Increasing the attractiveness of the LTAF
The consultation is important because it proposes to make it easier for a broader sub-set of retail investors and pension savers to invest in the LTAF. In turn, this should make the vehicle more attractive to managers that might consider launching an LTAF by further diversifying the fund’s investor base and potentially making it easier to increase AuM.
The FCA’s proposed amendments aim to do three things:
- broaden the eligible distribution of the LTAF to restricted retail investors, subject to additional investor protection;
- permit other authorised retail funds to increase their exposure to the LTAF; and
- make it easier for pension scheme savers to invest in LTAFs.
Broadening distribution to 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 on the same day as the LTAF consultation.
The financial promotion rules present three categories of investments that are marketed to retail investors (and you can read more about the rules in our blog).
- Readily Realisable Securities (RRS): listed or exchange traded securities, with no marketing restrictions.
- Restricted Mass Market Investments (RMMI): comprising Non-Readily Realisable Securities (NRRS) such as securities not listed on an exchange, Peer-to-Peer agreements, and qualifying crypto-assets, all of which may be marketed to retail investors but subject to restrictions.
- Non-Mass Market Investments (NMMI): comprising Non-Mainstream Pooled Investments (NMPI), such as unauthorised funds, and Speculative Illiquid Securities such as mini-bonds, all of which are not permitted to be marketed to retail investors.
At present, the LTAF is an NMPI, equivalent to the Qualified Investor Scheme (QIS) that is available to professional investors, and therefore falls into the third category, NMMI. This means that 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. The FCA notes that the LTAF has features that make it inherently more like other regulated funds that are available to retail investors (indeed, in some respects such as annual assessments, reporting, and liquidity rules, the LTAF’s standards are stricter than other regulated funds). By reclassifying the LTAF under category two, RMMI, the FCA makes it possible to market the fund to a broader array of retail investors, but subject to additional marketing requirements.
How to market an LTAF to retail investors
In Macfarlanes’ response to the FCA’s original LTAF consultation, we proposed that distribution should be subject to a series of objective tests to give managers and intermediaries clarity about whether an investor is eligible for investment. The FCA has essentially adopted a series of additional and objective requirements to achieve the same aim.
Due to the previously mentioned protections inherent to the structure of the vehicle, the FCA has judged that the LTAF does not need to comply with the marketing restrictions that apply to other RMMIs, such as the 24-hour cooling off period (but excepting the ban on inducements). However, the LTAF will have its own additional marketing restrictions:
- like other authorised funds, the LTAF will be subject to COLL rules in respect of notifying investors of changes to the fund, unitholder registration, the conduct of unitholder meetings, fees, and fund suspension; and
- managers must produce an LTAF-specific risk disclosure, comprising a defined risk warning, linked to a risk summary that should take around two minutes to read (see page 16 of the consultation paper for the template).
Non-advised retail investors will have a defined pathway to invest in an LTAF. If mass marketing, rather than a personal recommendation, occurs, then the Direct Offer Financial Promotion Rules are relevant. These rules provide a structure in which the afore-mentioned classification of the retail investor and communications must be applied. In addition, the distributor must implement an appropriateness test.
Making it easier for other funds to invest in an LTAF
Some firms will consider launching an LTAF 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 intends to facilitate this by allowing a Non-UCITS Retail Scheme set up as a fund of alternative investment funds (NURS FAIF) to invest up to 35% of the fund in an LTAF (and up to a total of 50% across several LTAFs or else the FAIF becomes a fund with inherently illiquid assets and subject to those more stringent rules).
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 the FAIF’s needs. Helpfully, the FCA will also disapply the FAIF’s enhanced due diligence requirement for the LTAF because of the latter’s stronger investor protections.
Notwithstanding this positive development, it is notable that the consultation does not address the rules that prevent a NURS investing in a second scheme that holds greater than 15% of its value in collective investment schemes.
Broadening pension scheme access
The FCA’s third area of amendments concerns the ability of DC pension schemes and their members to invest in an LTAF. There are three components to these reforms.
The FCA previously lifted the 35% limit on DC scheme’s investment in LTAF-linked funds via the default option (i.e. the investment option decided by the scheme trustees and into which all scheme members are automatically invested unless and until they decide to select another of the scheme’s available investment options). The consultation proposes to extend the policy to self-selected options (i.e. if a scheme member opts for a non-default option invested in an LTAF, the 35% limit would not apply). This initiative seems designed to treat default and non-default scheme members equivalently, although it might also seek to circumvent the concern that some pension trustees might be reluctant to put their scheme members into less liquid investments via the default option.
In addition, 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.
Finally, the consultation clarifies that an LTAF should be classified as a “non-standard asset” if held by a Self-Invested Personal Pension (SIPP), due to its illiquidity, and therefore subject to a higher capital charge. The effect is to make it more difficult to transfer the assets to another SIPP provider, as a trade-off for stronger investor protection.
What happens next?
The FCA’s proposals might change during the consultation, which closes on 10 October 2022. But given the broadly accommodating approach that the FCA has taken, the proposals are likely to be welcomed and any changes are more likely in respect of the details. A policy statement containing the final Handbook rules will be published in early 2023.
An outstanding issue that has not been resolved by the consultation is confirmation that the LTAF can be included in an 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. However, the FCA clarify that tax matters are for HM Treasury and HM Revenue & Customers to decide. Given cross-Government support for levelling up and improved economic growth, it is possible that a new Prime Minister and Chancellor (once the Conservative Party leader is decided on 5 September 2022) will make helpful policy changes.