Under the UK regulatory framework, specifically the Financial Conduct Authority’s (FCA) Collective Investment Schemes sourcebook (COLL), the Authorised Fund Manager (AFM) has a primary and overarching fiduciary duty. As per COLL 6.6, the AFM must manage the scheme in the best interests of the unitholders and in accordance with the fund’s constitutive documents (the instrument of incorporation and the prospectus) and the regulations. While maximising returns is a goal, it cannot be pursued in a way that contravenes the stated investment objectives, policies, or risk profile outlined in the prospectus. The prospectus is a legally binding document that informs investors how their money will be managed. The depositary’s role is one of oversight and safekeeping, not approving specific investment decisions. The duty to the regulator is to comply with rules, but the primary fiduciary duty in managing the assets is to the investors.

The correct answer is based on the provisions of the UK Companies Act 2006, which governs the rights of shareholders in corporate entities, including Investment Companies with Variable Capital (ICVCs). Specifically, Section 314 of the Act grants shareholders the right to require the company to circulate a statement (of not more than 1,000 words) regarding a matter to be dealt with at a general meeting. To exercise this right, the request must be made by members representing at least 5% of the total voting rights of all members who have a right to vote at the meeting. This is a key shareholder protection mechanism, allowing minority shareholders to have their views and proposed resolutions put before the entire shareholder base at the company’s expense. For a CIS administrator, understanding these statutory thresholds is crucial for ensuring the fund vehicle (the ICVC) complies with company law and respects shareholder rights, a principle underpinned by the FCA’s COLL (Collective Investment Schemes) sourcebook, which requires authorised funds to operate in accordance with their constitutional documents and applicable legislation.

This question assesses the candidate’s understanding of the fundamental regulatory classifications of UK funds and their marketing permissions, a core topic for the CISI exam. The primary risk stems from the distinction between a UCITS (Undertakings for Collective Investment in Transferable Securities) fund and a Non-UCITS Retail Scheme (NURS). Under the UK’s regulatory framework, derived from the Financial Services and Markets Act 2000 (FSMA) and detailed in the FCA’s Collective Investment Schemes sourcebook (COLL), a UCITS fund benefits from a ‘passport’. This passport allows it to be marketed to retail investors across the European Economic Area (EEA) with minimal additional authorisation from host member states. In contrast, a NURS is an authorised UK scheme designed for the UK retail market but does not have this passport. Attempting to market a NURS to retail investors in EEA countries like Germany and France is a major regulatory breach. It would fall foul of the marketing rules under the Alternative Investment Fund Managers Directive (AIFMD) and the specific national private placement regimes (NPPRs) of each country, which are typically not permissive for retail marketing. Therefore, the fund is not eligible for the proposed marketing campaign, creating significant legal and reputational risk.

In the UK regulatory framework for collective investment schemes, the structure of an Open-Ended Investment Company (OEIC), also known as an Investment Company with Variable Capital (ICVC), is designed with a fundamental separation of duties to protect investors. This is mandated by the Financial Conduct Authority’s (FCA) Collective Investment Schemes sourcebook (COLL). The Authorised Corporate Director (ACD) is responsible for the day-to-day management of the fund, including investment decisions. This creates an inherent conflict of interest, as the ACD’s commercial goals (e.g., maximising management fees) may not always align with the best interests of the fund’s shareholders. To mitigate this risk, the regulations require the appointment of an independent Depositary. The Depositary has two primary, legally mandated duties under COLL 6.6: the safekeeping of the scheme property (custody) and an oversight function. The oversight duty requires the Depositary to ensure the ACD complies with the rules in the COLL sourcebook and the fund’s constitutional documents, particularly concerning share issues/cancellations, valuation, and income distribution. This independent oversight is the cornerstone of investor protection in the OEIC structure, acting as the primary structural control against potential mismanagement or misconduct by the ACD. The other options are incorrect as an internal committee lacks independence, an auditor’s role is a retrospective financial check rather than ongoing operational oversight, and regulatory submissions are a compliance task, not a day-to-day governance control mechanism.

