[Federal Register Volume 79, Number 21 (Friday, January 31, 2014)]
[Rules and Regulations]
[Pages 5228-5247]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-01703]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 703, 715, and 741
RIN 3133-AD90
Derivatives
AGENCY: National Credit Union Administration (NCUA).
ACTION: Final rule.
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SUMMARY: This final rule permits credit unions to engage in limited
derivatives activities for the purpose of mitigating interest rate
risk. This rule applies only to Federal credit unions. The final rule
addresses permissible derivatives and
[[Page 5229]]
characteristics, limits on derivatives, operational requirements,
counterparty and margining requirements, and the procedures a credit
union must follow to apply for derivatives authority.
DATES: This final rule is effective March 3, 2014.
FOR FURTHER INFORMATION CONTACT: Justin M. Anderson, Staff Attorney,
Office of General Counsel, at the above address or telephone (703) 518-
6540; or Tom Fay, Senior Capital Markets Specialist, Office of
Examination and Insurance, at the above address or telephone (703) 518-
1179.
SUPPLEMENTARY INFORMATION:
I. Notice of Proposed Rule Making
II. Summary of Comments
III. Section-by-Section Analysis of the Final Rule
IV. Regulatory Procedures
I. Notice of Proposed Rule Making
In May 2013 the NCUA Board (Board) issued a proposed rule to permit
Federal credit unions (FCUs or credit unions) to engage in derivatives
transactions for the purpose of mitigating interest rate risk (IRR).
The proposal also required federally insured, state-chartered credit
unions (FISCUs) permitted by state law to engage in derivatives to
follow the requirements of NCUA's rule. The proposed rule required a
credit union seeking derivatives authority to meet minimum eligibility
criteria and included two levels of authority, Level I and Level II.
The two levels had different permissible limits of derivatives and
regulatory requirements. To obtain Level I or Level II authority, the
proposed rule required a credit union to apply to NCUA or, in the case
of a FISCU, its state supervisory authority (SSA). In addition, the
proposed rule described requirements on derivatives processes, systems,
and personnel; experience requirements; and restrictions on the use of
external service providers (ESPs). The proposed rule also addressed
credit unions in NCUA's pilot program and regulatory violations.
Finally, the Board specifically requested comment on the possibility of
requiring credit unions that apply for derivatives authority to pay an
application and/or supervision fee. The Board issued the proposed rule
with a 60-day comment period.
II. Summary of Comments
The Board received 75 comments on the proposed rule: 28 from FCUs;
16 from FISCUs; 13 from state credit union leagues; 9 from credit union
service organizations or third-party vendors, including investment
advisors and brokers; 3 from trade associations; 3 from SSAs; 2 from
law firms; and 1 from a Federal Home Loan Bank.
In general, commenters supported permitting credit unions to engage
in derivatives transactions. However, all commenters opposed at least
one aspect of the proposed rule. While most provisions of the rule
elicited comments, commenters focused on fees, permissible derivatives,
limits, processes, and experience requirements.
Most commenters believed the proposed requirements imposed high
costs and regulatory burdens on credit unions. Virtually all of the
commenters, however, believed that credit unions would be able to use
derivatives as a meaningful IRR mitigation tool if the Board did not
include application or supervisory fees and reduced the regulatory
requirements. The Board addresses comments on the proposed rule in more
detail in the following section.
III. Section-by-Section Analysis of the Final Rule
(a) General
The Board has made several changes in the final rule based on
public comments. Most notably, the Board has condensed and simplified
the rule and reduced the overall regulatory burden. The Board also
decided not to include, in this final rule, fees associated with using
derivatives. The final rule also addresses swap clearing regulations
issued in early 2013 by the Commodities and Futures Trading Commission
(CFTC). The following is a brief summary of the final rule:
The rule allows limited derivatives authority comprising
of plain vanilla interest rate derivatives for balance sheet management
and risk reduction.
Derivatives exposure is limited by two related measures, a
measure of notional amount of derivatives outstanding and a fair value
loss limit. The limits are designed to work in tandem, with the
notional limit a prospective limit on a credit union's derivatives
activity and the fair value loss limit based on the actual performance
of the derivatives held by a credit union.
[cir] The limit on notional amount of derivatives outstanding takes
into account the type of derivative and the time to maturity, two key
components that determine an instrument's sensitivity to interest rate
changes. This innovation provides significant flexibility under the
rule and improves the relationship between the notional limit and the
fair value limit.
[cir] The fair value threshold, if breached, will require a
participating credit union to cease new derivative investments, provide
notification and develop a corrective action plan.
Credit unions are required to apply for derivatives
authority. Generally the application process will be conducted in two-
stages. In the first stage, the credit union will present to NCUA an
IRR mitigation plan, which demonstrates how derivatives fit within that
plan and how it will acquire the appropriate resources, controls and
systems to implement a sound derivatives program. In the second stage
of the approval process, NCUA will evaluate the credit union on its
actual readiness to engage in derivatives transactions based on the
personnel, controls, and systems it has put in place. Credit unions new
to derivatives authority must operate safely for one year under limited
authorities before moving to full authority.
The rule outlines the appropriate resources, controls and
systems required for an effective derivatives program.
The Board believes the changes between the proposed and final rules
will significantly lower the cost and burden for credit unions to use
derivatives as part of their IRR mitigation strategy.
(b) Changes to Part 703
The proposed rule divided part 703 into two subparts, subpart A and
subpart B. Subpart A consisted of the current part 703, with minor
modifications, and subpart B consisted of rules and requirements
related the use of derivatives. The Board did not receive any comments
on the changes to Part 703, but is amending the definition of
``derivative'' in both subparts for accuracy. The Board has not made
any other changes to the structure of Part 703.
In addition, the Board notes that the requirements of new subpart B
do not apply to derivatives transactions that are permitted under Sec.
703.14, which include European call options, interest rate lock
commitments, certain embedded options, and certain options associated
with the sale of loans on the secondary market.
(c) Purpose and Scope (Sec. 703.100)
The purpose and scope section of the proposed rule indicated that
the rule applied to FISCUs that are permitted to engage in derivatives
by state law. The purpose and scope section also outlined which
sections of the rule applied specifically to the different levels of
derivatives authority (Level I or Level II, as defined in the proposed
rule). Based on public comment and other changes
[[Page 5230]]
to the rule, the Board has significantly revised this section.
