How to convert a null terminated string to string?

You can assign a null-terminated PChar directly to a String:

function GetFileName(DiskName: TFileNameIO): string;
begin
 Result := PChar(@DiskName);
end;

Just make sure the TDiskName always contains a null terminator. If it can ever be completely full of characters without a null, you will have to do this instead:

function GetFileName(DiskName: TFileNameIO): string;
var
 Len, I: Integer;
begin
  Len := 0;
  For I := Low(DiskName) to High(DiskName) do
  begin
    if DiskName[I] = #0 then Break;
    Inc(Len);
  end;
  SetString(Result, PChar(@DiskName), Len);
end;

Your function is not necessary because you can simply assign a character array to a string variable.

type
  TCharArray = array [1..512] of Char;
....
var
  arr: TCharArray;
  str: string;
....
arr := ...;
str := arr;

This results in str being assigned the contents of arr. The compiler implements this with a call to System._UStrFromWArray which first of all looks for a null-terminator. If it finds one, that determines the length of str. Otherwise, the entire contents of the array are copied, and Length(str)=Length(arr).

As a broader point, I would recommend that you change to using zero-based character arrays. From the documentation:

Zero-based character arrays are compatible with PChar and PWideChar. When you use a character array in place of a pointer value, the compiler converts the array to a pointer constant whose value corresponds to the address of the first element of the array.

This makes it easier for you to interop with functions that expect PChar arguments.

As an aside, passing TFileNameIO by value is inefficient because it involves a memory copy. Pass such types by reference. For instance as a const parameter.