In the context of the UK CISI regulatory framework, a Unit Trust is a collective investment scheme constituted under a trust. The structure is governed by a legal document called the Trust Deed. A fundamental principle for investor protection, mandated by the Financial Conduct Authority’s (FCA) Collective Investment Schemes sourcebook (COLL), is the strict separation of roles between the Manager (the Authorised Fund Manager or AFM) and the Trustee. The Manager is responsible for the investment management, marketing, and administration of the fund. The Trustee, which must be an independent entity, has the primary duty to act as the legal owner of the scheme’s assets (the ‘scheme property’). The Trustee holds these assets on trust for the ultimate benefit of the unitholders. This segregation ensures that the scheme’s assets are protected and kept separate from the Manager’s own assets, safeguarding them in the event of the Manager’s insolvency. The Trustee also has an oversight role, ensuring the Manager operates the scheme in accordance with the Trust Deed and the regulations outlined in COLL, particularly concerning pricing, dealing, and income distribution.

The correct answer is that the arrangement constitutes a Collective Investment Scheme (CIS) as defined by Section 235 of the Financial Services and Markets Act 2000 (FSMA 2000). According to FSMA 2000, a CIS has four key characteristics: (1) it involves arrangements concerning property of any kind; (2) its purpose is to enable participants to share in profits or income from that property; (3) the participants do not have day-to-day control over the management of the property; and (4) the participants’ contributions and the resulting profits are pooled. The scenario described meets all four of these conditions, making it a CIS. A Joint Venture typically implies that participants have a degree of control, which is explicitly absent here. A Real Estate Investment Trust (REIT) is a specific type of listed company that invests in property and is a form of CIS, but the fundamental classification based on the description is a CIS. An unregulated scheme is incorrect because operating a CIS is a regulated activity in the UK, requiring authorisation from the Financial Conduct Authority (FCA) as per the FCA’s Perimeter Guidance Manual (PERG).

A Collective Investment Scheme (CIS), as defined under Section 235 of the UK’s Financial Services and Markets Act 2000 (FSMA 2000), is any arrangement where participants’ contributions are pooled to invest in property, with profits or income arising from the investment being shared. The primary purpose from an investor’s perspective is to gain access to a professionally managed and diversified portfolio, which would be difficult or costly to achieve individually. This pooling of assets allows for the spreading of investment risk (diversification) across a wide range of securities. UK-authorised schemes, such as the unit trust mentioned, are heavily regulated by the Financial Conduct Authority (FCA) under its Collective Investment Schemes sourcebook (COLL), which provides significant investor protection. The other options are incorrect: CISs do not guarantee returns (a key risk warning); investors delegate management control and do not receive direct voting rights in underlying companies; and while some schemes can be held in tax-efficient wrappers like ISAs, they are not inherently tax-free vehicles.

This question tests knowledge of the core investment and borrowing powers for UK-authorised UCITS schemes, specifically the ‘spreading rules’ designed to ensure diversification and limit risk from a single issuer. These rules are mandated by the UCITS Directive and implemented in the UK by the Financial Conduct Authority (FCA) in the Collective Investment Schemes sourcebook (COLL), primarily in section COLL 5.2. The key rule applicable here is often referred to as the ‘5/10/40’ rule: 1. A scheme must not invest more than 10% of its Net Asset Value (NAV) in transferable securities or money-market instruments issued by a single body (the ‘10% rule’). 2. The total value of all holdings that individually represent more than 5% of the scheme’s NAV must not, in aggregate, exceed 40% of the NAV (the ‘40% rule’). In the scenario: – The fund’s NAV is £200 million. – The 10% limit for a single issuer is therefore £20 million. – The holding in Company A is £22 million, which is 11% of the NAV (£22m / £200m). This clearly breaches the 10% rule. The other large holdings (B, C, other approaches are all below this 10% threshold. The 40% rule is not breached, as the sum of holdings over 5% (Company A at 11%, Company B at 9%, Company C at 7%, and Company D at 6%) is 33%, which is below the 40% limit. The other options are incorrect as they refer to NURS rules (not applicable to a UCITS fund) or a general principle that isn’t the specific, quantifiable regulatory breach shown.

