The FCA has published its final rules for the Long Term Asset Fund (LTAF). The LTAF is a new authorised fund vehicle that aims 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.

The publication of the rules has achieved the Chancellor’s ambition to launch the LTAF by the end of 2021. Managers will be able to apply to the FCA for authorisation of an LTAF from 15 November 2021, although the FCA is encouraging early engagement from managers prior to any submission.

Thankfully, the FCA has accommodated much of the industry’s feedback to the proposals in its May 2021 consultation (the Consultation), although there remain some areas of concern.

Summary of the rules

Matters which changed following Consultation

• Redemptions: Redemptions must be available no more frequently than monthly, but with the additional overlay of investors having to give a minimum 90 days’ notice in advance. The introduction of the 90 day notice period is new, and is likely to have been lifted from the FCA’s work around liquidity mismatch in authorised open-ended property funds, in respect of which it has consulted on the introduction of a mandatory 90 to 180 day investor redemption notice period.
• Depositary ownership of assets: For now, the FCA will retain the rule applicable to all UK authorised funds requiring the depositary to take legal ownership of the LTAF’s assets. Given the burden that this places on depositaries, the FCA will consider modifying or waiving the rule in specific instances. Given any changes to the legal ownership rules affect all types of UK authorised funds, the FCA will consult separately on proposed amendments in the first half of 2022.
• Valuation: Crucially, the FCA has removed the proposed requirement for depositaries to determine “without qualification” that the LTAF manager has the necessary knowledge, skills, and experience to value the LTAF’s assets. There is no corresponding revision to the rules to ensure that external valuers are only liable in instances of gross, rather than simple, negligence in valuation, although the FCA and HM Treasury recognise that this is currently a barrier to external valuers being appointed to all alternative investment funds. In recognition that they would like the market for external valuers to work better, they are exploring a relaxation of some of these rules which derive from AIFMD. LTAF managers will be able to rely on the valuations of schemes that they invest in where valuation is undertaken by an external valuer, rather than being required to undertake their own valuation.
• Distribution: The FCA has taken the significant step of allowing the LTAF to be sold to certificated high net worth investors as part of a diversified portfolio via an amendment to the non-mainstream pooled investment rules. A consultation in 2022 will consider further broadening access among retail investors. 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.

Matters which remained broadly the same following Consultation

• Governance: The FCA will require a stronger level of governance than applies to unauthorised funds. The LTAF manager will be required to have independent directors and to undertake an annual value assessment, in common with other UK authorised funds. 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.
• Investment strategy: The LTAF must invest “mainly” in long-term assets. The FCA has clarified that this refers to the LTAF’s strategy generally, and not to any point-in-time snapshot of the LTAF’s holdings. This is important because it will give LTAF managers adequate flexibility, particularly during the start-up period or when dealing with significant levels of redemptions.
• Investment powers: The LTAF will have flexible investment rules; for instance, in being permitted to invest in other closed ended funds, such as limited partnerships. The FCA suggests a broad interpretation of the prudent spread of risk requirement: LTAF managers can be flexible in the investments held, but should avoid a concentration of risk, including during a start-up period. The final rules clarify some technical issues that arose in the consultation in relation to requiring investee schemes to have a prudent spread of risk, and to relax some of the originally proposed restrictions in respect of the LTAF investing in loans, which will be of interest to credit managers.
• Borrowing: Consistent with the Consultation, the final rules cap the LTAF’s borrowing at 30% of net asset value. There will be no relaxation of the rule during the start-up period.
• Disclosures and fees: LTAF managers must disclose their performance fees/carried interest and explain to investors how their fees work. There will be no cap on LTAF managers’ fees, although, separately, the DWP 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. The FCA encourages LTAF managers to adopt the Cost Transparency Initiative’s template for their disclosures, although the rules do not mandate adoption.
• Reporting: Due to the 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.

Initial reactions

Overall, managers and depositaries will welcome the FCA’s flexible and pragmatic attempt to make the LTAF a viable new vehicle. The final rules address many of the issues identified in our response to the Consultation.

The changes to the distribution rules mean that wealth managers will be able to consider the LTAF for their clients. This is a positive development as we could see no reason why professionally advised, high net worth investors, with sufficient risk appetite, should not be able to access the LTAF.

The depositary community will be satisfied with some of the concessions made around its role in valuation, although will be hoping for a further amendment in due course to avoid becoming legal owner of the LTAF’s assets.

Our key concern is the imposition of a 90-day notice period for investors wanting to redeem their investment. The LTAF is targeted at DC pension schemes whose underlying investors typically access their investments through platforms. Some platforms will not be operationally ready to accommodate notice periods in the short term. This could have a significant impact on the immediate success of the LTAF given the intended investor universe.