reach its promised potential. The LTAF aims to provide the U.K. market with an open-ended fund structure that allows invest­ment in long term less liquid asset classes while at the same time offering robust structural and governance safeguards.

The Financial Conduct Authority’s (FCA) recent launch of a public consultation¹ on this topic is therefore both interesting and exciting. The consultation seeks to balance retail investors’ appetite for non-traditional investments and higher returns against the risk of such investors not fully understanding the illiquid nature and corresponding risk of the underlying assets. The proposals are important as they aim to make it easier for a wider audience of retail investors and pension savers to invest in the LTAF, thus making the vehicle more attractive to asset managers weighing up whether to launch an LTAF to raise assets.

The LTAF consultation dovetails nicely with the FCA’s recent policy statement “PS22/10: Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions.” This aims to set out expectations and requirements around appropriate offerings of “high risk investments” in the wake of certain issues related to unregulated mini-bonds and cryptocurrency offerings to U.K. retail investors in the recent past. Under this policy statement, the FCA propose to treat the LTAF as a Restricted Mass Market Investment (RMMI), which automatically enables a broader range of retail investors to access the LTAF once attendant disclosure, risk and suitability requirements are met.

The FCA’s proposed LTAF amendments look to recalibrate three specific areas of the LTAF proposals, namely:

1. broaden distribution to include certain restricted retail investors, subject to additional investor protection requirements,
2. permit other authorized retail collective investment funds to increase their exposure to LTAFs and;-
3. facilitate easier investment to LTAFs for pension scheme savers

Let’s look at each in turn:

1.      Broadening distribution to certain retail investors

The FCA will classify the LTAF as a Restricted Mass Market Investment (“RMMI”). This classification forms part of the FCA’s new financial promotion rules, which were published as PS 22/10 on the same day as the LTAF consultation was released.

These new financial promotion rules lay out three categories of investments that may be marketed to retail investors:

(i) Readily Realizable Securities (RRS): Securities listed, or exchange-traded which have no additional marketing restrictions;

(ii) Restricted Mass Market Investments (RMMI): This classification is made up of Non-Readily Realizable Securities (“NRRS”) such as unlisted securities, as well as qualifying crypto-assets, and even peer-to-peer lending arrangement. RMMI may be marketed to retail investors but are subject to certain restrictions;

(iii) Non-Mass Market Investments (NMMI): This classification is made up of Non-Mainstream Pooled Investments (NMPI), such as unauthorized funds, and speculative illiquid securities such as mini bonds, none of which are permitted to be marketed to retail investors and each of which have been subject to recent FCA regulatory scrutiny following investor harm.

Currently, the LTAF is designated as an NMPI, equivalent to the Qualified Investor Scheme (QIS) made available to professional investors. It therefore forms part of category (iii) NMMI. As a result, the LTAF cannot be marketed to retail investors unless they are “opted-up” as a certified high-net worth investor or a self-certified sophisticated investor under the financial promotion rules. However, the FCA explicitly suggests that the LTAF has specific traits that make it more like certain other regulated funds already available to retail investors in the U.K. (liquidity, regulatory reporting, disclosures, and assessment of value requirements for example). In fact, certain rules are more stringent under LTAF rules than alternate retail fund regimes. The FCA is therefore proposing to classify LTAFs as RMMI, which would open up LTAFs to market to a wider array of retail investors, though would also subject them to more onerous marketing requirements.

The FCA requires that the seller of an LTAF to a retail investor conducts a number of objective tests. On top of this, LTAFs will have their own additional marketing restrictions such as being subject to the COLL rules to notify investors of changes to the fund, unitholder registration, the conduct of unitholder meetings, fees, and fund suspension. The LTAF manager must also produce an LTAF-specific risk disclosure, comprising a defined risk warning, linked to a risk summary that should take no more than two minutes to read.

2. Fund of Fund Investments into LTAFs

Some managers wish to launch LTAFs as a means of getting retail and DC scheme money into existing alternative funds or vice-versa via fund-of-funds or master-feeder structures. The FCA proposals facilitate these types of investment by allowing a Non-UCITS Retail Scheme (NURS) set up as a fund of alternative investment funds (NURS FAIF) to invest up to 35% of the fund in an LTAF (as well as up to 50% across several LTAFs). However, the manager of a NURS FAIF will need to ensure that the timing of the LTAF’s valuations, as well as its dealing policy, sufficiently aligns with those of the FAIF. Further, the FCA has disapplied the FAIF’s enhanced due diligence requirement for the LTAF due to the LTAF’s inherently stringent investor protection mechanisms.

3. Broadening pension scheme access

The final area of amendment relates to the ability of DC pension schemes to invest in an LTAF. These are seen as crucial for industry to ensure a viable scalable LTAF market in the U.K. and three primary elements are beneficial to this growth agenda:

(i) The FCA previously lifted the 35% limit on DC scheme’s investment in LTAF-linked funds via the default option. The consultation proposes to extend the policy to self-selected options (e.g. if a scheme member opts for a non-default option invested in an LTAF, the 35% limit would not apply). Therefore, the proposals treat default and non-default scheme members equivalently.

(ii) The FCA proposes to remove the 35% limit for illiquid investments in unit-linked funds via the default option in qualifying pension schemes – so long as “an appropriate level of consumer protection” is maintained. The rationale is to encourage the development of unit-linked products with the benefits of less liquid holdings.

(iii) Because of the LTAF’s inherent illiquidity, the FCA proposal states that an LTAF should be classified as a “non-standard asset” when held by a Self-Invested Personal Pension (SIPP). This designation makes the LTAF subject to a higher capital charge. This consequently makes it more difficult to transfer the assets to another SIPP provider, as a trade-off for stronger investor protection. 

Next Steps

The proposals remain open to comment and change with the consultation period ending on October 10, 2022. One material point not in the power of the FCA to dictate relates to taxation. The FCA clearly state that tax matters are for HM Treasury and HM Revenue & Customers (HMRC) to decide upon, not the FCA. It is therefore expected that industry groups will look to HMRC to provide comfort that the LTAF can be included in an individual savings account (ISA) wrapper. The benefit of not paying tax on income derived from investment returns would give retail investors more incentive to lock up their savings in a longer-term vehicle such as the LTAF.

The proposals remain open to comment and change with the consultation period ending on October 10, 2022. One material point not in the power of the FCA to dictate relates to taxation. The FCA clearly state that tax matters are for HM Treasury and HM Revenue & Customers (HMRC) to decide upon, not the FCA. It is therefore expected that industry groups will look to HMRC to provide comfort that the LTAF can be included in an individual savings account (ISA) wrapper. The benefit of not paying tax on income derived from investment returns would give retail investors more incentive to lock up their savings in a longer-term vehicle such as the LTAF.

Despite some tax wrinkles yet to be ironed out, industry sentiment is very positive regarding the FCA’s LTAF proposals. It appears the FCA have substantially addressed many of the initial industry pinpoints flagged when the LTAF proposals first surfaced. It is expected that the FCA will publish an LTAF policy statement containing the final Handbook rules in early 2023. In a ray of hope for those who support the democratization of private market investment, it appears that the U.K. LTAF is developing very nicely indeed.