(1) Applicability to FISCUs (Sec. 703.100)
The proposed rule required any FISCU permitted by state law to
engage in derivatives to follow NCUA's rule, including the application
process and regulatory limits. Approximately one-quarter of the
commenters addressed this requirement. All but one commenter argued
that NCUA is encroaching on states' rights and should not regulate
FISCUs' derivatives use. Commenters maintained that such regulation is
the province of the states, and that NCUA did not provide sufficient
support for Federal regulation of derivatives transactions.
After consideration of the comments, the Board has removed this
requirement from the rule. Given the absence to date of any problems
specific to FISCUs' derivatives use, FISCUs may follow applicable state
law (including a state parity provision) or other SSA authorization,
rather than this final rule.
NCUA will closely supervise all federally insured credit unions
that engage in derivatives, and will address any safety and soundness
concerns through use of applicable enforcement actions. Given the
complexity of, and risks associated with, derivatives activity, NCUA
will be publishing supervisory guidance in this area. This guidance
will address standards for the safe and sound operations of a
derivatives program, including expectations for comprehensive policies
and procedures, counterparty and collateral management practices,
internal control, accounting, and reporting systems, personnel with
appropriate levels of expertise, and asset-liability management
modeling capabilities. As insurer, NCUA's supervisory guidance will
apply to all federally insured credit unions. The final rule also
requires that a FISCU engaging in derivatives--whether pursuant to
authority granted under state law (including a state parity provision)
or other SSA authorization--must notify the applicable field director
in writing at least 30 days before it begins engaging in such
transactions. This provision will open a dialog between the FISCU and
NCUA about the objectives of each new derivatives program. It will also
facilitate efforts between NCUA and SSAs to coordinate off-site
monitoring and on-site supervision.
(2) Registered Investment Companies
The Board also wants to clarify application of this rule to Sec.
703.14(c), which reads as follows:
(c) Registered investment company. A Federal credit union may
invest in a registered investment company or collective investment
fund, as long as the prospectus of the company or fund restricts the
investment portfolio to investments and investment transactions that
are permissible for Federal credit unions.
The Board notes that this final rule will not allow FCUs that are
approved for derivatives to invest in a registered investment company
or collective investment fund that has derivatives. The Board does not
believe it is appropriate for FCUs to invest in entities that may use
derivatives for non-hedging purposes. The Board notes that derivatives
are complex instruments that can pose significant risk.
The Board has taken steps to mitigate that risk for credit unions
using derivatives, but does not have authority to do the same with
respect to registered investment companies and collective investment
funds. The Board is concerned that such entities using derivatives may
put credit unions, and therefore the NCUSIF, at risk. Thus, NCUA has
included a clarifying provision in the final rule stating that FCUs are
not permitted to invest in registered investment companies or
collective investment funds that allow derivatives to be in their
investment portfolios. The Board also notes that the purpose of this
rule is to permit credit unions to use derivatives for the very limited
purpose of mitigating IRR. It never intended for this rule to be a
vehicle for credit unions to take on additional risks through a
registered investment company or a collective investment fund.
(d) Definitions (Sec. 703.101)
The proposed rule included several new definitions. The Board
received three comments asking for clearer definitions of ``plain
vanilla derivatives,'' ``leveraged derivative,'' and ``weighted average
life.'' In addition to clarifying several of the definitions, the Board
has added new definitions to correspond with other changes in the rule.
The Board has also deleted definitions of terms that are no longer used
in the rule.
(e) Permissible Derivatives and Characteristics (Sec. 703.102)
The proposed rule permitted credit unions that have derivatives
authority to use interest rate swaps and interest rate caps. The
proposal further limited the use of interest rate swaps and interest
rate caps to those that are non-leveraged, based on domestic rates,
denominated in U.S. dollars, are not used to create structured
liability offerings, and settled within three days. The proposal
further limited the use of interest rate swaps to those that did not
have a fluctuating notional amount.
More than half of the commenters maintained that the list of
permissible derivatives was too restrictive to allow credit unions to
adequately hedge against IRR. Many of these commenters believed NCUA
should allow interest rate floors as a means of hedging against falling
rates. Other commenters suggested the list of permissible derivatives
should include swaptions, basis swaps, forward settling swaps, swaps
with amortizing features, interest rate collars, and interest rate
futures. These commenters cited IRR mitigation and low levels of
complexity as reasons for permitting these additional derivatives and
characteristics.
The Board has considered all of the derivatives and characteristics
suggested by commenters, and has expanded the list of permissible
derivatives and characteristics in the final rule. In reviewing each
suggested derivative, the Board compared the product's utility in
mitigating IRR to the derivative's overall complexity and risk. After
careful deliberation, the Board is permitting credit unions to apply
for the following derivatives and characteristics:
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Derivatives Derivative characteristics
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Interest rate swaps........ Amortizing notional amounts for swaps, caps, and floors.
Interest rate caps.........
Interest rate floors....... Forward start date for swaps (90-day maximum).
Basis swaps.
Treasury futures.
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[[Page 5231]]
The following is a description of each new derivative or
characteristic that the Board has included in this final rule. The
following discussion does not include plain vanilla interest rate swaps
and interest rate caps, which the Board discussed in the proposed rule:
(1) Interest Rate Floors. An interest rate floor requires payment
to the holder when an underlying interest rate (the ``index'' or
``reference'' interest rate) falls below a specified contract rate (the
``floor rate'').
(2) Basis Swaps. A basis swap is an interest rate swap in which the
parties exchange two floating rate indices. For example, Party A enters
into a five-year agreement with Party B in which Party A makes
quarterly payments to Party B of the U.S. dollar Prime rate multiplied
by $10,000,000 (the notional amount), and Party B makes quarterly
payments to Party A of the Three-Month U.S. dollar LIBOR rate times
$10,000,000. The Board believes that basis swaps can be a useful
hedging tool and are commonly used when one party is active in two
money markets and wishes to limit the exposure to the risk that the
spread between the two interest rates fluctuates.
(3) Amortizing Notional Amounts. An amortizing notional amount is a
characteristic of an interest rate cap, interest rate floor, or
interest rate swap where the notional amount of the derivative
decreases over time according to a predetermined, fixed schedule. The
Board agrees the use of amortizing derivatives can potentially enhance
hedge effectiveness, provided the amortizing schedule is set at the
time of the derivative transaction. For example, a $5 million five-year
interest rate swap where the notional amount is reduced $1 million each
year after year one. However, the Board is not permitting derivatives
with amortizing notional amounts in which the notional amount is
indexed to another financial instrument. For example, a credit union
cannot enter into an interest rate swap where the notional amount
declines based on the amount and frequency of repayments of a reference
mortgage pool or portfolio. In such circumstances, the reference index
is known but the amounts are unknown and can vary throughout the term
of the contract. This adds significant uncertainty to the performance
of the derivative, resulting in modeling and pricing complexity that is
inconsistent with the objectives of this final rule.
