Risk management oversight and the role of the fund director

The board’s role in risk oversight

Fund directors play a crucial role in risk oversight and should distinguish between inherent risks in the fund’s investment strategy and unexpected risks. Open, ongoing, transparent dialogue among directors, advisers, and key service providers is essential for effective risk oversight.

This paper outlines key responsibilities, concepts, principles, and initial questions to aid fund directors in their risk oversight responsibilities. It builds on our May 2022 paper, highlighting enhanced or new content.

• The first section lays out a fund director’s role and duties.
• The second section outlines common risk management program elements and practices to help fund directors better understand how investment advisers and service providers manage risks to the funds they oversee.
• The final section covers specific areas of existing, evolving, and emerging risks that impact the investment management industry.

Roles and duties of fund directors

Fund directors are tasked with understanding and overseeing how the fund’s adviser manages risk. Although there are no regulatory-defined duties regarding risk, directors can establish a solid foundation for risk oversight by understanding the: 

• Obligations arising under state law, the Investment Company Act of 1940, and the Securities Act of 1933
• Applicable guidance from courts and the Securities and Exchange Commission 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 risk.
  

Risk management framework and program

Effective risk management should be tailored to the fund’s size, structure, and attributes. While fund directors are not responsible for managing risk, they should understand the adviser’s risk framework, including risk identification, assessment, mitigation, monitoring, and reporting. Directors should evaluate how the adviser customizes its risk management to address both existing and emerging risks. Although not responsible for day-to-day risk management, directors play a crucial role in overseeing the process.

Most risk management programs follow similar principles, aiming to manage significant risks within an acceptable tolerance level rather than eliminating all risks. As advisers grow and external factors change, their risk management programs should adapt accordingly.

Existing, evolving, and emerging risks

Regardless of the specific risk management program used, effective risk management typically includes key elements and processes that generally can be divided into the following categories: 

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

Guiding the way forward for directors

Although fund directors are not directly responsible for identifying, analyzing, and managing risks, they play a vital role in effective risk governance. This paper aims to assist fund directors in enhancing their understanding of risk management frameworks and the various investment, technological, operational, regulatory, and strategic risks that registered funds encounter in a rapidly evolving regulatory landscape.