Under the UK’s implementation of the Alternative Investment Fund Managers Directive (AIFMD), specifically within the FCA Handbook’s FUND 3.7 and SYSC 7 sourcebooks, an Alternative Investment Fund Manager (AIFM) is required to establish and maintain a permanent and independent risk management function. A critical component of this function is the implementation of an adequate and documented risk management policy. This includes conducting periodic stress tests and scenario analyses to address potential risks related to the fund’s investment strategy, liquidity profile, and investor base. The scenario describes a clear failure in this duty. The AIFM’s stress tests were not ‘appropriate’ or ‘severe but plausible’ because they relied solely on recent positive historical data and failed to consider hypothetical adverse market conditions. Regulators expect forward-looking analysis, not just a review of past performance. This failure directly led to an inadequate liquidity management plan, breaching the core AIFMD principle of robust risk management. The other options are incorrect: CASS rules relate to the protection of client money and assets, not internal risk modelling; UCITS rules do not apply to an AIF; and while prospectus disclosure is important, the primary regulatory breach identified in the investigation is the failure of the internal risk management process itself.

This question assesses the understanding of an Authorised Fund Manager’s (AFM) responsibilities during severe market stress, specifically within the UK regulatory framework governed by the Financial Conduct Authority (FCA). The correct action is to consider suspending dealings. According to the FCA’s Collective Investment Schemes sourcebook (COLL 7.2), an AFM has the power to suspend dealings in a fund’s units if they have a reasonable opinion that it is in the interests of all the unitholders. In a scenario with high redemption volumes and falling asset prices, continuing to sell assets to meet redemptions can create a ‘fire sale’ dynamic. This would unfairly prejudice the remaining unitholders by eroding the Net Asset Value (NAV) at an accelerated rate. This action directly aligns with the FCA’s Principle 6 (Treating Customers Fairly), as it protects the collective interest of all investors rather than favouring those who redeem first. The other options are incorrect: continuing to sell liquid assets first is unfair to remaining investors; fundamentally altering the strategy without approval would breach the prospectus and COLL rules; and exceeding borrowing limits is a direct violation of COLL 5.2, which caps temporary borrowing for a UCITS scheme at 10% of its NAV.

This question assesses the understanding of the fund administrator’s oversight responsibilities concerning a fund’s Strategic Asset Allocation (SAA) under the UK regulatory framework. The correct answer is to notify the fund manager. The fund’s prospectus is a legally binding document, and the SAA outlined within it forms a core part of the investment contract with unitholders. A significant deviation from the SAA, even before a hard limit is breached, constitutes ‘style drift’ and alters the fund’s risk profile. Under the FCA’s Collective Investment Schemes sourcebook (COLL), particularly COLL 6.6, the Authorised Fund Manager (AFM) is responsible for ensuring the scheme is managed in accordance with its instrument of incorporation and prospectus. The fund administrator’s oversight or trustee/depositary function is to monitor this compliance. When a deviation is detected, the immediate and proper procedure is to escalate the issue to the fund manager, who is the entity with the mandate to make investment decisions and execute trades for rebalancing. Instructing the custodian is incorrect as the administrator has no authority to direct trading. Simply continuing to monitor is a failure of the proactive oversight function, as action is required before a breach occurs. Reporting to unitholders is a disclosure step that would happen later; the primary immediate action is remediation, which begins with notifying the manager.

This question addresses the critical regulatory issue of ‘closet tracking’ within the context of active versus passive management, a key topic for the CISI Collective Investment Scheme Administration exam. A ‘closet tracker’ is a fund that is marketed and charges fees as an actively managed fund but whose portfolio construction and performance closely mimic a benchmark index, effectively providing a passive-like return for a much higher cost. The UK’s Financial Conduct Authority (FCA) has focused heavily on ensuring funds deliver value for money. This was a primary outcome of their Asset Management Market Study. Consequently, the FCA introduced the Assessment of Value (AoV) regime, codified in the Collective Investment Schemes sourcebook (COLL 6.6.20R). This rule requires Authorised Fund Managers (AFMs) to conduct an annual assessment to justify the charges taken from their funds against a range of criteria, including performance, quality of service, and costs. A fund with a high Ongoing Charges Figure (OCF) but low ‘active share’ and benchmark-hugging performance, as described in the scenario, would likely fail its AoV. This practice is considered misleading to investors and a breach of the regulatory duty to act in their best interests and provide communications that are fair, clear, and not misleading (as per COBS 4). The other options are incorrect as CASS relates to the custody of client assets, UCITS V depositary liability concerns the safekeeping and oversight of fund assets, and an incorrect NAV calculation is a pricing error, not a strategic value-for-money issue.

