Regulatory briefing: What would launching a long-term asset fund entail? [updated]

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There is much interest in the UK’s proposed long-term asset fund. Melville Rodrigues sets out what creating would involve

Melville Rodrigues

Melville Rodrigues is head of real estate advisory at Apex Group

Defined contribution (DC) pension schemes are projected to continue growing at a staggering pace. The UK regulator, the Financial Conduct Authority (FCA), has indicated that DC pension assets have risen by approximately £120bn (€139bn) in four years to £460bn in 2019, and are expected to rise to over £1trn by 2030. However, two thirds of the schemes do not invest in illiquid assets, while the remaining third only invest between 1.5% and 7%, mainly in real estate – according to a survey for the Department for Work and Pensions.

Investment in illiquid assets such as private equity, real estate, infrastructure, private debt and venture capital, which are typically not traded on public markets, is often known as ‘productive finance’. It usually requires long-term commitments and can be complex and expose investors to risks not normally associated with listed investments. DC pensions and other investors can be attracted to productive finance because of diversification benefits and the ability to generate higher returns compared to those from liquid assets (returns in part reflected by the lack of immediate liquidity and associated risks).

The FCA intends to facilitate DC pensions, high-net-worth and other investors investing in productive finance via the proposed long-term asset fund (LTAF). It issued on 25 October a policy statement that permits LTAF launches from 15 November 2021.

What key structuring solutions will investment managers need to adopt to launch and operate an LTAF? The table below summarises key LTAF features and is designed for those interested in launching and operating LTAFs.

The FCA has helpfully indicated it will strive to authorise LTAFs without undue delay (that is well within the six-month benchmark applying to authorised funds), and encourage engagement with prospective applicants.

Interested managers should now be proactively progressing strategic plans to consider operating an LTAF. I suggest they will be able to attract substantial DC pension and other productive-finance capital from investors.

	Key LTAF features for those interested in launching LTAFs
Regulatory status	Authorised open-ended fund and an alternative investment fund (AIF) for UK AIFMD purposes. The LTAF will operate within a new Chapter of the FCA Collective Investment Schemes sourcebook (COLL 15) and will be required to be named Long-term Asset Fund or LTAF.
Structure	The LTAF is essentially a regulatory platform. There is flexibility on the LTAF being constituted as an authorised contractual scheme (ACS), an authorised unit trust (AUT), investment company with variable capital (ICVC) or limited partnership (LP). The LTAF can also operate as property authorised investment fund (PAIF). Given its AIF status, the LTAF will need a full-scope UK alternative investment fund manager (AIFM) and a depositary. HM Treasury considers it likely that each structure will adopt the current tax rules for authorised investment funds, and recognises that its current review of the VAT treatment of fund management expenses may be relevant to LTAFs.
Investors	Professional investors, high-net-worth (eligible to commit in a non-mainstream pooled investment (NMPI)) and other investors. The investors importantly includes DC pension schemes. The FCA plans to consult in the first half of 2022 on permitting a broader range of retail investors.
Manager	LTAF authorised fund managers will need to comply with rules in COLL 15 and other relevant sourcebooks, and (as indicated above) only a manager with a full-scope AIFM status can operate an LTAF. The FCA comments that, as LTAFs might invest in assets that are complex and risky, managers of LTAFs will need to have appropriate resources as well as good systems and controls. In addition, managers must comply with additional governance and oversight rules, given the types of risk to which the LTAFs might be exposed. The manager will need to assess how it has managed the LTAF in the best interests of the fund, its investors and the integrity of the market. The assessment must consider how the assets of the fund have been valued, due diligence has been conducted in line with good practice, and the manager has managed liquidity and conflicts of interest.
Underlying investments	LTAFs will have wide investment flexibility, and be permitted to invest in a range of long-term illiquid assets, with few restrictions on eligible investments. The investments could have diverse risk characteristics and return profiles. LTAF managers must undertake due diligence on investments in line with good practice and disclose in the fund’s prospectus how they carry out due diligence.
Investment strategy	LTAFs must invest mainly in assets that are long-term and illiquid in nature, or in other collective investment schemes (CIS) which invest in such assets. The FCA expects at least 50% of the value of an LTAF’s underlying investments to be unlisted securities and other long-term assets or other CIS investing in such assets. In the context of LTAFs looking for diversified returns from real estate, infrastructure and private debt and other illiquid assets, I suggest the LTAFs will be attracted to invest via CISs. The FCA signals that, with a fund intending to make “investments that are only suited to a closed-ended vehicle”, the FCA would not expect the manager to seek authorisation of that fund as an LTAF. I hope the government will legislate soon for the Professional Investor Fund (PIF) unauthorised contractual scheme, which operates as a closed-ended vehicle. The PIF proposal addresses a gap in the current UK real estate fund offering (albeit the PIF is unconstrained in terms of eligible asset classes and investment strategies), and the LTAF would be entitled to invest in PIFs. In the 27 October 2021 Autumn Budget, HM Treasury indicated its intention during the coming months to consult on specific proposals for legislative reform – given responses to its call for input which considered the PIF and other fund proposals.
LTAF investment powers	LTAFs are required to have a prudent spread of risk. The manager should consider whether an LTAF’s exposures are sufficiently diversified, including exposures to underlying investments through structures such as holding companies or CIS. LTAFs may invest in other CISs in the context of obtaining efficient exposure to a diversified portfolio of private assets.
Borrowing	The maximum level of borrowing is 30% of net asset value. There are no specific limits on the aggregate borrowing of underlying investments.
Valuation	The manager remains responsible for valuations and impartiality, even if the manager uses valuation advisers. LTAFs must publish monthly valuations. If the depositary determines that the manager has the resources and procedures to carry asset valuation, the manager need not appoint an external valuer.
Redemptions and subscriptions	LTAFs will need mandatory notice periods of at least 90 days and cannot offer redemptions more frequently than monthly. These are minimum requirements and longer notice periods or less frequent dealing may be relevant for some LTAFs. The FCA does not expect any LTAF to offer daily dealing.
Promotion/prospectus	A manager will need to disclose, and help investors and potential investors understand, how an LTAF will be managed, provide examples of performance fees, treatment of the LTAF as a NMPI and other important features. In addition to meeting the ‘fair, clear and not misleading’ benchmark, there are FCA disclosure requirements on investment strategies, subscription and redemption terms and charging provisions.
Governance and reporting	The senior manager responsible under the FCA’s senior managers and certification (SMCR) regime will need to ensure that the manager operates an LTAF in the best interests of the fund, its investors and the integrity of the market, that an annual assessment of value is carried out, and that there are enough independent directors on the board. In addition, the manager must appoint a SMCR approved person to assess, and publicly report on, the valuation of investments, due diligence, conflicts of interest and liquidity management. The manager should produce an assessment of value as part of the LTAF annual report. The FCA will require an LTAF to report quarterly to its investors on the investments in the portfolio, transactions during the period and any significant developments in the investments (which is in addition to the half-yearly and annual reports required for authorised funds). It is anticipated that the proposed Sustainability Disclosure Requirements (SDR) will apply to LTAFs.