Funds Legal Update

We take a look at the Long-Term Asset Fund, described by the Financial Conduct Authority (FCA) as "an innovative new category of open-ended authorised funds". The vehicle is designed to invest efficiently in long-term, illiquid assets, thereby opening up the possibility of pension schemes investing in asset classes such as private equity.

The FCA has been busy in the environmental, social and governance (ESG) space. The regulator is seeking initial views on sustainability disclosure requirements plus a new labelling system for sustainable investment products, and has released an updated ESG strategy. The government has also published guidance giving more detail on climate transition plans.

Finally, we take a quick look at the qualifying asset holding company regime, which aims to ensure that investors are taxed on income and gains received from holding companies broadly as if they had invested in the underlying assets directly.

The Long-Term Asset Fund arrives

Back in May 2021, the FCA consulted on a regime to enable UK-authorised open-ended funds to invest more efficiently in long-term, illiquid assets (CP21/12) – see our earlier Funds Legal Update for background. On 25 October 2021, the FCA published a policy statement (PS21/14) on the new type of fund, the Long-Term Asset Fund (LTAF).

The new vehicle is designed to invest efficiently in long-term, illiquid assets (e.g. venture capital, private equity, and private debt). This will make it easier for defined contribution pension schemes and sophisticated or high-net worth investors to access these asset classes.

The FCA has made changes to the rules to address feedback to its May 2021 consultation paper, including in the following areas:

• The role of the depositary in overseeing the manager's competence in valuing the fund – in particular, the proposed requirement for depositaries to determine “without qualification” that the manager has the necessary knowledge, skills, and experience to value the LTAF’s assets has been removed.
• The promotion of non-mainstream pooled investments rules – so LTAFs can be promoted to certified high-net worth investors as part of a diversified portfolio.
• Redemptions – these must be available no more frequently than monthly, but with the additional overlay of investors having to give minimum 90 days’ notice in advance.

For now, the regulator will keep the rule applicable to all UK authorised funds requiring the depositary to take legal ownership of the LTAF's assets, although where a firm wants to launch an LTAF, the FCA will consider applications to waive this.

The new rules in the FCA Handbook (in particular a new chapter, COLL 15) came into force on 15 November 2021.

The FCA plans to consult in H1 2022 on whether to enable a broader range of consumers to invest in LTAFs in a controlled way.
 

UK sustainability disclosure requirements

On 3 November 2021, to coincide with COP26 Finance Day, the FCA published a discussion paper on sustainability disclosure requirements (SDR) and investment labels (DP21/4). 

The regulator is seeking initial views on SDR and a new labelling system for sustainable investment products. These are the two main aspects of the government's "Greening Finance: A Roadmap to Sustainable Investing Roadmap" (which we covered in our previous Funds Legal Update) that need action from the FCA to implement them.

The deadline for responses is 7 January 2022, and the FCA plans to consult on policy proposals in Q2 2022.

This paper focuses on the elements of SDR relevant to firms involved in investment management and decision-making processes. The FCA is exploring the best approach to introducing requirements for financial advisers in due course.

One approach the FCA is considering is a three-tiered system (see Figure 2 of DP21/4):

• Product labels. A standardised product classification and labelling system would help consumers understand the sustainability characteristics of different products and navigate the products on offer.
• Disclosure layer 1. Consumer-facing product-level disclosures could provide standardised information on the product's key sustainability attributes. This would allow consumers to better understand the sustainability characteristics of the product, compare similar products or the same product over time, and hold the provider to account for sustainability claims made.
• Disclosure layer 2. Detailed disclosures could be made at entity and product level, on sustainability risks, opportunities and impacts, providing more granular information and additional information as relevant. The disclosures could be useful to institutional investors and other stakeholders.

Under this approach, the disclosure requirements would build on the FCA's proposed Task Force on Climate-Related Financial Disclosures (TCFD)-aligned disclosure requirements, widening the scope to other sustainability factors beyond climate. In setting the potential scope of firms and products, the FCA could as a starting point consider basing this on the proposed scope of its TCFD regime.

FCA strategy for ESG priorities

On 3 November 2021, the FCA published its strategy for its ESG priorities, setting out how it intends to deliver the target ESG-related outcomes from its Business Plan 2021/22. 

The strategy is based on five core themes:

• Transparency: promoting transparency on climate change and wider sustainability along the value chain.
• Trust: building trust and integrity in ESG-labelled instruments, products, and the supporting ecosystem.
• Tools: enhancing industry capabilities and supporting firms’ management of climate-related and wider sustainability risks, opportunities and impacts.
• Transition: supporting the role of finance in delivering a market-led transition to a more sustainable economy.
• Team: developing strategies, organisational structures, resources and tools to support the integration of ESG into FCA activities.

For each of these themes, the FCA describes the key actions it is currently taking or intends to take.

The strategy also sets out the core principles that the FCA has used to identify its themes and near-term priorities, and an overview of how it has delivered against the priorities in its October 2019 feedback statement (FS19/6) on climate change and green finance.

The FCA will give interim updates on the progress of the ESG strategy in its business plan and annual report in 2022, and publish a more detailed stock-take on progress in 2023.

Mandatory publication of climate transition plans

On 3 November 2021, the government confirmed that it would introduce mandatory requirements for certain companies to publish net-zero transition plans setting out how they will decarbonise in the period to 2050.

The government indicated in its October 2021 paper, "Greening Finance: A Roadmap to Sustainable Investing", that it would require asset managers (amongst others) to publish transition plans that consider the government’s net zero commitment on a "comply or explain" basis.

The government has now released guidance giving more detail on what a transition plan is and what will be required (see HM Treasury's "Fact Sheet: Net Zero-aligned Financial Centre" (3 November 2021)). The guidance clarifies that the government is not requiring firms to adopt mandatory net zero targets. 

The government will expect firms to start publishing transition plans in 2023.
 

Asset holding companies regime

This measure introduces a regime for the taxation of qualifying asset holding companies (QAHCs), with various exemptions available. A QAHC must be at least 70% owned by diversely owned funds, or certain institutional investors, and mainly carry out investment activity with no more than insubstantial ancillary trading. No exemptions will be available in respect of investments in UK real estate.

The measure, which will take effect in April 2022, forms part of a wider review of the UK funds regime to consider reforms which could enhance the UK’s competitiveness as a location for asset management and investment funds.

The aim is to recognise circumstances where holding companies are used to facilitate the flow of capital, income and gains between investors and underlying investments, so that investors are taxed broadly as if they invested in the underlying assets and the holding companies pay no more tax than is proportionate to their activities.