(4) Treasury Futures. A Treasury future is an IRR management tool
and a contractual obligation to either buy (take delivery of) or sell
(make delivery of) U.S. Treasury notes on a specified date in the
future. The final rule restricts permissible Treasury futures to those
that deliver Treasury notes (Treasury notes with maturities of up to 10
years, as compared to Treasury bonds which have maturities greater than
ten years).
(5) Forward Starting. A forward start date is a characteristic of
an interest rate swap that allows the start date of the exchange of
interest rate payments to begin at some date in the future. The Board
is permitting forward start dates of up to 90 days from the date the
credit union executes the transaction. The Board believes that longer
forward start dates can impose undue risk on a credit union.
As discussed in more detail below in the section on applications, a
credit union must demonstrate that it has the need for, and capacity to
manage, the type of derivatives and associated characteristics it is
seeking. Accordingly, in its application for derivatives authority, a
credit union must specify which type(s) of derivative(s) it is
requesting, include a description of each type of derivative it seeks
to use, a discussion of how the type of derivative(s) fits within its
IRR mitigation plan, and a justification and statement of use for each
type of derivative.
The Board notes that this requirement is different from the
proposed rule, which permitted any approved credit union to use
interest rate swaps or interest rate caps without specifically applying
for these types of derivatives. With an expanded list of permissible
derivatives and characteristics in the final rule, the Board believes
it is necessary and prudent for credit unions to specify how each
requested type of derivative fits in the credit union's unique asset-
liability structure and IRR mitigation plan. The Board believes this
system in the final rule appropriately balances an expanded list of
permissible derivatives and safety and soundness.
The Board notes that a credit union may subsequently apply for
additional types of derivatives or characteristics that it does not
seek in its original derivatives authority application. The final rule
includes procedures for applying for authority to use additional types
of derivatives.
The Board believes the types of derivatives and characteristics in
this final rule will provide credit unions with effective tools to
hedge IRR. NCUA's analysis of other derivatives and characteristics
suggested by commenters, in particular swaptions and interest rate
collars, did not warrant inclusion of these derivatives transaction
types at this time. The Board determined that the other types of
derivatives suggested by commenters added higher levels of complexity
and risk without adding to a credit union's IRR mitigation strategy.
The Board believes the expanded list of derivatives it has included in
the final rule will allow a credit union to successfully use
derivatives as part of its IRR mitigation strategy.
The Board reiterates that derivatives are only one tool for credit
unions to mitigate IRR and are not the only way credit unions should be
managing this risk. The Board believes that the expanded list of
derivatives and characteristics in the final rule will provide credit
unions with additional, meaningful tools to mitigate IRR. The Board
notes that as part of its annual review of one-third of all
regulations, it will reconsider the requirements of this rule within 36
months from its effective date.
Finally, the Board notes that all derivatives under this final rule
must have the characteristics adopted in this final rule, unless a
credit union receives NCUA's approval for a differing characteristic.
In addition to the characteristics in the proposed rule, the Board
is also including one new item and revising another. First, the final
rule includes a requirement that all derivatives used by credit unions
meet the definition of a derivative under generally accepted accounting
principles (GAAP). This requirement will ensure that credit unions are
using derivatives in such a way to be recognized as such under GAAP,
and preclude transactions that result in a form of lending or
borrowing.
Second, the Board is increasing the maximum maturity to 15 years.
In the proposed rule, the Board set a maximum maturity limit for Level
I authority of seven years and at ten years for Level II. The Board
believes this change will allow credit unions to effectively hedge
various points on the yield curve and allow for longer-term assets,
like mortgages, while at the same time preventing an excessive exposure
to very long maturities. As discussed below, the Board has imposed a
new maturity weighted notional limit on the aggregate derivative
portfolio, which will account for the risk of derivatives with longer
maturities.
(f) Derivatives Authority (Sec. 703.103 and Appendix A)
(1) Structure
The final rule reflects the Board's determination that all credit
unions using derivatives should adhere to one set of regulatory
requirements. In the final rule, the Board has eliminated the
[[Page 5232]]
``Level I'' and ``Level II'' derivatives authority structure in the
proposed rule. This structure permitted eligible credit unions to apply
for either Level I or Level II authority; each level had different
permissible limits and regulatory requirements. Many commenters
believed that some of the regulatory requirements outlined in the
proposed rule were overly burdensome and could restrict credit unions
from effectively using derivatives.
Based on these comments, the Board determined that this structure
does not efficiently administer a derivatives regulatory framework.
Therefore, the Board has eliminated the two level authority structure
and has adjusted many of the regulatory requirements. The Board
believes the final rule is less prescriptive and more efficient for
credit unions, but also retains the necessary safety and soundness
provisions.
The final rule introduces ``entry'' and ``standard'' limit
authorities. The two authorities differ only by the permissible limits
under which a credit union must operate. The limits are as follows:
------------------------------------------------------------------------
Entry limits (% of Standard limits (%
net worth) of net worth)
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Total fair value loss........... 15 25
Weighted Average Remaining 65 100
Maturity Notional (WARMN)......
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When initially granted its authority, a credit union must first
operate under the entry limits for one year before it can increase the
volume of its activities under the standard limits. A credit union that
has engaged in derivatives for a continuous period of one year
(beginning on the trade date of its first derivatives transaction) will
automatically progress from the entry limit to the standard limit,
unless it has received written notice from NCUA of relevant safety and
soundness concerns. It is not necessary for a credit union to submit an
additional application to progress from the entry limits to the
standard limits. The Board notes that relevant safety and soundness
concerns are ones that undermine the credibility of the credit union's
management of its derivatives program or expose the credit union to
undue risk. NCUA will make this determination on a case-by-case basis,
taking into account the overall condition of the credit union and the
severity of the safety and soundness concerns.
The Board believes the one-year entry period will allow credit
unions to obtain experience with derivatives to ensure their programs
are safe and sound. This period also provides NCUA with an opportunity
to examine a credit union's actual use of derivatives before that
credit union begins using the higher limits in the standard limit
authority. While credit unions in NCUA's derivatives pilot program must
apply to maintain their derivatives authority under this final rule,
most of them will meet the one year of activity threshold and may
immediately use standard limit authority after they are approved. The
following discussion provides a description of the fair value and
notional limits.
