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

A hedge fund's operating structure has the chief investment officer also serving as chief risk officer, with the risk function reporting to him. An investor performing operational due diligence flags this. What is the primary concern?

The main concern is lack of independence: the CIO is compensated for performance and so has an incentive to take risk, and as CRO could override or soften limits and underreport exposures. Effective risk governance needs risk oversight separate from the people who generate returns.

  1. ALack of independence means risk limits may be overridden by the person whose performance compensation depends on taking riskCorrect
  2. BCombining roles raises the fund's administrative costs above industry norms
  3. CThe structure violates the requirement that the CRO hold an FRM certification
  4. DThe fund cannot use leverage unless the CRO is a separate individual

Explanation

Effective risk oversight requires independence from the risk-taking function. A CIO paid on returns has an incentive to relax limits or underreport risk, so combined roles weaken checks and balances. The other options cite non-existent requirements or cost issues that are not the key concern.

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