This question assesses understanding of core investor protection principles within the UK’s regulatory framework, specifically governed by the Financial Conduct Authority (FCA). The correct answer highlights the fundamental duty of a fund to operate in accordance with its disclosed investment objectives and risk profile. The FCA’s Collective Investment Schemes sourcebook (COLL) and Conduct of Business sourcebook (COBS) are central to this. Under COLL 4.2, the prospectus must contain all information necessary for investors to make an informed judgement about the investment. A significant change, such as introducing a complex derivatives strategy not previously disclosed, constitutes a fundamental change to the fund’s nature. This directly contravenes the information provided to investors upon which they based their decision. Furthermore, this situation breaches several of the FCA’s Principles for Businesses, most notably Principle 6 (‘A firm must pay due regard to the interests of its customers and treat them fairly’) and Principle 7 (‘A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading’). The Key Investor Information Document (KIID) or PRIIPs Key Information Document (KID) would also become misleading. The other options, while representing valid business or investment risks (operational costs, counterparty risk, performance risk), are secondary to the primary regulatory breach of failing to adhere to the fund’s constitutional documents and misleading investors about the risks they are undertaking.

Under the UK’s regulatory framework, specifically the FCA’s Collective Investment Schemes sourcebook (COLL 6.3), an Authorised Fund Manager (AFM) has a primary duty to ensure that the scheme’s property is valued fairly and accurately. When a fund holds an asset that is illiquid or for which a ready market price is not available, a simple quoted price may not represent the true ‘fair value’ at which the fund could realistically liquidate its position. Therefore, a liquidity adjustment may be necessary. The factors in the correct answer directly address the practical challenges of selling a large, illiquid position: the size of the holding versus the market’s capacity to absorb it (daily volume), the time it would take to sell without causing a market disturbance, and the associated costs (both explicit, like brokerage fees, and implicit, like the bid-ask spread and price impact). This approach is also consistent with the principles of the Alternative Investment Fund Managers Directive (AIFMD), which places a strong emphasis on robust and prudent valuation policies for less liquid assets. The other options are incorrect because they confuse asset-specific valuation with other concepts: historical cost is irrelevant to current fair value; overall fund flows relate to liquidity management, not the valuation of a single asset; and while credit rating and interest rates affect an asset’s price, they do not determine the specific discount required to account for its lack of liquidity.

The correct answer is the Alternative Investment Fund Managers Directive (AIFMD). This question tests the ability to differentiate between the two primary European fund structures, UCITS and AIFs, based on their investment strategy and target investors. The fund described in the scenario is an Alternative Investment Fund (AIF) because it falls outside the strict criteria of a UCITS fund. Specifically, its strategy of investing in illiquid assets (unlisted infrastructure projects) and its use of ‘significant leverage’ are prohibited under the UCITS Directive. The UCITS framework, implemented in the UK via the FCA’s Collective Investment Schemes sourcebook (COLL), is designed for retail funds investing in liquid, transferable securities with strict diversification and borrowing limits. Since this fund is not a UCITS, it is classified as an AIF by default. The AIFMD provides the regulatory framework for the managers of such funds (AIFMs). It governs the authorisation, ongoing operation (including requirements for a depositary and independent valuation), and transparency of AIFMs, and it establishes a passporting regime for marketing AIFs to professional investors across the EEA (though post-Brexit, UK firms rely on individual member states’ National Private Placement Regimes (NPPRs)). MiFID II governs the provision of investment services, and while relevant to the manager, it does not govern the fund product itself. The NURS framework is a UK domestic regime for non-UCITS funds aimed at retail investors and is not the primary directive governing an AIF intended for cross-border professional marketing.