(2) Description of Fair Value Loss and Notional Limits (Sec. 703.103
and Appendix A)
The proposed rule included a notional limit for interest rate
swaps, a book value limit for interest rate caps, and a combined
notional and book value for all derivatives positions. In addition, the
Board also proposed a fair value loss limit for interest rate swaps and
a maturity limit based on weighted average positions for all
derivatives.
Approximately half of the commenters suggested ways the Board could
improve the limit structure. Commenters focused on the measurements for
interest rate swaps and interest rate caps, and on the problematic
aspects of a mixed attribute limit methodology that combines a notional
limit for interest rate swaps with a book value for interest rate caps.
Some commenters suggested using total assets as a notional limit
versus a net worth percentage and recommended increasing the maximum
maturity limits to account for longer duration assets, like mortgages.
Other commenters suggested adjusting the notional amounts of
derivatives for time to maturity to account for a lower degree of risk
for shorter maturity transactions. Finally, with respect to the fair
value loss limit, commenters requested NCUA include the changes in fair
value in the underlying hedged item (i.e. the corresponding asset or
liability) along with the derivative for the regulatory limit.
First, the Board has eliminated the proposed maximum weighted
average maturity limits. Instead, it has adopted a single maximum
maturity limit for all derivatives transactions of 15 years.
Second, the Board has replaced limits on individual derivative
instruments with a consolidated fair value loss limit and weighted
average remaining maturity notional (WARMN) limit for all derivatives
transactions. The Board believes this approach holds risk exposures at
a more constant degree regardless of maturity, and is more reasonable
and effective to implement and monitor.
(i) Considerations for Notional and Fair Value Loss Limits
The Board recognizes that notional amounts, in and of themselves,
do not constitute the economic risk exposure of derivatives. Rather,
they serve as the reference principal amount upon which parties in a
derivatives transaction calculate periodic payments. The notional
amount of a derivative contract does not directly represent the actual
amounts exchanged or the overall exposure to credit and market risk. In
addition, the Board is aware that not all derivatives have the same
price sensitivity to changes in interest rates and using a simple gross
notional limit could be unduly restrictive.
The Board faced a similar challenge in determining how to implement
a fair value loss limit for transactions that are presumed to be used
as IRR hedges, where the change in the fair value of the hedged item
(asset or liability) could potentially offset the change in the value
of the derivative, which is not considered in the fair value loss
limit.
However, derivatives can create incremental financial and operation
risk. Thus, at this time, the Board believes that a well-constructed
limit on total derivatives activity is a critical piece of an effective
regulatory framework for derivatives.
The Board seeks a limit framework that is as simple as possible,
while providing sufficient authority for credit unions to achieve
meaningful reductions in their IRR and recognizing derivatives should
not be the sole mitigation strategy for extraordinary levels of IRR.
Therefore, the final rule limits derivatives exposure with two related
measures, a measure of the notional amount of derivatives outstanding
and a fair value loss limit.
[[Page 5233]]
The limits are designed to work in tandem, with the notional limit a
prospective limit on a credit union's derivatives activity and the fair
value loss limit based on the actual performance of the derivatives
held by the credit union.
Fair Value limit. The fair value loss limit for
derivatives transactions in the final rule is 15 percent of net worth
for ``entry'' authority, and 25 percent of net worth for ``standard''
authority. These limits are for all derivatives positions outstanding
on the date a credit union reports its transactions. The fair value
limit, if breached, requires a participating credit union to cease new
derivatives transactions, provide written notification to NCUA, and
develop and submit a corrective action plan to NCUA.
The proposed rule had established fair value loss limits for swaps
only while limits for cap premiums were considered as part of the
notional limit. The Board believes that simplifying the framework to
have one fair value limit for all derivatives positions is an effective
approach in governing credit union's derivatives activity.
Many of the commenters suggested that the Board consider a
methodology that takes into account the offsetting effect of the hedged
item. Commenters maintained that this approach would better align with
the strategy of using derivatives for risk mitigation where the
associated gain (loss) from the hedged item would have an offsetting
gain (loss) to the derivative. The Board considered this approach and
has concluded that doing so would add too much complexity. As such, the
limit methodology is based upon the derivatives positions only. The
Board believes this approach is more transparent and more
straightforward to monitor, measure, and control.
Credit unions calculate the fair value loss by totaling the fair
value gains and losses on all of its outstanding derivatives positions.
If this sum results in an aggregate net loss, the credit union must
compare the loss amount, expressed as a percentage of net worth, to the
applicable fair value loss limit. Appendix A of the final rule defines
what constitutes a gain or a loss and provides an example of how the
fair value loss amount should be reported for each of the permissible
derivative types (swaps, options, and futures).
Unlike the proposed rule, the final rule requires credit unions to
calculate the aggregate gain (loss) for options. As noted above, the
proposed rule only required this calculation for swaps. An option's
gain or loss is the difference between the option's fair value and its
corresponding unamortized premium on the date the credit union reports
its transactions. The Board recognizes that credit unions may amortize
the upfront premium paid to purchase a cap or floor over the life of
the option. In order to determine a gain or loss on an option, credit
unions should use the unamortized balance on an option at the reporting
date to determine the gain (loss) amount.
Weighted Average Remaining Maturity Notional (WARMN)
limit. This limit on the notional amount of derivatives outstanding
takes into account the type of derivative and time to maturity, two key
components that determine an instrument's sensitivity to interest rate
changes. This innovation provides significant flexibility under the
rule and improves the relationship between the notional limit and the
fair value limit. The WARMN calculation is designed to correspond to
the net worth at risk (15% and 25% for entry and standard limits) in an
interest rate shift of 300 basis points. While the WARMN limit
corresponds to a fixed percentage of net worth (65% and 100% of net
worth for entry and standard limits), the maturity weighting method
provides for higher gross notional amounts for shorter duration
derivatives portfolios, but lower gross notional amounts for longer
duration derivatives portfolios.
The Board received several comments on the effectiveness of
applying a notional limit to a derivatives program. Commenters
expressed concern that a simple notional limit does not represent the
true economic risk of a transaction, and requested that if it proceeded
with this type of limit the Board consider weighting the notional
exposure by time (maturity) and its respective price sensitivity. By
doing so, it would make a notional limit more consistent with the
actual price risk of the underlying transaction (shorter maturity
derivatives could have higher permissible notional amounts than longer
maturity ones).
