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What Is a Chief Risk Officer, and Should Hedge Fund Managers Have One?

“In the wake of the financial crisis, risk governance has emerged as a key topic,” and “[a]t no time in history has there been a greater need for companies to evaluate and strengthen risk governance.”  These statements, from the executive summary of a recent survey conducted by Capital Market Risk Advisors (CMRA) and the Professional Risk Managers’ International Association (PRMIA), reflect the perception of risk shared by many hedge fund managers, in the broader economy and on Capitol Hill.  That survey, titled “Risk Governance: A Benchmarking Survey” (Survey) analyzes, among other things, the role of Chief Risk Officers (CROs) at various types of financial institutions, including hedge funds.  According to the Survey, only about 50 percent of institutional investors have a CRO and hedge fund boards are less likely than boards of other types of institutions to have executive sessions with the CRO.  Many hedge fund managers do not have a CRO at all, which means that the substantive functions of the CRO are performed by someone else (e.g., the Chief Operating Office (COO), Chief Compliance Office (CCO) or portfolio manager), or are not performed at all.  In either case, the Survey and sources interviewed by Hedge Fund Law Report concurred that there is value in localizing various risk management functions in one person – both in protecting against downside and in identifying areas for upside.  Broadly, a CRO serving in a consultative role, as opposed to merely a control role (we explore the difference in greater detail in this article), can help the fund manager identify underappreciated areas of risk, or areas where risk has been overstated.  A CRO can add value in risk avoidance and risk appreciation.  This article details the substance of a CRO’s typical role at a hedge fund manager; reporting procedures; control versus strategic roles for CROs; trend and exception reports; CRO compensation; and the likelihood that Congress or a regulator will require hedge funds to have CROs or someone performing their substantive functions.

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