The correct answer is to escalate the matter internally to the REIT’s board and the administrator’s own compliance department. This aligns with the CISI Code of Conduct, particularly the principles of ‘Integrity’ and ‘Professionalism’. The administrator has a duty to act with due skill, care, and diligence. Ignoring the issue or colluding with the manager would be a direct breach of these principles. Reporting directly to HMRC is an extreme step that bypasses the firm’s internal governance and escalation policies, which should be the first port of call. The core issue is the potential breach of UK tax law governing REITs. Under HMRC regulations, a UK REIT must distribute at least 90% of its tax-exempt property rental profits as Property Income Distributions (PIDs) to maintain its favourable tax status. Intentionally misclassifying a capital gain as rental income to meet this threshold is a serious misrepresentation that could lead to the loss of REIT status, resulting in significant tax liabilities for the fund and negatively impacting shareholders. The administrator’s role, as overseen by the FCA (under principles like PRIN 1: Integrity and PRIN 2: Skill, care and diligence), is to ensure proper administration and to protect the interests of the investors by escalating such significant regulatory risks to the highest level of governance within the fund structure.

This question assesses the candidate’s understanding of a fund administrator’s responsibilities regarding portfolio monitoring and adherence to a fund’s stated investment policy and risk profile, a core concept in risk-based asset allocation. For a UK-authorised fund, particularly a UCITS scheme, the Key Investor Information Document (KIID) and the prospectus are legally binding documents. The Synthetic Risk and Reward Indicator (SRRI), a scale from 1 (lowest risk) to 7 (highest risk), is a mandatory disclosure in the KIID. The FCA’s Collective Investment Schemes sourcebook (COLL) requires the Authorised Fund Manager (AFM) to manage the scheme in accordance with its constitutive documents and prospectus. A significant deviation, or ‘style drift’, from the stated risk profile constitutes a breach of these obligations and is a failure to treat customers fairly, as mandated by the FCA’s Conduct of Business Sourcebook (COBS). The correct administrative procedure is not to change the fund’s objective to match the drift, but to execute the pre-defined rebalancing strategy to bring the portfolio back in line with its promised risk-return characteristics.

This question assesses the fund administrator’s critical oversight role in monitoring compliance with a fund’s investment policy, specifically regarding Tactical Asset Allocation (TAA). The correct answer is to immediately notify the fund manager and the depositary of the potential breach. Under the UK regulatory framework, the fund’s prospectus is a legally binding document that sets out the investment objectives and restrictions. The stated tactical deviation limit of +/- 5% is a hard limit. The manager’s allocation of 78% equities represents an 8% deviation from the 70% strategic benchmark, clearly exceeding this limit. The administrator’s primary responsibility, as a key part of the fund’s control environment, is to monitor for such breaches and escalate them promptly. This duty is aligned with the FCA’s Principles for Businesses (PRIN), particularly Principle 3 (Management and control). The FCA’s Collective Investment Schemes sourcebook (COLL) places a direct oversight duty on the depositary (COLL 6.9) to ensure the scheme is managed in accordance with its constitutional documents and regulations. The administrator acts as a first line of defence in this process, and failure to escalate a known breach to both the manager (for rectification) and the depositary (for oversight) would be a significant regulatory failing. Waiting for valuation confirms the financial impact but doesn’t change the fact the breach has already occurred. The administrator has no authority to alter prospectus limits or execute trades to correct the position.

This question assesses knowledge of the governance and regulatory requirements for making fundamental changes to an Open-ended Investment Company (OEIC) under the UK’s Financial Conduct Authority (FCA) rules. According to the FCA’s Collective Investment Schemes sourcebook (COLL), specifically COLL 4.3, any ‘fundamental change’ to a scheme requires the explicit approval of its shareholders. A change to the core investment objective and policy, as described in the scenario (moving from UK Equity Income to Global Technology), is a prime example of a fundamental change. The required procedure is to convene a general meeting of shareholders and pass an extraordinary resolution, which typically requires a majority of at least 75% of the votes cast. While the FCA and the Depositary must be notified, and updated documents like the prospectus must be filed, their notification or approval does not replace the primary requirement of shareholder consent for such a significant alteration to the nature of the investment.