The Board acknowledges that the notional amount of a derivatives
contract does not directly represent the amount of risk in a
transaction and other factors, such as the derivative type and its
tenor, are key risk drivers. For example, interest rate floors and
interest rate caps will have lower sensitivity to interest rate
movements given the inherent structure of the instruments. To better
account for the varying price sensitivities between interest rate
options and interest rate swaps, the Board incorporated adjustment
factors into the limit calculation methodology that keep these
different product types roughly comparable from a risk exposure
standpoint.
The notional limit methodology has been adjusted to take into
account the impact of average life and maturity on a transaction's
price sensitivity (its risk). The methodology scales exposure limits
based on years and uses a ten-year maturity as the basis for assigning
relative weights. The notional limit in the final rule has been
designed to provide credit unions with a constant level of total risk
assumption capacity. This allows for increased notional capacity for
derivatives that have shorter terms and as they approach maturity by
weighting notional amounts based on the underlying derivatives'
remaining time to maturity. This better accounts for the risk and
permits greater flexibility to replace maturing hedges. NCUA
established the maximum transaction limits after taking into account
the projected price sensitivity of options and swaps in the current
market and stressed for an instantaneous, parallel, and sustained shock
in the yield curve of 300 basis points. This allows for significant
price moves over time and creates room within which credit unions can
actively manage exposures.
The Board has adopted a conservative approach for calculating the
WARMN by prohibiting the netting of offsetting transactions for limit
measurement purposes (i.e. pay-fixed swap transactions which were
offset with receive-fixed swap transactions must show the total
notional amount of both transactions). Rather than netting offsetting
transactions, the rule requires all transactions to be cumulatively
aggregated. The notional limit in the final rule applies to all
derivative transactions. Credit unions must calculate the WARMN limit
to determine compliance as detailed in Appendix A of the final rule.
The following are definitions and a calculation example as follows:
(A) Interest rate swaps--The total of all notional amounts
regardless of whether a pay fixed, receive fixed, or basis transaction
are used. Netting or offsetting of transactions when done for risk
reducing purposes are to be reported gross for the calculation of
adjusted notional for limit purposes. Transactions with amortizing
notional amounts must use the current notional amount as per the
amortization schedule at the reporting date.
(B) Interest rate options--The total of all notional amounts for
caps and floors are reduced by two-thirds (factored down to 33 percent
of the total). Reducing the gross notional amounts for caps and floors
by two-thirds approximates the reduced price
[[Page 5234]]
sensitivity of options compared to interest rate swaps.
(C) Futures--U.S. Treasury note futures will use the underlying
contract size for notional limits. For example, a 5-year Treasury note
futures contract with an underlying contract size of $100,000 will use
$100,000 of notional as a five-year maturity.
An illustration with definitions and calculations is included in
Appendix A of the rule.
The Board believes the limit structure described above balances
ease of calculation for credit unions with a meaningful and accurate
measure of risk associated with using derivatives.
(g) Collateral, Margining, and Counterparty Management (Sec. 703.104)
Two sections in the proposed rule addressed collateral and
counterparty requirements for credit unions operating a derivatives
program. The collateral requirements in the proposed rule specified the
permissible types of collateral, the respective margining, and the
minimum transfer requirements. In the section addressing
counterparties, the proposed rule included requirements on who is a
permissible counterparty and the requirements for the credit union to
manage the counterparty credit risk.
Approximately half of the commenters addressed either or both of
the proposed requirements for collateral or counterparties. All of the
commenters that addressed the collateral requirements suggested a more
expansive list of permissible collateral types. Some commenters
suggested permissible collateral include agency pass-through
residential mortgage-backed securities, callable agency debentures from
government sponsored enterprises (GSEs), and collateralized mortgage
obligations. Other commenters suggested that NCUA's collateral
requirements align with the Chicago Mercantile Exchange's eligible
collateral requirements for cleared swaps.
For collateral requirements, some commenters believed the
requirement to support pricing collateral daily would be too costly and
unnecessary and should be less stringent. Others urged NCUA not to
impose margining rules at this point, but rather wait until relevant
rules required by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) http://www.hblr.org/2013/04/margin-costs-of-otc-swap-clearing-rules/_ftn11 are promulgated.
Only a few commenters addressed the issue of counterparties. These
commenters believed the rule should be expanded to include additional
counterparties, like Federal Home Loan Banks.
Based on comments and the implementation of CFTC swap clearing
regulations, the Board has amended the sections on collateral and
counterparties to address swap clearing, expansion of the permissible
types of collateral, and streamlining the requirements for credit
unions.
(1) CFTC Swap Clearing
Since the promulgation of the proposed rule, the CFTC finalized
rules that provide credit unions with an End-User Exception or
Cooperative Exemption from swap clearing. The CFTC's final rules on
derivatives clearing requirements were required by the Dodd-Frank Act.
Title VII of the Dodd-Frank Act imposes comprehensive changes in the
regulatory framework for derivatives and includes amendments to the
Commodity Exchange Act (CEA) and the Securities Exchange Act of 1934.
This new section makes it unlawful for any person (including financial
institutions) to engage in a swap that the CFTC has determined requires
clearing unless the person submits the swap for clearing to a
derivatives clearing organization (DCO) or an exception applies.
Clearing changes the traditional relationship between counterparties by
placing a clearinghouse intermediary between counterparties.
The two CTFC exceptions are the End-User Exception, which applies
to small financial institutions with total assets of $10 billion or
less and the Cooperative Exemption, which applies to entities with
assets greater than $10 billion where the entity is a cooperative. The
CFTC's definition scope includes credit unions. Therefore, all credit
unions have the exceptional right, as cooperatives, to elect to either
clear swaps or engage in a traditional bilateral agreement. The Board
notes that the clearing structure only applies to swaps as of the date
of this rule.
For cleared derivatives transactions, each party to the swap
submits the transaction to a DCO for clearing. This reduces
counterparty risk for the original swap participants in that they each
bear the same risk attributable to facing the intermediary DCO as their
counterparty. In addition, DCOs exist for the primary purpose of
managing credit exposure from the swaps being cleared and therefore
DCOs are effective at standardizing transactions and mitigating
counterparty risk through the use of exchange-based risk management
frameworks.
Finally, swap clearing requires both counterparties to post
collateral (i.e. initial margin) with the clearinghouse when they enter
into a swap. The clearinghouse can use the posted collateral to cover
defaults in the swap. As the valuation of the swap changes, the
clearinghouse determines the fair market value of the swap and may
collect additional collateral (i.e. variation margin) from the
counterparties in response to fluctuations in market values. The
clearinghouse can apply this collateral to cover defaults in payments
under the swap.
