One of the purported benefits of the U.K. leaving the European Union was that it would have autonomy and flexibility to frame regula­tions outside of the large EU policy making machine. An acid test of this newly found policy freedom was the Long-Term Asset Fund (LTAF), the U.K.’s initiative to create a new authorized fund structure to house less liquid investments for U.K. investors. The Chancellor of the Exchequer, Rishi Sunak, claimed that it was his ambition that the LTAF would be launched by the end of 2021 and given the Financial Conduct Authority (FCA) publicly consulted on the LTAF ruleset in May 2021, and the final rules were published in October 2021, it can be said that in terms of speed of move­ment it has passed that test.

The LTAF became officially available on November 15, 2021. However, as the Regulatory Field Guide went to press none had yet been approved by the FCA.

The intention behind the creation of the LTAF is to provide the U.K. with an open-ended fund structure that allows invest­ment in long term less liquid asset classes while also offering robust structural and governance safeguards. The governance framework is particularly important given the LTAF concept is largely a reaction to certain high-profile negative liquidity events found in other U.K. structures in recent years. While fund liquidity events are not unique to the U.K. market, certain sen­sitivities remain particularly acute within the FCA given the widespread impact of the liquidity issues faced by the Woodford funds¹ and certain authorized open-ended property funds matters that continues to rumble on.

Weighed against that backdrop, there was also great appetite within the U.K. to create a newly authorized fund vehicle to make it easier for defined contribution (DC) pen­sion schemes, and professional, sophisti­cated and high net worth investors to ac­cess alternative and illiquid assets through an open-ended fund structure. Historically, U.K. investors would invest in long-term assets through closed ended structures such as limited partnerships, or invest­ment trusts with a relatively narrow band of eligible investors granted access. It was agreed that the LTAF must be supported by strong levels of transparency, governance, and investor protection given its target in­vestor base.

In addition to helping DC pensions with in­creasing exposure to higher returning long term assets with a view to bridging the widening pensions funding gaps, another touted positive knock-on effect of LTAF is its ability to act as a conduit to channel private finance towards a range of UK pri­vate market opportunities and boost the so called “real economy”.

Predominantly, the U.K. asset manage­ment industry participants were pleased with the final LTAF rules, considering the FCA accommodated many of the points raised through the mid-2021 consultation. However, there are some challenges and items which need to be addressed in prac­tical terms before asset managers can truly be up and running successfully on LTAF asset gathering. While the LTAF is techni­cally “live,” there remain crucial wrinkles to be ironed out before we see growth in the market. But what is certain is that inves­tor appetite and latent demand is high and now the U.K. has a fit-for-purpose fund structure to cater for investors who want long term exposures, flexible redemption terms and a high level of governance over­sight on their fund investments. 2022 will be a big year for LTAFs in the U.K.

Let’s assess the top 10 LTAF points of interest:

1. Redemption Terms

The LTAF is an open-ended fund structure. Redemptions must not be available more frequently than monthly and a minimum notice period of 90 days to redeem also applies. The notice period makes sense in terms of alleviating some of the liquidity mismatch issues previously experienced. However, in practical terms it raises op­erational issues for the U.K. market. The LTAF is primarily targeted at DC pension schemes and wealth management seg­ments each of whom typically access their investments through investment platforms. Platforms generally operate on daily deal­ing life cycles and their operational models are largely hard coded for daily dealing and therefore might not be operationally ready to accommodate these notice periods in the short term. With the LTAF potential op­portunity evident, it is hoped that the req­uisite investments are made to accommo­date this new operational reality.

2. Structuring and Distribution

The LTAF may be established as a unit trust, open ended investment compa­ny (OEIC) or an Authorized Contractual Scheme (ACS). The FCA considers that the principal target market for the LTAF is professional investors and in particular DC pension schemes, as well as sophisti­cated retail investors. LTAF comes under the definition of a non-mainstream pooled investment (NMPI) rather than a non-UCITS retail scheme (NURS). However, the FCA has at the same time tweaked its NMPI rules to specifically allow the LTAF to be sold to certificated high net worth investors as part of a diversified portfolio. Therefore, LTAFs will be sold through wealth manage­ment channels to eligible investors provid­ing a more diversified source of inflows beyond merely the DC pension market. The FCA is also making technical changes to the permitted links rules to help DC pen­sion schemes accommodate illiquid assets more easily within their portfolios via the LTAF. And finally, consultation in 2022 will consider further broadening LTAF access among retail investors.

3. Investment and Borrowing Powers

The FCA expects an LTAF to invest at least 50% of its assets in unlisted securi­ties and other long-term assets such as interests in immovables or other funds investing in such assets. This confirms an LTAF can be comprised of a mix of unlisted assets, listed but illiquid assets and investment in other illiquid funds (both regulated and unregulated, includ­ing limited partnerships). Further, there is no requirement to ensure the underlying Collective Investment Scheme (CIS) does not invest more than 15% in other CIS, which is welcome since it allows invest­ment into “funds of funds”. There are also specific initial and ongoing due diligence requirements where an LTAF invests more than 20% in unregulated funds or other LTAFs. Investment in intermediate holding vehicles, domestic and overseas is permit­ted. The final rules also relax some of the originally proposed restrictions in respect of the LTAF investing in loans, which will be of interest to credit managers.

Another useful outcome from the consul­tation is that the FCA has clarified that the LTAF should be generally invested in long term assets as a strategy and is not specifi­cally applicable to any point-in-time snap­shot of the LTAF’s holdings. This gives LTAF managers increased flexibility, particularly immediately after launch when scaling up investments or in the case of significant redemptions where assets are sold off to fund redemption proceeds.

