New FCA Rules designed to enhance the appeal and access to the long-term asset fund (“LTAF”)

Although the rules permitting long-term asset funds ("LTAFs") came into effect in November 2021, so far no LTAF has yet launched. Nevertheless, the FCA is proceeding with its promised further LTAF proposals to broaden the scope of the LTAF regime to include distribution to some retail investors.

In the policy statement setting out those rules, the FCA committed to consult further on allowing LTAFs to be distributed more widely, following feedback it had received that the “target investor market” for the LTAF had been drawn too narrowly.  This feedback was echoed by the Productive Finance Working Group in its recommendations to the FCA, published last September.

On 1 August the FCA made good on this promise when it published consultation paper CP22/14 “Broadening retail access to the long-term asset fund”.  The consultation is open until 10 October 2022 and the FCA expects to publish final rules in early 2023.

The consultation paper sets out rules that will make the LTAF available to a broader range of retail investors, by categorising a unit in an LTAF as a Restricted Mass Market Investment (“RMMI”), rather than a Non Mainstream Pooled Investment (“NMPI”), which is currently the case.  If an LTAF were an RMMI, the rules governing its financial promotion would be broadly the same as the new rules recently published by the FCA in its policy statement “Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions”.  An LTAF could be mass marketed to retail investors and directly offered to some unadvised retail investors through direct offer financial promotions (“DOPFs”), if certain conditions are satisfied.

This is a welcome development. Currently an LTAF is categorised as an NMPI, which puts the LTAF on the same footing as a Qualified Investor Scheme  (“QIS”), an authorised fund for professional and institutional investors but which does not offer the same level of investor protection as the LTAF. Despite the enhanced investor protections of the LTAF, it is currently not generally available to retail investors in the same way as an Undertaking for the Collective Investment in Transferable Securities (“UCITS”) or a Non-UCITS Retail Scheme (“NURS”).

The FCA wishes to enable a broader range of retail investors to access the LTAF whilst ensuring those investors understand the risks involved and can absorb potential losses. The FCA therefore intends to impose requirements to protect investors further. The requirements will also align the rules governing the LTAF with those that currently apply to UCITS and NURS, while taking into account that LTAFs are less liquid than those retail funds.

The new FCA rules do not affect the eligibility criteria for LTAFs formed as ACSs, which will continue to be subject to the MiFID professional or £1m minimum investment requirement as well as their inherent administrative constraints, ruling out the use of LTAF ACSs for direct mass market investment.

Proposals

Increasing the ability of some retail investors to invest

The proposed rules will re-categorise units in an LTAF as RMMIs.  This will permit firms to make mass market financial promotions to retail investors.  These financial promotions must:

• Include a prescribed risk warning:
  • with specific references to investment horizon, liquidity and redemptions
  • be in the FCA template form:
    • there are different templates for digital and non-digital promotions
    • the digital template is more prescriptive than the non-digital template
  • or if it isn’t, keep records of the rationale for deviation and explain why:
    • eg it might be misleading
  • Not include any form of incentive to investors to invest in LTAFs

Firms may make DOPFs to certain retail investors on the understanding that the investor cannot subscribe for units in the LTAF until further requirements are met.  The additional requirements  are the same as for a DOPF in respect of an RMMI that is not an LTAF (i.e. unlisted shares and bonds and peer-2-peer agreements), except that retail investors in LTAFs will not need to be provided with the 24-hour cooling off period applicable to other RMMIs.

Before a firm or person makes a DOPF to a prospective retail investor it must first:

• obtain the unadvised prospective retail investor’s full name
• provide a personalised risk warning in the prescribed form and way (which differs depending on whether the DOPF is made digitally or not)
  • the personal risk warning should link to the general risk warning relating to the LTAF
• categorise the unadvised prospective retail investor as:
  • a certified high net worth investor
  • a certified sophisticated investor
  • a self-certified sophisticated investor
  • a certified restricted investor

To become a certified restricted investor, an investor must sign a declaration that they have not in the last 12 months, and will not in the next 12 months, invest more than 10% of their net assets in RMMIs.  For the purpose of the declaration:

• net assets excludes primary residence, pension (or any pension withdrawals) or any rights under qualifying contracts of insurance

Once these steps have been carried out the DOPF may be communicated to the unadvised prospective retail investor.  An investor’s application in response to the DOPF can only be fulfilled if an appropriateness assessment is carried out in relation to that investor in accordance with FCA rules and guidance, which among other things, assesses the investor’s knowledge and experience in the relevant investment field to determine whether the LTAF is appropriate for that investor.