(2) Changes in the Final Rule
The Board has merged the two proposed sections addressing
collateral and counterparties and made conforming changes in the final
rule. First, the Board has included in the final rule that any credit
union using exchange traded or cleared derivatives must comply with the
applicable exchange or DCO regulations on these types of derivatives.
Second, for non-centrally cleared derivatives, the Board has retained
many of the requirements in the proposed rule, but has also made
several changes to address comments it received.
(i) Collateral and Margining
Exchange traded or cleared swap transactions are subject to the
clearing member's requirements, which is regulated by the respective
exchange or DCO's eligible collateral requirements. The current
eligible collateral by these exchanges are within the investment
authority granted under the Federal Credit Union Act for credit unions.
Margining requirements are also promulgated by the exchanges and DCO's,
and would be consistent with an initial margin and daily variation
margining with no minimum transfer amounts.
For non-centrally cleared transactions, the Board has retained all
of the proposed requirements. However, the Board has expanded the list
of permissible collateral types to include GSE issued agency
residential mortgage-backed securities and GSE debentures. The Board
agrees with commenters that these types of collateral may be useful for
credit unions and do not pose significant liquidity risks when used for
this purpose. The Board recognizes, however, that the counterparty may
limit the eligible collateral list to less than the permissible
authority. Margining for non-cleared transactions as part of a
bilateral credit support annex must still have a minimum transfer
amount of $250,000.
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(ii) Counterparties
With respect to counterparties, the Board addresses the different
arrangements a credit union may have given clearing requirements, the
ability of credit unions to use exchange-traded derivatives, and
applicable exemptions that credit unions can use for non-centrally
cleared derivatives. The Board included in the final rule that credit
unions must use CFTC registrant swap dealers, introducing brokers, and
futures commission merchants whether using cleared or non-cleared
derivatives clearing or non-clearing. However, the Board has eliminated
major swap participants (MSP) as permissible counterparties. The Board
notes that MSPs are substantial holders of derivatives positions and
may not be in the market of dealing derivatives to other parties. Swap
dealers and introducing brokers, however, regularly act as
counterparties in the ordinary course of business as dealers to
derivatives transactions. The Board believes swap dealers and
introducing brokers are a sufficient universe of counterparties for
credit unions to execute transactions, consistent with the safe and
sound operation of a derivatives program.
(h) Reporting Requirements (Sec. 703.105)
The proposed rule required senior executive officers of a credit
union with Level I or Level II authority to report to the credit
union's board of directors at least monthly on the following topics:
Noncompliance, utilization of limits, itemization of the credit union's
positions, the credit union's financial condition, and the cost of
executing new transactions. Less than a quarter of the commenters
addressed the issue of reporting requirements. All of these commenters
disagreed with the requirement of monthly reporting, instead favoring
quarterly reporting.
After further evaluation, the Board is amending this section by
requiring that senior executive officers, and, if applicable, the
credit union's asset liability committee, receive derivatives reports
from credit union staff on a monthly basis and the credit union's board
of directors receive derivatives reporting from the credit union's
senior executive officers at least quarterly. The Board is retaining
the requirements of what must be included in these reports from the
proposed rule, with a few minor technical amendments. The technical
amendments conform to the other changes the Board has made throughout
the rule. The Board believes these changes are less burdensome, while
ensuring the proper credit union officials receive the reports that are
necessary to oversee the credit union's derivatives program.
(i) Operational Requirements (Sec. 703.106)
The proposed rule contained requirements relating to a credit
union's personnel, internal controls structure, transaction management,
and asset liability management (ALM). The Board has made several
changes to this section to simplify and consolidate the requirements,
and make this section of the rule less burdensome while retaining
elements necessary to ensure a safe and sound derivatives program.
(1) Personnel
(a) Board of Directors and Senior Management
The proposed rule set minimum knowledge and experience requirements
for a credit union's board of directors and senior management.
Specifically, the rule required that a credit union's board of
directors complete derivatives training before a credit union could
begin a derivatives program and annually thereafter. The proposed rule
also required that senior executive officers have sufficient experience
and knowledge to oversee the credit union's derivatives program.
Most commenters did not address the experience requirements for a
credit union's board of directors and senior executive officers.
However, a few commenters felt the training and experience requirements
for credit union board members are excessive and unwarranted. These
commenters requested that the Board eliminate this requirement, arguing
that the board members do not need annual training on this topic.
The Board believes that a credit union's board of directors and
senior executive officers need to have sufficient experience and
knowledge to effectively oversee and effectuate a derivatives program.
Therefore, the Board is retaining the proposed requirements. However,
the Board is deleting the provision that requires a credit union to
provide notification to NCUA when positions become vacant and
documentation evidencing knowledge and experience for any new senior
executive officer. This deletion is a reduction in regulatory burden
that the Board believes will help credit unions administer a
derivatives program more efficiently, without sacrificing safety and
soundness.
(b) Qualified Derivatives Personnel
The proposal also required a credit union to have qualified
derivatives personnel. The rule required the qualified derivatives
personnel to have three or five years of direct transactional
experience with derivatives based on the level of authority for which a
credit union was approved. The qualified derivatives personnel are
responsible for ALM, accounting and reporting, trade execution, and
credit and collateral management.
The majority of the commenters that addressed the qualified
derivatives personnel requirement argued against the proposed
experience requirements. Commenters believed the proposed experience
requirements would result in large expenses to a credit union in its
attempt to attract and retain qualified individuals. Some commenters
argued that the experience requirements were arbitrary, unrealistic,
and unattainable. As alternatives, commenters suggested shorter
experience requirements or allowing credit unions to substitute capital
markets experience in place of derivatives experience. Some commenters
also suggested that the final rule allow greater use of external
service providers as an alternative to having qualified derivatives
personnel (relaying on external service providers is addressed in
additional detail in the section on ESPs).
After careful consideration, the final rule does not require a
credit union to have one or more employees with a specific number of
years of experience. Rather, the final rule addresses the overall
experience of the credit union staff overseeing the credit union's
derivatives program. To that end, the Board has replaced the specific
years of experience requirement with a general requirement that a
credit union have staff with commensurate experience in the following
areas: ALM; accounting and financial reporting; derivatives trade
execution and oversight; and counterparty, collateral, and margining.
With respect to the qualified derivatives personnel having
experience with ALM and transaction management, the Board has retained
the requirements on these topics from the proposed rule. The Board
believes that the addition of an effective derivatives program should
include enhanced capacity by the credit union staff to analyze and
understand the credit union's IRR.
