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FCA consults on LTAFs and feeds back on liquidity mismatch in authorised open-ended property funds consultation, LNB News 07/05/2021 61
The Financial Conduct Authority (FCA) has published feedback statement FS21/8, which contains feedback to consultation paper CP20/15 on liquidity mismatch in authorised open-ended property funds. The FCA says stakeholders raised concerns around operational challenges for fund managers and other firms, in particular in relation to ensuring that the infrastructure to support purchase and sale of holdings by retail investors will work seamlessly with notice periods. Some of these operational challenges also need to be addressed to make progress on new options for a Long-Term Asset Fund (LTAF), and are addressed in a new consultation, CP21/12, A new authorised fund regime for investing in long term assets. This contains proposals on a regime to enable UK-authorised open-ended funds to invest more efficiently in long-term, illiquid assets. Responses are sought by 25 June 2021.
The UK’s Chancellor, Rishi Sunak, has set an ambitious timetable to make available a new open-ended, FCA authorised fund vehicle, the LTAF, to help certain types of retail investors access unlisted and illiquid assets, including private equity and infrastructure.
So-called ’retailisation’ has great benefits for policymakers, investors and portfolio companies; however, past attempts to achieve this aim have fizzled out. The LTAF appears to resolve previous difficulties, but policymakers and the industry must overcome a few tricky problems over the coming months if the LTAF is to take off. The FCA has published a consultation containing proposals for the LTAF’s structure and the terms of its authorisation.
This briefing details the rationale for the LTAF, its proposed features and the next steps before the new fund type is available by the end of 2021.
As the UK emerges from the coronavirus (COVID-19) pandemic and Brexit, policymakers are considering innovative ways to kick-start the country. The government was also elected on an agenda to ’level up‘ the country, spreading economic growth across the regions. In practice, this means large-scale investment in infrastructure, small businesses and green technology.
For all the challenges of the pandemic, an unexpected benefit has been a significant increase in the country’s savings rate. In addition, policymakers have long considered the large pool of savings sitting in defined contribution (DC) pension schemes to be an under-utilised source of capital for the type of long term investments that can drive meaningful economic expansion. The LTAF is designed to be a means of unlocking these mass market savings for the purposes of private investment.
Although regulators are concerned that putting ordinary savers’ money into private investments might be too risky, there are existing vehicles that permit this to some degree. Regulations have set strict standards such as requiring investors to receive advice and ensuring that those investors properly understand the risks involved. With adequate safeguards, such as portfolio diversification, private assets can help investment managers spread their clients’ risk and increase investment returns.
However, the blow-up of Woodford’s flagship Equity Income Fund has brought a fundamental problem to public attention: investment in illiquid assets can mean that fund managers are unable to pay out to their investors on demand. Regulators are determined to avoid more broken promises and more savers out of pocket.
It is possible for UK closed-ended funds, such as investment trusts, to invest in private assets. This can be a good way of accessing illiquid assets for many retail investors, particularly because the price of these funds includes a liquidity premium. The downside is that these funds trade at a market price and often below the value of the fund’s assets.
The LTAF presents an alternative solution. The concept is to move away from daily dealing and instead to align the fund’s redemptions with the liquidity of the fund’s assets. This could mean that a fund investing in private equity might have a six-month or annual redemption window, for instance. Clearly setting investors’ expectations about the nature of their long-term investments at the outset removes the risks of a run on the fund and another Woodford-like scenario.
The FCA has published its long awaited consultation on the creation of the LTAF.
The consultation contains the following proposals:
• fund governance and reporting: the Authorised Fund Manager (AFM) must appoint an approved person under the Senior Managers Regime to undertake an assessment as to how the LTAF’s assets have been valued, how due diligence has been undertaken, and how liquidity and conflicts of interest have been managed in the best interests of the fund, investors and the integrity of markets. This assessment must occur in addition to the existing requirement for AFMs to publish an annual value assessment report and ensure that there are enough independent directors on the board
• investor disclosures: regardless of the complexity of the LTAF and its investments, the prospectus must include specific disclosures that are fair, clear, not misleading and in plain language
• eligible investors: the LTAF may only be marketed to professional investors and sophisticated retail investors, but not retail investors more broadly even if those investors are advised. The permitted links rules will be amended to permit DC pension schemes to invest in the LTAF. The FCA suggests that it will consider extending eligibility to other types of retail investors (such as advised retail investors) in the future
• eligible assets: the FCA expects at least half of the LTAF’s assets to be invested in unlisted securities, long-term assets and in other funds invested in those assets
• investment powers: the LTAF’s powers will be based on the Qualified Investment Scheme (QIS) but additionally it will be able to invest in loans that meet certain conditions and fund of funds
• risk management: the LTAF will be required to have a prudent spread of risk, like an Undertakings for the Collective Investment in Transferable Securities (UCITS) or a Non UCITS Retail Schemes (NURS), rather than simply a spread of risk like the QIS
• borrowing: borrowing will be capped at 30% of the fund’s total value, higher than the 10% allowed for NURS but less than 100% permitted for the QIS to ensure that borrowing to invest can happen but not to such an extent that liquidity mismatches become more likely
• valuation: the LTAF will apply the standards given in FUND 3.9 and in the Alternative Investment Fund Managers Directive (AIFMD) delegated regulation (Commission Delegated Regulation (EU) No 231/2013), including the requirement for depositary oversight. Valuation must be done by an external valuer unless the manager can demonstrate its competence to do the valuation itself. The price must be published monthly even if there is no dealing in the fund’s units
• redemptions and subscriptions: while the LTAF will not be daily dealing, managers will have flexibility to align their approach to liquidity management, including the use of tools to manage liquidity, the dealing window and limits on the ability of investors to subscribe in or redeem from the funds, with the liquidity of the LTAF’s assets
• due diligence: the manager must undertake due diligence of its investments in conformance with good practices and disclose in the LTAF prospectus how this has been done
• conditions to operate as an LTAF manager: only full scope AIFMs will be allowed to manage an LTAF. Managers that delegate portfolio management to another firm must ensure compliance with requirements in relation to knowledge, skills and experience
• costs and charges disclosure: managers must disclose their fee structure including any performance fees and all costs incurred directly or indirectly by the LTAF
• authorisation timescales: the FCA will initially take more than one month but less than six months to authorise an application for an LTAF and encourages firms to engage prior to applying for authorisation
The government hopes the first LTAF will be launched before the end of 2021. The FCA’s consultation period is relatively short, closing on 25 June 2021. The government and the FCA will take into account the feedback to the consultation in addition to the work of the Productive Finance Working Group, which comprises the authorities and industry representatives and is looking at other market related barriers to the LTAF’s success, such as the attitude of DC trustees towards alternative asset classes and the methodology of the charge cap calculation.
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