As mainstream asset managers consider moving further into alternative assets, the evolving regulatory approach presents both opportunities and risks. In this article, we summarise the FCA's updated priorities and recent policy developments.
Developments in the UK regulatory landscape mirror those around the world. Regulators are seeking to enable retail investors to diversify their portfolios into wider asset classes to aid economic recovery. Equally, though, regulators remain focussed on investor protection and market integrity, and are reassessing their supervisory priorities.
FCA Alternatives portfolio letter
In August 2022, the FCA refreshed (PDF 193 KB) its priorities and strategy for the Alternatives portfolio of firms (which is distinct from the FCA's Asset Management portfolio of firms, which manage predominantly mainstream assets).
Several priorities in the inaugural January 2020 Alternatives portfolio letter (PDF 181 KB) remain relevant. For example, the FCA is still concerned about inappropriate marketing and distribution practices by firms targeting retail investors. And as expected, effective market abuse controls and robust risk and liquidity management functions remain high on its agenda.
However, there are also specific new areas of focus. The FCA notes many firms in the portfolio deal with retail investors and that firms should consider their obligations under the incoming “Consumer Duty”. Alternatives firms will need to review their activities and investor base to consider whether they are captured and how they can evidence good retail customer outcomes.
The letter also highlights the FCA's new commitments relating to ESG (to reflect greenwashing concerns), and to strengthening the UK's position in global wholesale markets. The FCA emphasises that firms must act with integrity to support these initiatives. Those that don't “will be held to account”. Managing conflicts of interest fairly and promoting healthy cultures (including diversity and inclusion) are also new priorities, whereas client assets (CASS), anti-money laundering and Brexit are no longer on the prioritised list.
The FCA expects CEOs and firms' boards to consider carefully its priorities, identity which risks are relevant to their business model, and take action to mitigate them in line with the FCA's expectations. Firms can expect an FCA questionnaire soon to gather more information about their business model, products and clients.
The Asset Management portfolio strategy (PDF 180 KB) of January 2020 has not been refreshed to date. It remains to be seen when the FCA will roll out its revised approach for “mainstream” asset managers.
The Long-Term Asset Fund (LTAF)
The FCA is considering whether to expand the range of alternative products available to retail investors.
In November 2021, the FCA's new LTAF regime (PDF 974 KB) came into effect, creating a new category of authorised fund to allow for greater diversification and to facilitate investment in long-term illiquid assets. LTAFs need to be authorised, and are expected to invest at least 50 percent of assets in illiquid assets, be valued at least monthly, and have a minimum 90-day notice period for investor redemptions.
No LTAFs have yet been authorised by the FCA. Some fund management companies are considering how an LTAF would align with their product strategy, capabilities, and resources.
There are various challenges to navigate before a successful launch. For example, whether a firm has sufficient expertise in both managing alternative assets and operating open-ended funds, can implement an effective approach to valuing hard to value assets, and is able to partner with appropriate administrators and third parties to ensure a smooth and cost-effective operating model. As with any new regime, fund managers will need time to adapt before LTAFs can be manufactured, authorised and marketed successfully.
So far, the promotion and marketing of LTAFs has been restricted to professional, sophisticated and certified high net worth individuals. The FCA is now consulting (PDF 1.07 MB) on whether to allow retail investors to access LTAFs. This would be enabled by categorising LTAFs as “restricted mass market investments” in line with the FCA's new approach (PDF 1.86 MB) to classifying high-risk investments.
The proposed changes would introduce an appropriateness test, risk warnings and summaries, and changes to align the LTAF rules with certain investor protection rules that apply to other authorised funds. A 35% restriction on illiquid assets in unit-linked funds would also be removed for certain pension scheme investors.
Restricted retail investors would have to undertake appropriateness assessments to ensure they understand the investment risks and redemption terms, before being able to invest up to 10% of their investible assets in LTAFs and other restricted products.
The FCA plans to publish final rules in early 2023. Fund managers that are considering launching LTAFs for a retail target market should consider carefully the FCA's proposals and continue to monitor policy developments. Where firms also operate in the EU, they should keep up to date with the ongoing review of the European Long-Term Investment Fund (ELTIF) regulation.
To adapt to the evolving policy landscape, Alternatives firms will need to take into account the FCA’s updated supervisory priorities and the impact of the new Consumer Duty. The portfolio letter presents an opportunity to review existing arrangements and approaches to ESG, front office controls, liquidity risk management and product governance.