In particular, a derivatives program will require enhanced capacity
to estimate the credit union's earnings and economic value based on the
market's expectation of future interest rates and any potential changes
from these expectations. While a projection of income over a short
period of time is customarily used by credit unions for financial
planning, the Board believes that the longer maturity and increased
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complexity of permissible derivatives contracts will require credit
unions to project their earnings over longer periods of time. In
addition, because interest rate derivatives are priced using the
forward interest rate curve, and the value of these contracts changes
when there is a shift in the market's expectation of future interest
rates, credit unions need to incorporate the forward interest rate
curve into their baseline assumptions. It is important for the credit
union to consider its earnings and economic value in the context of
these forward rates, and how changes from these forward rates would
affect the institution's projected financial performance. Moreover,
analyses of the effects of changing interest rates should include both
parallel and non-parallel changes in rates over the maturity spectrum
(both a flattening and steepening of the yield curve).
The Board believes these changes reduce the overall expense and
burden on the credit union, while ensuring that credit unions have
adequate experience to manage a derivatives program. As discussed
below, before a credit union can begin using derivatives, NCUA will
ensure that the credit union has staff with the experience necessary to
comply with this section. While credit unions are not required to
obtain staff with a specific length of experience, the Board notes that
it may be necessary for a credit union to hire outside staff to comply
with this section of the rule.
(2) Internal Controls Structure
The proposed rule required credit unions engaging in derivatives to
maintain adequate internal controls, including proper separation of
duties, a written and schematic description of the derivatives decision
process, an internal controls review, a financial statement audit,
legal review, and a hedge review.
Few commenters addressed the internal controls structure
requirements. However, the comments the Board did received argued that
experience requirements for attorneys to conduct a legal review and the
requirement for an internal controls review conducted by an external
auditor were overly burdensome, costly, and unnecessary.
Based on comments and a reevaluation of the rule, the Board has
significantly condensed and simplified the internal controls structure
requirements. The Board has retained the requirement for a credit union
to maintain a process and responsibility framework that visually
demonstrates the derivatives decision process. The Board has also
retained the required separation of duties without amendment.
In response to commenters, however, the Board is amending the
section on internal controls review to indicate that a credit union
must only obtain this review for the first two years of its derivatives
program. The Board believes that an internal controls review is only
needed for the first two years of a derivatives program, as that will
be the time when the credit union is implementing and expanding its
internal controls.
The final rule also provides that this review may be conducted by a
credit union's internal auditor, if it has one. The Board believes that
if credit union has an independent auditor on staff, it is not
necessary for the credit union to bear additional expense to produce
this review.
The Board has also moved the requirement for a legal review to the
section addressing collateral and counterparties. The proposed rule
required a credit union to obtain counsel with at least five years of
experience with derivatives transactions. Based on public comment, the
Board is not including this experience requirement in the final rule.
Finally, the Board is retaining the proposed requirements for a
financial statement audit and a hedge review. However, the Board is
eliminating the requirement that the person conducting the financial
statement audit have at least two years of experience with derivatives.
The Board has reconsidered this requirement and does not believe it is
necessary for a financial statement auditor to have a specific number
of years of experience with derivatives. However, the Board believes a
credit union should use a person or persons that have relevant
experience accounting for these instruments.
(3) Policies and Procedures
The proposed rule required credit unions to maintain and operate
according to written, comprehensive policies and procedures. The
proposal required that these policies and procedures cover the
following topics: The scope of activities; risk management; accounting
and reporting; limits; and oversight and responsibilities. In addition,
the proposed rule required a credit union's board of directors to
review the policies annually and update them when necessary.
One commenter maintained that credit union board members should not
be required to review the policies and procedures for a derivatives
program. This commenter did not provide a justification for the
comment. The Board continues to believe that a credit union should
operate according to written policies to govern the credit union's
staff operations of the derivatives program. However, the Board does
not believe the final rule needs to be as prescriptive as the proposed
rule. The Board, therefore, has eliminated the list of specific items a
credit union must have in its policies and procedures and moved this
section to the section addressing operational requirements.
In the final rule, the Board requires credit unions to have
policies and procedures that address everything in the rule, except for
sections relating to applications, pilot program credit unions,
regulatory violation, and eligibility. In addition, the Board is
retaining the requirement that a credit union's board of directors
reviews these policies at least annually, and updates them when
necessary. The Board continues to believe that it is important for a
credit union's board of directors to update the credit union's policies
and procedures as the condition of the credit union and its market
position change.
(j) External Service Providers (ESPs) (Sec. 703.107)
The proposed rule restricted who a credit union could use as an ESP
and indicated what activities an ESP could conduct or support for the
credit union. The proposal defined ``support'' as having the credit
union conduct the function with assistance from an ESP and ``conduct''
as allowing an ESP to conduct a function with the credit union's
oversight. Credit unions approved for Level I derivatives authority
were permitted to have ESPs conduct more activities than credit unions
approved for Level II derivatives authority. The proposed rule
contemplated that credit unions with Level II authority would have less
reliance on ESPs and be able to conduct more activities independently,
in-house.
Several commenters argued that the restrictions on the use of ESPs
were too great. These commenters argued that ESPs are an efficient and
inexpensive means to safely and soundly conduct a derivatives program.
These commenters sought to use ESPs for most of the functions needed to
successfully carry out a derivatives program, as opposed to employing
high cost internal derivatives personnel.
The Board agrees that, if properly managed, ESPs can be an
efficient and cost effective way to carry out many of the functions of
a derivatives program. Based on the comments and NCUA's staff
evaluation, the Board is amending the section of the rule addressing
ESPs.
Most notably, the Board is eliminating a majority of the provisions
that
[[Page 5237]]
describe the activities an ESP can conduct and support. The final rule
permits a credit union to use ESPs for most functions, provided the
credit union complies with the other requirements related to ESPs.
However, the Board is retaining the requirement that a credit union
must internally and independently conduct ALM and liquidity risk
management. The Board believes these two functions are fundamental to a
credit union's understanding of derivatives and how they fit into its
IRR mitigation strategy. The Board notes that while a credit union must
conduct these functions internally it may obtain assistance from ESPs,
for example use of ESP produced software and modeling tools. The Board
believes this change makes the final rule clearer and easier for credit
unions to follow, and also makes it less burdensome and costly for
credit unions to administer a derivatives program.