In the United Kingdom, the Financial Conduct Authority (FCA) is the primary regulatory body responsible for the authorisation and supervision of Collective Investment Schemes (CIS) and the firms that operate and administer them. This authority is granted under the Financial Services and Markets Act 2000 (FSMA 2000). The FCA has three statutory objectives: to secure an appropriate degree of protection for consumers, to protect and enhance the integrity of the UK financial system, and to promote effective competition in the interests of consumers. For a UK-domiciled UCITS fund, the administrator must adhere to the detailed rules set out in the FCA Handbook, particularly the Collective Investment Schemes sourcebook (COLL). While the Prudential Regulation Authority (PRA) is a key UK regulator, its focus is on the prudential soundness of systemically important firms like banks and insurers, not the conduct and authorisation of most CIS operators. The SEC is the US regulator, and ESMA is the EU authority; while their rules may be influential, the FCA is the direct, legally mandated regulator for a UK fund.

The correct answer highlights a critical failure in the AIFMD oversight regime. Under the UK’s implementation of the Alternative Investment Fund Managers Directive (AIFMD), found within the FCA’s FUND sourcebook (specifically FUND 3.11), a depositary has three primary duties: safekeeping of assets, oversight of the AIFM, and cash flow monitoring. The scenario describes a clear breach of the cash flow monitoring duty. The depositary must have knowledge of all cash movements and accounts to ensure that all payments made by investors have been received and that all cash of the AIF has been booked in cash accounts opened in the name of the AIF, the AIFM acting on behalf of the AIF, or the depositary acting on behalf of the AIF. Notifying the depositary a week after the transactions have occurred prevents it from performing this duty effectively and in real-time, which is a significant regulatory failing. The other options are incorrect as the scenario does not provide evidence of an AML breach, the issue is not about the valuation process itself, and the administrator’s primary duty is to act on the AIFM’s instruction, not to independently verify the depositary’s notification status.

This question assesses the candidate’s ability to identify and differentiate between the main types of financial risk. The scenario describes a failure in an internal process (NAV calculation) caused by a system flaw (a software bug). According to the Basel Committee and as adopted by UK regulators like the Financial Conduct Authority (FCA), this is a classic example of Operational Risk. Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. In the context of the UK CISI exam, understanding this is crucial. The FCA’s Senior Management Arrangements, Systems and Controls (SYSC) sourcebook requires firms to have robust governance and control arrangements to manage operational risks effectively. Furthermore, the Collective Investment Schemes sourcebook (COLL) has specific rules on the valuation and pricing of units/shares, and a failure in this process represents a significant operational breakdown. Market risk relates to losses from movements in market prices, credit risk to a counterparty defaulting, and liquidity risk to the inability to meet financial obligations or sell assets without a significant loss. None of these are the primary risk described.

This question assesses the candidate’s understanding of the depositary’s critical oversight duties as mandated by UK regulations, which are derived from European directives. The correct answer is A. Under the FCA’s Collective Investment Schemes sourcebook (COLL 6.6), which implements the UCITS V Directive in the UK, a depositary has three core responsibilities: (i) safekeeping of scheme assets, (ii) cash flow monitoring, and (iii) oversight duties. The scenario described falls directly under the oversight function. This duty requires the depositary to ensure that the Authorised Fund Manager (AFM) acts in accordance with the fund’s constitutional documents (e.g., the prospectus) and all applicable regulations. A related-party transaction that may breach investment restrictions and represent a conflict of interest is a primary concern. The depositary’s immediate responsibility is to investigate the transaction to ensure it is compliant and, crucially, that it is in the best interests of the scheme’s unitholders. other approaches is incorrect as the depositary’s role is preventative; it must challenge potential breaches before they cause loss to investors, not simply process them. other approaches is incorrect as providing investment recommendations is the role of the AFM, not the depositary. other approaches is an extreme and incorrect immediate action; the first step is inquiry and verification with the AFM, with escalation to the FCA being a subsequent step if the issue is not resolved satisfactorily.