LTAF borrowing is permitted up to 30% of the net asset value which is less than the 100% allowed for QIS, but there are no rules on aggregate borrowing of underlying investments. There is no derogation of the limit during the start-up period.

4. Valuation

The valuation rules are largely retained and do not reflect much of the industry feed­back from the consultation. This is perhaps indicative of the balancing act the FCA has to contend with given previous fund liquidity events and its desire to retain high levels of oversight while also fostering an LTAF re­gime flexible enough to thrive. Importantly, the final rules row back on a previous FCA suggestion to have LTAF depositaries de­termine “without qualification” that the LTAF manager has the necessary knowl­edge, skills, and experience to value the LTAF’s assets. The final rules merely re­quire that the depositary determines that the LTAF manager has the resources and procedures for carrying out such a valua­tion. An LTAF manager is required to ap­point an “external valuer”, unless it can demonstrate that it has the competence and experience to value the types of assets in which the LTAF invests. Valuations must be carried out monthly.

The liability standards applying to exter­nal valuers have not been amended from “simple” to “gross” negligence in valua­tion, and even though both the FCA and HM Treasury recognize that this acts as a significant barrier to external valuers being appointed to LTAFs (and other U.K. illiquid funds) they have committed to exploring a relaxation of some of these rules in the future.

5. Depositary Ownership of Assets

The FCA has acknowledged that the re­quirement to have the depositary register the title to assets in its own name, rather than the name of the fund or the manager, is not practical for all eligible assets that an LTAF might invest in. However, for now the rule is retained albeit with a carve out that LTAFs on a case by case basis can apply to the FCA to waive the Depositary registra­tion requirements in specific instances. This is not an ideal outcome for sourcing of LTAF depositaries and it is hoped some pragmatism is shown in the case-by-case reviews but also that the consultation can look to align U.K. depositary asset registra­tion standards with international standards such as AIFMD or UCITS.

6. Permitted Links Revisions

Given the fact that the FCA considers that the principal target market for the LTAF is the defined contribution pension market, there are some very specific rule revisions with added additional flexibility for invest­ments in LTAFs by DC pension schemes.

These include revisions to the per mitted links rules that will make it possible for LTAFs to be part of the default arrange­ment of an occupational or work place DC pension scheme. The 35% limit for LTAF-linked funds that form part of the default arrangement of a pension scheme has been removed, while certain requirements remain on insurers to provide risk warnings and ensure that the fund is suitable for the ultimate investors. To ensure the propos­als only apply to default arrangements, the FCA has further proposed introducing con­ditional permitted LTAFs and making them available only in relation to default arrange­ments. This carves out the LTAF from the definition of QIS for COBS 21.3 purposes, so that the LTAF would not be available for retail investors investing outside of the pension environment. With the final LTAF rules integrating into the regulatory frame­work for DC pension scheme investments in unit-linked long-term insurance products, this looks to be a good channel of distribu­tion for LTAF manufacturers into the future.

7. Fee Cap

A key aspect of the commercial arrange­ments of any new LTAF will be the extent to which a profit allocation to the manager can be accommodated. This is an important factor both in attracting the best manag­ers and in aligning the interests of manag­ers and investors in most long-term asset classes. LTAF managers must disclose their performance fees/carried interest and explain to their investors how their fees work. There will be no cap on LTAF manag­ers’ fees, although, separately, the U.K. Department of Work & Pensions is con­sidering how to accommodate these fees within the DC charge cap to ensure the charge cap rules do not present a barrier to the success of the LTAF regime.

Rather helpfully, in its Budget on October 27, 2021, the U.K. Government flagged its intention to consult later this year on further changes to the charge cap for DC schemes, with a view to considering amendments to its scope to better accom­modate performance fees. This consulta­tion will be an important factor in shaping the commercial attractiveness of the provi­sion of LTAFs by asset managers and is worth tracking in 2022.

8. Tax

Tax is always an important fund structuring consideration, particularly for illiquid asset funds. The FCA notes that the LTAF rules permit them to be established as prop­erty authorized investment funds (PAIFs), and that an LTAF could be structured as an authorized contractual scheme (ACS). The FCA worked closely with HM Treasury and HM Revenue & Customs (HMRC) throughout the development of the LTAF. However, details on the tax treatment of LTAF specifically remains scant and there is an ongoing wider review by HM Treasury of the tax regime for U.K. funds. A tax trans­parent ACS structure for the LTAF could be attractive, given that the tax transparent nature of the ACS should enable tax ex­empt investors such as registered pension schemes to preserve their tax exemptions and access to relevant double tax treaties. As always, the final tax regime applicable to LTAF will have an inevitable impact on its attractiveness to investors.

9. Governance

The FCA sets the bar high for LTAF ongo­ing governance and oversight. Managers of LTAFs must be full-scope U.K. alterna­tive investment fund managers - firms that currently only have “managing an unau­thorized AIF” as a classification will need to seek a variation of permission (which may take up to six months to obtain). Such firms will also need to appoint at least two independent directors. LTAF managers must undertake additional assessments in respect of the LTAF’s liquidity, due dili­gence, valuation of the assets and con­flicts of interest, and may not delegate this responsibility.

10. Quarterly Investor Reporting

Due to the FCA’s desire for high levels of transparency, LTAF managers must make quarterly reports to investors, and within 20 days of the end of the quarter. The FCA suggests that infrequent trading in illiquid markets means that reporting will generally not be unduly burdensome, but it does add another regulatory report to asset manager’s inventory.