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

A hedge fund manager is setting up its governance framework. An investor's due diligence team asks which arrangement best supports independent oversight of valuation and risk at the fund. Which arrangement is the strongest?

The strongest arrangement is a valuation committee with independent members together with a risk function that reports outside the front office. This separates control from performance-driven decision makers and reduces conflicts of interest, whereas letting the portfolio manager oversee risk or valuations undermines independence.

  1. AThe chief risk officer reports to the portfolio manager who generates the fund's returns
  2. BA valuation committee that includes independent members and a risk function reporting outside the front officeCorrect
  3. CThe portfolio manager approves valuations of illiquid positions to ensure consistency with the trading strategy
  4. DThe fund's administrator is replaced by an in-house team supervised by the investment team

Explanation

Independent oversight requires that valuation and risk functions are separated from the people whose compensation depends on performance. A valuation committee with independent members and a risk function outside the front office achieves this. The other arrangements place control in the hands of the portfolio manager, creating a conflict of interest.

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