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

A hedge fund manager is deciding where to place the risk management function. The fund's investors have asked for evidence that risk oversight is credible and not compromised by performance pressure. Which structural arrangement would best address this concern?

The best arrangement has the chief risk officer reporting to the CEO or board, with pay independent of fund performance. This keeps the monitor separate from those taking risk, so oversight is credible. Reporting to the investment head or self-monitoring by managers leaves the conflict in place.

  1. AThe chief risk officer reports to the chief investment officer, who sets the CRO's bonus
  2. BThe chief risk officer reports directly to the CEO or board and is compensated independently of fund performanceCorrect
  3. CEach portfolio manager appoints and monitors their own risk analyst
  4. DRisk monitoring is performed quarterly by the portfolio managers themselves using their preferred models

Explanation

Independence requires that the risk function not report to, or be paid by, the people whose risk-taking it monitors. Reporting to the CEO or board with pay not tied to fund performance removes the conflict. Reporting to the CIO or using portfolio-manager-appointed analysts leaves the monitor dependent on the monitored.

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