From investment and borrowing powers to distribution and widening access, Grania Baird and Leon Chng from Farrer & Co discuss the features and possibilities of LTAF.
As part of the ‘Edinburgh Reforms’, it was announced that the new long-term asset fund (LTAF) will replace the European Long Term investment Fund (ELTIF) in the UK. The LTAF will provide a UK-authorised fund structure that enables investment in illiquid assets while offering structural safeguards appropriate to the underlying assets. Despite some initial industry scepticism and that the FCA is still to finalise certain proposed rule changes, several LTAFs are in the planning stage, and we expect the first LTAF to be authorised by the FCA this year.
Benefits
The LTAF is a welcome additional vehicle for the UK market for investment in long-term illiquid assets and is likely to appeal to investors with long-term investment horizons who understand and are able to bear the risks associated with such assets and who wish to invest in an FCA authorised fund structure.
In particular, the LTAF is likely to be of interest to DC pension schemes, larger charities which often have a longer-term investment horizon, as well as some sophisticated or high-net-worth investors.
The government hopes the LTAF will not only provide investors with an alternative route to returns but also support economic growth and the transition to a low-carbon economy. Given that the LTAF will allow investors access to illiquid assets such as infrastructure and real estate, there is real potential for the fund to help with critical issues around net zero.
Investment and borrowing powers
The LTAF has wide investment powers and can borrow up to 30% of its net asset value.
Key points include:
- the investment strategy must be to invest mainly in assets which are long-term and illiquid in nature or in other funds which invest in such assets;
- the manager of the LTAF must ensure that the scheme property aims to provide a prudent spread of risk;
- a wide range of investments is permitted, including shares and bonds (listed and unlisted), real estate, commodities, loans, funds (regulated and unregulated), and funds of funds.
Given the rules on dealing and liquidity management, the LTAF will look quite different to other FCA-authorised funds. Dealing is not permitted more frequently than monthly and can be set at longer intervals. Investment can be on a subscription basis or a commitment basis. While investors will have to give at least 90 days’ notice to redeem, in practice, the FCA expects many LTAFs to set significantly longer redemption notice periods.
Other permitted liquidity management tools include initial lock-in periods and minimum holding periods, deferral of redemptions, limits or caps on the number of units that can be redeemed and side pockets.
Governance
The FCA has set additional governance requirements for the LTAF. The manager must be a full-scope alternative investment fund manager with the knowledge, skills and experience needed to understand the LTAF, the assets it will hold and associated risks. Furthermore, the manager must employ sufficient personnel with relevant skills, knowledge and experience, and will not be able to rely on a delegated portfolio manager to meet these requirements. Finally, quarterly reports must be provided to investors, in addition to half-yearly and annual reports.
Tax treatment
The LTAF must meet the genuine diversity of ownership (GDO) to be taxed as an FCA-authorised fund. The standard GDO provisions apply. In addition, the LTAF can meet the GDO where at least 70 per cent of the units or shares in the LTAF are held by one or more relevant investors. Relevant investors are an AUT, OEIC or overseas equivalent which meets the GDO condition, a UK or foreign regulated insurer which is not a close company and the trustee, manager or administrator of a pension scheme (but not SIPPs or SSAS).
Distribution and widening access
When first announced, the original distribution market for the LTAF was relatively limited, given that the LTAF was to be categorised for marketing purposes in the same way as unregulated collective investment schemes. However, the FCA has proposed relaxing this to allow limited distribution of the LTAF to retail investors.
As now proposed by the FCA, the LTAF will be classified as a restricted mass market investment (RMMI). This means that retail investors who receive advice will be able to invest in an LTAF subject to receiving the new risk warning and risk summary, and provided suitability requirements are met. In respect of direct offers, retail investors will be able to invest up to 10 per cent of their investable assets into an LTAF or other RMMI products and must certify that this is the case, so-called certified restricted investors. Firms will need to take reasonable steps to establish that such investors are certified restricted investors and an appropriateness test must be met.
Industry guidance
The Productive Finance Working Group has issued helpful guidance on investing in less liquid assets, which contains material on available fund structures, including a guide on the LTAF. This should facilitate greater investment in such investments and use of the LTAF. As we await FCA authorisation, the LTAF is certainly worth keeping an eye on.
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