Widening access to LTAFs

Following its August 2022 consultation (see our summary here), the FCA has published final rules on broadening access to Long-Term Asset Funds (LTAFs). The changes confirmed the FCA's intention to make the LTAF available to retail investors, self-select defined contribution pension schemes and self-invested personal pensions (SIPPs). Importantly, this will be within the guardrails of various investor protection rules. 

Until now, the promotion of LTAFs had been restricted to professional investors, certified and self‑certified sophisticated investors, and certified high net worth individuals (HNWI). This therefore signals an important moment for the UK authorities as they look to increase investor choice (democratising private assets) and to bolster private investment in illiquid assets.

This article summarises the key aspects of the rule changes, and provides considerations regarding the distribution strategy and tackling wider challenges around the LTAF.

The new rules and guidance came into effect on 3 July 2023 via PS23/7. The FCA largely proceeded as it had proposed in the consultation paper — the main effect of the rules being to:

• Recategorise an LTAF unit from a Non-Mass Market Investment (NMMI) to a Restricted Mass Market Investment (RMMI) —  allowing distribution to retail investors under certain conditions.
• These conditions include the need for an appropriateness test, risk warnings, a limit on investing only up to 10% of the investor's net assets, and the application of certain rules that apply to wider authorised funds to LTAFs.
• There were also changes made to the pension distribution rules, extending the possibility of LTAF distribution beyond default defined contribution scheme arrangements — allowing self-select investors the opportunity to invest. For the purposes of SIPPs, LTAFs have been classified as non-standard investments.

The rules therefore offer fund managers the possibility to offer LTAFs to a much wider audience. These changes could accelerate what has been a relatively slow start to the LTAF regime and address some constraints on the distribution side of the equation. 

At the same time, fund managers will need to implement a properly controlled distribution strategy with appropriate oversight and governance.

It is notable that the FCA mentioned the Consumer Duty at various points throughout the policy statement and flagged that it should be considered at all stages of the investment lifecycle.

This reiterates the need for fund managers to ensure the product and associated literature is understandable, well designed, and reaches only the desired target market. Firms will need to enable investors to make informed decisions and offer them appropriate support as needed. 

A robust distribution strategy should also be informed by the FCA's 2021 multi-firm review on product governance and the Consumer Duty, and should include:

• A sufficiently granular target market and negative target market — this should be clearly documented and should form the basis of the distribution strategy.
• A clearly defined distribution operating model — this should include a set of criteria that align to firms' operational standards on the type of distributors that they wish to work with, with appropriate internal ownership and accountability.
• Due diligence arrangements over third-party distributors — already an increasing focus in the context of Consumer Duty — fund managers should implement a risk-based approach to due diligence to ensure their distributors are fit for purpose and that the product recipient matches the product’s target market.
• Ongoing oversight and MI — the approach to ongoing oversight should be described in a formalised policy framework. Although the feedback loop from distributors is an ongoing discussion under Consumer Duty, fund managers should consider from the outset the types of MI they need to evidence good consumer outcomes when partnering with distributors.
• Consideration of vulnerable customers —  firms should consider characteristics of vulnerability at all stages of the design process, and thereafter in the context of consumer understanding and support. For example, given the relatively illiquid nature of LTAFs compared to daily dealing funds, they may not be suitable for investors with lower financial resilience.

More generally, fund managers will need to be able to evidence the delivery of good outcomes for retail investors against the Consumer Duty outcomes and cross-cutting obligations. This will require them to go further in how they identify, address and communicate foreseeable harm for retail investors. 

This will be particularly important, given that the LTAF is a new product and is more complex and less liquid than some other fund products.

Fund managers that have already launched LTAFs will need to ensure required enhancements (and evidencing of good outcomes) are made before the Consumer Duty enters into force on 31 July. Regarding aspects of the new LTAF-related rules, existing LTAF managers will need to update their prospectus and instruments of incorporation by 3 July 2024 at the latest. 

Although the FCA's changes smooth some of the distribution challenges, there are other challenges that fund managers need to overcome to successfully launch an LTAF. These include:

• Choice of fund structure and Tax — investor familiarity, existing operating models, investment strategy and speed to market are some of the factors to consider when selecting the fund structure. For each of the options available, there are differing tax considerations and special tax regimes may be available. The relative merits of the available legal structures (e.g. authorised contractual schemes and open-ended investment companies) need to be considered carefully.
• Governance, skills and expertise — ensuring that the firm has the relevant knowledge and experience across managing open-ended funds and private assets, combined with independent Non-Executive Directors that are able to challenge where appropriate.
• Valuation — Investment in hard to value assets requires the establishment and maintenance of an effective process, valuation policy and pricing methodology, along with a robust approach to the LTAF monthly valuation requirement.
• Liquidity risk management — ensuring that the asset liquidity profile is consistent with the redemption policy, supported by appropriate product testing and scenario analysis.
• Systems and processes — assessing whether systems can produce LTAF-specific reports in an accurate and timely fashion, and coherently visualise consumer-outcome MI in an informative manner for relevant governance bodies.

If you need assistance with launching an LTAF or with determining your distribution strategy and operating model, please get in touch.