This question assesses the candidate’s understanding of the critical procedures following the discovery of a material pricing error in a UK-authorised fund, specifically focusing on the regulatory duties outlined in the FCA’s Collective Investment Schemes sourcebook (COLL). The correct answer is to suspend dealings, notify the regulator, and calculate compensation. This is because the error (0.65%) exceeds the typical de minimis materiality threshold (in this case, 0.50% of the NAV), meaning it has a significant impact on the price at which investors have subscribed or redeemed. Under the FCA’s COLL 7.2, the Authorised Fund Manager (AFM) must suspend dealing if it is in the interests of the unitholders. Allowing dealing to continue at a known incorrect price would breach the FCA’s core principle of Treating Customers Fairly (TCF). The AFM has ultimate responsibility for the fund’s valuation, even if the task is delegated to a TPA. Notifying the FCA is a mandatory regulatory requirement for such a material breach. Calculating compensation is essential to restore any investors who subscribed at the inflated price to the position they would have been in had the error not occurred. The other options are incorrect because they fail to prioritise the immediate protection of investors and regulatory compliance, which are the AFM’s primary duties in this risk scenario.

This question assesses the candidate’s understanding of the regulatory requirements for Alternative Investment Fund Managers (AIFMs) in the UK concerning stress testing and liquidity risk management, as mandated by the Alternative Investment Fund Managers Directive (AIFMD) and implemented in the FCA Handbook. Under the FCA’s FUND sourcebook (specifically FUND 3.7), which transposes AIFMD into UK regulation, AIFMs are required to establish and maintain a permanent risk management function. A key part of this function is to implement adequate risk management systems, which must include conducting periodic stress tests and scenario analyses to address the fund’s various risks, including liquidity risk. The correct action upon identifying a potential weakness through a stress test is for the AIFM’s governing body to formally review its existing policies and procedures. The test has revealed that the current liquidity management framework may be inadequate for the simulated market conditions. Therefore, the primary and most appropriate response is a strategic review of the liquidity management policy, the portfolio’s composition, and the appropriateness of the risk limits. This aligns with the FCA’s expectation that firms should act on the output of their risk management processes to ensure they can manage their funds in the best interests of investors at all times. This principle is further reinforced by the FCA’s rules and guidance on managing liquidity in open-ended funds (e.g., Policy Statement PS19/24). Incorrect options: – Suspending dealing is an extreme measure of last resort under the FCA’s COLL sourcebook (COLL 7.2). It is only used when there is an actual, imminent crisis preventing the manager from calculating a fair price or meeting redemptions, not as a response to a potential future scenario identified in a test. – Reporting directly to unitholders is not the immediate required action. The AIFM’s duty is to manage the risk first. Any material change to the fund’s risk profile resulting from the review would subsequently be communicated through updated formal documents like the prospectus or Key Information Document (KID). – Only increasing the cash buffer is a tactical, and potentially insufficient, response. The regulations require a holistic review of the entire risk management framework, not just a single adjustment. The underlying issue might be the fund’s overall investment strategy, which a simple cash increase would not solve.

This question assesses the core definition of a Collective Investment Scheme (CIS) under UK regulation, specifically as outlined in Section 235 of the Financial Services and Markets Act 2000 (FSMA 2000). For an arrangement to be classified as a CIS, four key conditions must be met. The two most critical for this scenario are: (1) the purpose is to enable participants to share in the profits or income from the acquisition or management of property, and (2) the participants do not have day-to-day control over the management of that property. While both the investment club and the unit trust involve pooling contributions to invest for profit, the crucial difference lies in the control element. In a UK-authorised unit trust, which is governed by the FCA’s Collective Investment Schemes sourcebook (COLL), investors (unitholders) hand over their capital to a professional fund manager who makes all the investment decisions. The unitholders have no day-to-day control. Conversely, the investment club described in the scenario is structured so that all members actively vote on every decision, meaning they retain day-to-day control. This retention of control means the arrangement fails a key part of the S.235 definition and is therefore not typically considered a CIS.

This scenario highlights a critical breach of a fund manager’s fiduciary duty, specifically concerning the fair treatment of clients. The correct answer identifies the failure to ensure fair allocation of trades, a core principle governed by the UK’s Financial Conduct Authority (FCA). Under the FCA’s Conduct of Business Sourcebook (COBS), particularly COBS 11.3, firms must establish and implement an order allocation policy that ensures fair allocation of aggregated orders and transactions among clients. Favouring one fund over another, especially a newer fund to boost its performance (‘window dressing’), at the expense of other clients is a direct violation. This action also breaches FCA Principle 6, which states a firm must pay due regard to the interests of its customers and treat them fairly (TCF). Furthermore, the Authorised Fund Manager (AFM) has a duty under the Collective Investment Schemes Sourcebook (COLL 6.6A) to act in the best interests of the scheme and its unitholders. By disadvantaging the unitholders of the UK Equity Fund, the manager has failed in this duty. Under the Senior Managers and Certification Regime (SM&CR), the fund manager, as a certified person, is personally accountable for adhering to conduct rules, and such a breach could lead to regulatory action against both the firm and the individual.

This question assesses the understanding of the regulatory implications of ‘closet tracking’ within the UK framework. A closet tracker, or benchmark hugger, is a fund marketed and priced as actively managed but whose portfolio holdings and performance closely mimic a passive benchmark index. The key issue is that investors are paying high fees, typical of active management, for a service that is effectively passive. Under the UK’s Financial Conduct Authority (FCA) regime, this practice raises significant concerns, primarily related to the Consumer Duty. The Consumer Duty requires firms to act to deliver good outcomes for retail customers, and is underpinned by four key outcomes, one of which is the ‘Price and Value’ outcome. This outcome dictates that the price of a product or service must be reasonable relative to the benefits it provides. Charging active fees for passive performance is a clear potential breach of this fair value requirement. Furthermore, this scenario breaches several FCA Principles for Businesses, notably Principle 6 (‘A firm must pay due regard to the interests of its customers and treat them fairly’) and Principle 7 (‘A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading’). Under the FCA’s Collective Investment Schemes sourcebook (COLL), Authorised Fund Managers (AFMs) are required to conduct an annual ‘Assessment of Value’, explicitly justifying their funds’ charges against a range of criteria, including performance. The data presented in the scenario would make it extremely difficult for the AFM to justify the high OCF, making a breach of the COLL 6.6.20R requirement highly likely.

The correct answer is to verify the proposed changes against the fund’s prospectus and the FCA’s COLL sourcebook. The role of the Collective Investment Scheme (CIS) administrator is not to make investment decisions but to ensure the fund operates within its prescribed legal and regulatory boundaries. The fund’s prospectus is a legally binding document that details its investment objectives, strategy, and restrictions. Any proposed change, especially a significant one involving new asset classes like physical commodities, must first be checked for compliance with this document. Furthermore, as a UK-authorised UCITS scheme, the fund is subject to the FCA’s Collective Investment Schemes sourcebook (COLL). Specifically, COLL 5 outlines the investment and borrowing powers for UCITS schemes, defining eligible assets and diversification limits. Physical commodities and certain types of derivatives may not be eligible assets for a UCITS fund or may be subject to strict limits. The administrator’s primary duty is to prevent a breach of these rules, which could lead to regulatory sanction and investor detriment. Instructing the custodian or notifying unitholders would be premature and inappropriate before confirming the proposal’s legality and compliance.

This question tests the application of IFRS 13 Fair Value Measurement within the context of UK collective investment schemes, governed by the FCA’s Collective Investment Schemes sourcebook (COLL). IFRS 13 defines a three-level hierarchy for valuation inputs: – Level 1: Quoted prices in active markets for identical assets (e.g., shares on the London Stock Exchange). – Level 2: Inputs other than quoted prices that are observable, either directly or indirectly (e.g., a recent transaction price for a similar unlisted company, interest rates). – Level 3: Unobservable inputs, which require the valuer to use their own assumptions and models (e.g., a discounted cash flow model based on internal forecasts). The FCA’s COLL 6.3 rules require the Authorised Fund Manager (AFM) to have procedures to ensure the scheme property is valued accurately and at a fair price. This is critical for the fair treatment of investors entering, exiting, and remaining in the fund. In this scenario, the price from the six-month-old funding round might have initially been considered a Level 2 input. However, the loss of a major client is a significant, material event that renders this historical price obsolete and no longer representative of the asset’s current fair value. Continuing to use it would overstate the fund’s NAV, disadvantaging new investors and unfairly benefiting redeeming ones. Therefore, the valuer must move to a Level 3 methodology. This involves using a valuation technique (like a DCF model) and incorporating the new, unobservable information (the impact of the client loss on future cash flows) to arrive at a new, defensible fair value. Applying an arbitrary haircut is not a robust valuation technique, and suspending the fund is an extreme measure not warranted as the first step.