Risk management oversight and the role of the fund board

The board’s role in risk oversight

In three distinct sections, this paper outlines key concepts, principles, and some initial questions that fund directors may find useful as they seek more information to support their risk oversight responsibilities:

• Section 1 lays out a fund director’s role in risk oversight
• Section 2 addresses common fund risk management program elements and practices to help directors better understand how investment advisers and service providers manage risks.
• Section 3 discusses specific areas of existing, evolving, and emerging risks that impact the investment management industry.

Roles and duties of fund directors

Fund directors are responsible for understanding and overseeing how the fund’s adviser manages risk. While there are no regulatory-defined duties with respect to risk, directors can establish a strong foundation for risk oversight by understanding the:

• Obligations arising under state law, the Investment Company Act of 1940 (1940 Act) and the Securities Act of 1933 (1933 Act)
• Applicable guidance from courts and the Securities and Exchange Commission (SEC) regarding their expectations for directors
• Most significant operational, regulatory, and emerging risks affecting a fund and fund complex
• Risk management programs and processes implemented by the adviser and service providers to identify, manage, and mitigate risks

The risk management framework and program

Effective risk management is not a one-size-fits-all exercise and should be tailored to the fund and fund complex’s size, structure, and other relevant attributes. While fund directors are not responsible for risk management, they should understand the adviser’s risk framework, the program for risk identification, assessment, mitigation, monitoring, and reporting. Fund directors should appreciate how the adviser tailors its risk management program to address the existing risks it faces, as well as to emerging risks.

Despite the diversity in how risk management programs and practices may be designed and implemented, most risk management programs follow a similar approach and principles. Risk management programs should be designed to identify, measure, and manage the most significant risks to within an acceptable risk appetite or tolerance level, not eliminate or fully mitigate every risk. Moreover, as advisers grow, their product offerings evolve, and external factors change (e.g., regulatory environment), their risk management programs should as well.

Regardless of the particular risk management program or model that is used by the adviser and other service providers, there are significant elements and processes that are typically included in an effective risk management program as discussed in more detail in the following sections.

Existing, evolving, and emerging risks

While an overarching risk management program can help address the many risks impacting advisers, service providers, and ultimately the funds, there are additional specific risks to consider. These risks fall into four categories:

• Investment risk
• Operational risk
• Strategic risk
• Regulatory risk

The paper provides important questions that directors may consider for each of these risk areas.

Guiding the way forward for directors

As each fund may face unique risks, the director’s responsibility as an overseer gains importance. But considering how inundating the evolving risk landscape can be, this paper has carefully curated questions and best practices that can help them navigate aspects of their oversight role.