On April 15, 2010, the Mutual Fund Directors Forum issued a report entitled “Risk Principles for Fund Directors: Practical Guidance for Fund Directors on Effective Risk Management Oversight.” The report provides an overview of the role that mutual fund directors play in risk oversight and seeks to provide boards with a better understanding of their responsibilities in the area of risk governance. The guidance is designed to help fund directors better understand how risk can be managed in the mutual fund business and to help directors assess whether, given the specific facts relevant to the funds they oversee, their funds' adviser and other service providers address risk in a manner that protects the interests of fund shareholders. The report included the following guidance for fund directors:
- Directors need to understand risk so that they can evaluate intelligently what risks to assume and manage those risks appropriately.
- While fund directors generally cannot be expected to directly identify and analyze risks, their oversight responsibility impels them to ask whether the adviser has appropriate systems and processes in place for identifying, analyzing and managing risk, including the particular market, credit, legal, fiduciary, reputational, operational, organizational and other risks applicable to the funds they oversee.
- Risk oversight by the board should involve an assessment of the adviser's culture and risk awareness and should encourage the implementation and continuous improvement of a robust process for identifying, managing, prioritizing and monitoring the fund’s risks.
- Directors should seek to understand the "risk appetite" of each fund and how that risk appetite is rooted in investor expectations and affected by changing market conditions. Directors should understand how policies set at the board level relate to a fund’s “risk appetite” and should be satisfied that a robust and responsive process is in place to periodically review and revise risk tolerances set forth in fund guidelines, such as position limits, counterparty credit limits, concentration limits and valuation policies.
- Directors should examine whether the adviser’s organizational structure provides adequate checks and balances, including appropriate segregation of front, back and middle-office functions.
- Given the current focus on risk management, fund directors may wish to ask whether a chief risk officer and/or dedicated risk management staff is appropriate or necessary, taking into account the size and complexity of the fund and the adviser.
- Fund directors should satisfy themselves that there is a process in place for reviewing the issues raised by new products and strategies before being implemented.
- Fund directors should seek to understand how management identifies and manages operational risk.
- Fund directors should develop a foundational understanding of the risks that arise as part of the investment management process and should be satisfied that the adviser is effectively managing those risks. Directors should ensure that they have access to a variety of information that facilitates an understanding of how investments are performing, as well as the various risks that they entail.
- Directors should assess whether investment performance and investment risk are being monitored in a meaningful way. Directors should focus on specific policies that drive fund performance and should be mindful of how much risk is being undertaken to generate incremental performance.
- Directors should focus their attention on valuation of investments, the use of complex securities and issuer and counterparty risk.
- Directors should consider the use of a risk matrix or risk inventory to ensure that an effective, thorough and thoughtful appraisal of areas of risk applicable to the fund and its adviser is being conducted.
The report concludes by acknowledging that because the circumstances and risks of funds vary greatly, there can be no single solution to ensure effective risk oversight by directors. To help directors in evaluating their current risk oversight capabilities and identify areas in which they can improve, the guidance includes exhibits which provide specific questions that directors can ask to address the topics covered within the report. The report is available at: http://www.mfdf.com/images/uploads/resources_files/ MFDFRiskPrinciplesforFundDirectorsApril2010.pdf.