The Financial Conduct Authority (FCA) will take forward proposals to establish a type of open-ended authorised investment fund which will help support investment in less liquid assets like infrastructure and private equity.
This comes several months after the UK regulator gathered feedback on the long-term asset fund (LTAF) in a bid to replace the current open-ended property fund model, which has come under criticism over liquidity and even led to investment firms closing their funds.
According to the FCA, investment in assets such as infrastructure and private equity have the “potential to generate better returns for investors”, including those saving for retirement in defined contribution (DC) pension schemes, as well as benefit the wider economy by supporting the recovery from covid.
It added that some investors are currently “unable or unwilling” to invest in long-term assets, even though “these could meet their investment goals”.
Nikhil Rathi (pictured), chief executive of the FCA, said: “We are supporting fresh collaborative thinking designed to improve the effectiveness of UK markets while protecting standards.
“If this innovative fund structure, created by our rules, is taken up by the asset management industry, it may provide alternative routes to returns for investors, while supporting economic growth and the transition to a low carbon economy.”
See also: Regulators to change liquidity rules for open-ended funds
LTAF regime primarily aimed at DC schemes
The newly established rules create an LTAF regime, an FCA-regulated fund that is designed specifically to help investment in assets including venture capital, private equity, private debt, real estate and infrastructure.
As investments in this type of vehicle may take longer to sell, LTAFs will require a minimum notice period of at least 90 days. The new type of fund will also be required to permit redemptions no more frequently than monthly.
The LTAF is aimed at DC pension schemes which may be interested in investing, in line with their investment horizons and risk appetite. It also offers long-term opportunities for sophisticated investors and some high net worth individuals.
The regulator will consult next year on the potential for widening the distribution of the LTAF to certain retail investors.
It said: “While this would potentially open a controlled route for retail investors to higher risk assets than some of the other routes currently available such as unauthorised funds, safeguards would also be needed to ensure retail investors understand the risks involved. Next year’s consultation will set out proposals for how this could be achieved.”
The LTAF fund and its operation formed part of the recommendations of the Productive Finance Working Group’s (PFWG) roadmap, published in September 2021. The FCA worked with the PFWG as part of its consultation process on these rules.
See also: Majority of retail investors would ditch property funds if FCA implements notice periods
No overnight ‘big bang’
Steven Cameron, pensions director at Aegon, said: “This is at the heart of the ‘investment big bang’ where the prime minister and chancellor are keen to encourage pension schemes to allocate more of their funds to long-term illiquid assets including infrastructure projects and ‘productive finance’ in their important drive to build Britain back better and greener.
“The hope is such investments will also deliver better returns for the benefit of pension scheme members. LTAFs are a key stage in the critical path towards DC pensions investing more in illiquids. Trustees and scheme managers may choose this approach to access illiquid investments, investing a small proportion of scheme default funds in these, rather than in individual long term projects.
“This will allow them to achieve greater diversification and a spreading of risk within this form of investment while also drawing on the expertise of the LTAF manager in this specialist area.
“However, it’s unlikely we’ll see an overnight ‘big bang’ rush. Members of DC pension schemes now fully expect their pension funds to be priced daily and to be able to switch funds, transfer between schemes or from age 55 access their pensions flexibly, all without any delay or notice period. LTAFs will have notice periods of various lengths and the underlying assets won’t have daily prices with redemptions no more frequently than monthly.
See also: Investors sceptical FCA LTAF proposal is the panacea for property fund liquidity mismatch
“One consideration will be the length of notice periods set by LTAFs with the FCA prescribing a minimum of 90 days but with some likely to be far longer if targeting certain types of illiquid investment. Arrangements for arriving at a daily price between LTAF valuation points to feed into the default fund price will all be critical.
“Schemes will also need to explore how to manage liquidity within the default fund, when the proportion in the LTAF is not readily realisable. This will in turn require detailed scenario planning including for extreme events and a full understanding of regulatory and capital requirements.”
‘We believe there would be significant interest among certain individual investors’
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, added: “Investing in illiquid assets offers a huge opportunity for investors to boost their pension pots by investing in areas such as private equity and infrastructure.
“However, for this to succeed investors need to be very clear on what they are invested in, what they are paying and what their rights are when it comes to issues such as redemptions and dealing – getting this right is vital to building confidence in LTAFs and making them a mainstream part of the defined contribution landscape in the future.
“The question of widening the scope of LTAFs to other retail investors was also highlighted and we welcome the FCA’s decision to review this in 2022 – it is important to take the time to get this right. We believe there would be significant interest among certain individual investors but again it is important they understand exactly what it is they are buying and the role it plays in their overall investment planning.”
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