FCA proposes new illiquid fund structure for DC schemes

In the consultation published on Friday, the regulator detailed that the new long-term asset funds would be open-ended and would be able to invest in assets such as venture capital, private equity, private debt, real estate and infrastructure.

Considering that DC schemes typically construct their default arrangements by combining a number of funds — which means these providers prefer to use a fund that is 100 per cent illiquid as part of a wider portfolio with other liquid assets — the FCA is proposing to remove the illiquid investments cap.

Currently, there is a 35 per cent limit on illiquids where a long-term asset fund forms part of the default arrangement of a pension scheme, which would be removed.

This new proposal follows a consultation published in March by the Department for Work and Pensions that questioned whether the charge cap acts as a barrier to DC scheme investments in a range of alternatives, such as venture capital, illiquids and growth assets.

This consultation is, in part, a response to the “plan for growth” published by the Treasury in its spring Budget on March 3, in which it announced plans to free up DC investment in particular to play a part in the country’s post-Covid economic recovery, and the government’s green agenda.

Steven Cameron, pensions director at Aegon, noted that the government and the FCA are “clearly keen to find ways of breaking down barriers which currently discourage DC pension schemes from investing in illiquid assets including infrastructure and other forms of productive finance”.

He noted that while the consultation on the long-term asset fund may address some of these barriers, “in particular by giving trustees of DC schemes additional confidence in how they are being managed”, this is not the only challenge when investing in illiquids.

“Perhaps more fundamentally, daily dealing on investments within DC schemes is currently regarded as standard,” Cameron said.

“While pension savings is long term, members expect to be able to switch funds, transfer between schemes, and from age 55 take retirement income without any delay or notice period.

“This cultural expectation will also need to be addressed unless DC schemes can find other ways to manage liquidity mismatches which don’t also result in additional risks for the member.”

Overall, the FCA explained that while investors can already invest in illiquid assets through closed-ended structures, some of these prefer investing in open-ended funds where there are opportunities to put money in or take it out at the net asset value of the assets.

However, as seen with property funds, open-ended structures investing in illiquid assets can face problems if they offer daily dealing to investors, the regulator noted.

“The FCA is therefore proposing that LTAF rules embed longer redemption periods, high levels of disclosure, and specific liquidity management and governance features,” it said.

In the meantime, the watchdog has postponed its decision on notice periods for open-ended property funds — with an initial suggestion that investors in open-ended property funds could have to wait 180 days to get their money back — as it said it needs more time to receive feedback on the new long-term asset fund.