The UK’s Financial Conduct Authority (FCA) has decided on the regulatory regime for a Long-Term Asset Fund (LTAF), a new type of authorised open-ended fund that is hoped will unlock more investment in illiquid assets by defined contribution (DC) schemes.

It said the LTAF “addresses the market failure that DC default pension schemes do not invest in long-term, illiquid assets, despite having the investment horizon to do so”.

“The LTAF means that scheme members now have better opportunities to benefit from potential illiquidity premiums of long-term illiquid assets,” the regulator said. “By requiring the LTAF’s redemption terms to match the liquidity of the underlying investments, we consider this will help advance our market integrity objective.”

According to a policy statement published today, the regulator has decided that LTAFs should be required to permit redemptions no more frequently than monthly, and to have at least a 90-day notice period on redemptions.

The FCA has also changed the permitted links rules for unit-linked insurance to allow DC pension schemes to consider the proportion of illiquid assets across their investment portfolios, rather than to restrict the proportion of illiquid assets in each underlying fund in which they invest.

It said this would enable more flexibility in the construction of DC scheme portfolios while maintaining an adequate level of protection for DC default scheme investors.

“We are supporting fresh collaborative thinking designed to improve the effectiveness of UK markets while protecting standards,” said Nikhil Rathi, the CFA’s chief executive officer.

Counting success

The FCA said that if the new rules were successful, “LTAFs will be launched and DC pension schemes will choose to invest in them, increasing their exposure to long-term illiquid assets, and improving the returns for their members in the longer term”.

At the Association of Investment Companies, CEO Richard Stone said the organisation feared 90-day redemption notice periods would not prove sufficient, especially in times of stressed markets.

“If too short, this could threaten the long-term resilience of the LTAF,” he said. “It will be a challenge for managers to set adequate notice periods, especially if the structure also incorporates leverage.”

The FCA said the 90-day notice period and maximum redemption frequency were minimum requirements and that managers “must set appropriate terms and redemption policies for an LTAF, ensuring they are consistent with the fund’s liquidity profile and the investment strategy they are operating”.

Callum Stewart, head of DC investment at Hymans Robertson, said the consultancy was supportive of the FCA’s proposals to extend the range of vehicles for pension schemes to access long-term investments such as illiquids.

“This development should support greater product innovation and choice for DC schemes, and ultimately improve outcomes for members. Member security and the transparency of costs and charges are also important considerations,” he said.

The FCA said it would welcome LTAFs disclosing consistently with cost transparency templates developed by the pension industry’s Cost Transparency Initiative (CTI), although it did not plan to require this as not all LTAFs may have investors who use the CTI templates.

The UK government is keen to remove obstacles to DC pension schemes investing more in illiquid UK assets, such as infrastructure. The publication of the FCA’s policy statement on the LTAF rules comes after an industry consultation and also follows the recent publication of several recommendations for facilitating greater investment in long-term, illiquid assets by the Productive Finance Working Group.

Earlier this year, the FCA delayed decisions over introducing similar restrictions on redemptions and notice periods to open-ended property funds, which have experienced a series of liquidity crunches in recent years, as it turned its attention to the LTAF.

In addition to the LTAF being aimed at DC pension schemes the FCA amended the distribution rules it had proposed to enable the new fund type to be promoted to high net worth individuals in addition to sophisticated and professional investors.

It will be consulting next year on the potential for widening the distribution of the LTAF to certain retail investors.

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