There is no obligation for firms to make their LTAFs available to retail investors.  The FCA notes that some LTAFs will not be suitable for retail investors.

Manufacturers and distributors of LTAFs must continue to comply with existing product governance rules and will be required to comply with the new Consumer Duty where LTAFs are made available to retail investors.

Increasing the permitted exposure of LTAF to other types of authorised fund

The proposed rules will permit a NURS that is set up as a fund of alternative investment funds (“FAIF”) to invest up to 35% of its value into units of a single LTAF and up to a maximum of 50% of its value in LTAFs in total.  FAIFs will not need to carry out enhanced due diligence on the underlying LTAFs because of the level of investor protection already required for LTAFs.

Increasing the ability of pension schemes to invest

The proposed rules will extend the distribution of LTAFs to members of Defined Contribution (DC) pension schemes and more widely by:

• permitting the broadening of the distribution of LTAFs beyond the default arrangement via self-select options in qualifying schemes, subject to similar protections to those that currently apply to default arrangements:
  • insurers must ensure protections are in place to prevent individual investors over-exposing themselves to an LTAF-linked fund, eg capping the maximum individual exposure to the LTAF to the same level as the default arrangement of the same qualifying scheme
• extending the distribution of LTAFs to investors in long-term, unit-linked products who have appropriate professional support on fund selection, to include investors in non-workplace pensions and workplace pensions that are not qualifying schemes:
  • insurers must again protect individual investors against over exposure in the way described above
• using the permitted links rules to give status equivalent to that currently afforded to LTAFs to other illiquid assets where the unit-linked product is part of the default arrangement of a qualifying scheme:
  • this will enable firms to develop unit-linked products which contain other kinds of illiquid assets, but only under the same terms that currently apply to LTAFs

Increasing investor protection

The proposed amendments to the LTAF rules will align them further with the investor protections that apply to other retail authorised funds, in respect of:

• unitholder engagement in relation to proposals for fundamental or significant changes to the fund
• in the event of a suspension of dealing, provision of regular investor updates
• arrangements for the conduct of unitholder meetings
• restrictions on the types of payments and charges applicable to LTAF unit classes made available to retail clients, including rules relating to charging performance fees

Impact

Increased retail access to the LTAF should benefit the industry.  Of particular interest will be the broadening of the range of pension schemes that will be able to invest freely in LTAFs.  Time will tell whether or not this will encourage DC pension scheme trustees to start to authorise investment into LTAFs, which would require a shift away from such schemes investing only in daily dealing funds.

Enabling a broader range of retail investors to access the LTAF is also welcome, although it will need to be seen whether or not firms decide that the additional regulatory burden involved in onboarding restricted investors will be worth the effort of generally marketing LTAFs to them.  Past experience has shown that firms tend to avoid marketing QIS and unauthorised funds to the existing permitted categories of retail investor, such as certified and self-certified sophisticated investors and certified high net worth individuals, due to the compliance burden.

The industry was no doubt hoping for marketing LTAFs to be treated more akin to marketing a NURS, and be made generally available for retail investors.  The additional investor protections proposed for the LTAF align it to the rules applicable to NURS, so were the policy to change in future this might not require excessive additional regulation to achieve.

The LTAF might also be a more attractive vehicle if the following issues are addressed:

• making LTAFs eligible as qualifying investments for Stocks and Shares ISAs:
  • amending the rules relating to ISA eligibility is a matter for HM Treasury and HMRC, not the FCA
• looking at the safekeeping requirements for depositaries in relation to all assets, including non-custodial assets, which are onerous in respect of illiquid assets:
  • the FCA previously committed to consulting on this point during the course of 2022
• improving the tax regime for LTAF OEICs and AUTs receiving a balance of dividend and interest income:
  • to avoid tax leakage occurring in the LTAF vehicle
  
  

See our previous client briefing for further information:

• Review of the Productive Finance Working Group’s recommendations to the FCA on long term asset funds (LTAFs)
• UK FCA policy statement on long term assets funds (LTAFs)
• FCA consults on its long term asset funds (LTAFs) proposals

For further information and guidance on LTAFs, please get in touch with your usual Eversheds Sutherland contact or the authors listed below: