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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A asset manager's CRO observes that portfolio managers routinely operate at 95-98% of their allocated tracking-error limits, and that limit breaches are usually resolved by temporarily raising the limit after the fact. Which conclusion about the firm's risk culture is most appropriate?

The firm's risk appetite is effectively being set by the front office. Raising limits after breaches means they are negotiable rather than binding, which shows weak accountability and challenge from risk management, a sign of a poor risk culture despite the quick resolution of breaches.

  1. AThe culture is strong because breaches are always resolved quickly
  2. BRisk appetite is effectively set by the front office, indicating weak accountability and a culture that treats limits as negotiableCorrect
  3. CThe limits are too low and should be abolished
  4. DThe behavior is acceptable provided the breaches are reported to clients annually

Explanation

Retroactively raising limits after breaches shows limits do not bind and that the business, not the board or risk function, determines appetite. This signals weak challenge and accountability. Fast resolution by raising limits is not evidence of discipline, and abolishing limits would worsen the problem.

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