The Board is also retaining the restrictions on who cannot be an
ESP. The Board believes these restrictions are necessary to preclude
conflicts of interest. The Board is also retaining requirements that a
credit union have the internal capacity and experience to oversee and
manage any ESP and that the credit union documents the specific use of
ESPs in its process and responsibility framework. While the Board
believes ESPs can be a safe and sound way to conduct many functions,
the Board reiterates that NCUA considers anything produced by an ESP as
the product of the credit union. Therefore, it is necessary that the
credit union have the internal capacity and expertise to ensure the
work done by ESPs is accurate and sufficient for its purposes. Also,
NCUA staff will use the process and responsibility framework in
conjunction with a credit union's application to determine if the use
of ESPs is proper and if the credit union can effectively manage the
use of ESPs.
(k) Credit Union Eligibility (Sec. 703.108)
The proposed rule required a credit union applying for either Level
I or Level II authority to provide an IRR mitigation plan; have a CAMEL
rating of 1, 2, or 3, with a management component of 1 or 2; and have
assets of at least $250 million. In addition, any credit union applying
for Level II had to demonstrate why the limits under Level I are
insufficient.
As noted above, the eligibility requirements were one of the most
commented on topics. Approximately half of the commenters addressed
this issue. All but one commenter argued that the Board should reduce
or eliminate the asset threshold in the proposed rule. These commenters
argued that an asset threshold of $250 million is arbitrary and would
exclude credit unions that need, and are capable of engaging in,
derivatives transactions. Also, one commenter did not believe that the
rule should contain a restriction on credit union participation based
on CAMEL ratings. This commenter argued that some lower CAMEL rated
credit unions may need, and be able to successfully manage, a
derivatives program.
The Board continues to believe that a $250 million asset threshold
and a CAMEL rating based eligibility requirement will ensure that well-
managed credit unions that need derivatives to mitigate IRR are able to
obtain this authority. However, the Board recognizes that there may be
some credit unions with assets under $250 million that need and are
capable of effectively managing a derivatives program.
The Board, therefore, is retaining the eligibility requirements in
the proposed rule, but is including a provision in the final rule that
provides an NCUA field director with the authority to permit a credit
union that has assets under $250 million to apply for derivatives
authority. The field director will only permit a credit union that does
not meet the asset threshold to apply if he or she concludes that the
credit union needs derivatives to manage its IRR and can effectively
manage a derivatives program. Further, a field director may set
additional stipulations or conditions related to the application of a
credit union that is below the $250 million asset threshold. The Board
believes this provision gives field directors flexibility to determine
if a credit union that does not meet the asset threshold can benefit
from and effectively manage derivatives. A field director may not,
however, permit a credit union that does not meet the CAMEL code
eligibility requirements to apply for derivatives authority. The Board
believes it is crucial for a credit union to be well run and in sound
financial condition to take on the additional complexity of
derivatives.
(l) Application Process, Content, and Review (Sec. 703.109-Sec.
703.111)
The proposed rule included a detailed procedure for credit unions
to apply for one of the two levels of authority. The proposed
application process required credit unions to submit an IRR mitigation
plan. In addition, credit unions were required to obtain all necessary
personnel, systems, and infrastructure before the credit union could
apply for Level II authority.
Approximately ten percent of the commenters addressed the
application process. The majority argued against the upfront costs
associated with applying for Level II derivatives authority. These
commenters believed that a requirement to have systems, processes, and
personnel in place before receiving approval was inefficient and could
lead to a waste of institution resources. Several other commenters were
in favor of a more streamlined application process. These commenters
believed that the propensity for rising interest rates in the near term
warrants a quicker application process.
In response to commenters, the Board has replaced the requirement
that credit unions obtain all necessary personnel and infrastructure
before NCUA grants approval with a more streamlined application
process. The changes are highlighted below.
(1) Applying for Derivatives Authority
The Board is retaining the requirement that a credit union seeking
derivatives authority must submit a detailed application to the
appropriate field director.
(2) Application Content
The Board is retaining the required application content items, but
has expanded on each to ensure clarity in the final rule. The Board has
also included a requirement that the credit union include a list of the
types of derivatives and characteristics it is applying for and a
business justification for each. The Board believes the clarifying
changes it made in this section will make it easier for credit unions
to submit a complete and accurate application, which will help NCUA
expedite its review.
(3) NCUA Approval
Consistent with amendments to the section on derivatives authority,
the Board is amending this section to increase the efficiency of NCUA's
application review process, as well as allow credit unions to receive
an approved application before procuring all necessary resources.
In lieu of requiring a credit union to obtain all necessary
personnel and systems before receiving final approval, the Board is
amending the application review process. This process is made up of the
following steps:
(i) Interim Approval
First, a credit union must submit a detailed application to NCUA.
This application must include all of the information in the application
content section, which NCUA may further
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clarify through guidance. While the Board has eliminated a deadline for
NCUA to review and approve or deny an application, the Board notes that
NCUA's goal is to respond to every application within 60 days.
(ii) Acquisition of Infrastructure To Comply With the Rule
A credit union that receives approval of its application must then
acquire all of the personnel and systems that are necessary to comply
with this final rule. The Board recognizes that each credit union will
have its own approach to establishing its infrastructure and that this
acquisition period may vary from credit union to credit union.
(iii) Notice of Readiness
Once a credit union has acquired and implemented all of the
necessary elements to comply with this rule, it must notify NCUA that
it is ready to begin using derivatives.
(iv) Final Approval
After NCUA receives a notice of readiness, it will review the
credit union's derivatives program to ensure the credit union is in
compliance with this final rule. The Board notes that a credit union
may not begin using derivatives until it receives this final approval.
NCUA's goal is to provide approval or denial within 60 days from the
date it receives the notice of readiness. In rendering a decision, NCUA
may conduct an onsite review to verify the credit union is ready and
able to start using derivatives. In addition, NCUA may permit a credit
union it denies to remedy any deficiencies in its program and reapply.
However, reapplication is solely at the discretion of the applicable
field director and reapplication efforts do not ensure that a denied
credit union will receive authority if deficiencies persist.
Finally, the Board notes that a credit union may choose to submit
an application after acquiring all of the necessary resources. In this
situation, it is not necessary for the credit union to submit a
separate notice of readiness. NCUA's goal is to approve or deny these
applications within 120 days from the date it receives the credit
union's complete application and request for final approval. Again, the
Board notes that this process will only apply to a credit union that
has acquired all of the necessary resources and is ready to begin using
derivatives when it applies.
The Board believes this new application structure is more efficient
and streamlined and allows a credit union to receive interim approval
of its application before expending resources to acquire the
infrastructure necessary to operate a derivatives program in compliance
with this final rule.
(m) Application for Additional Derivatives and Characteristics (Sec.
703.112)
Consistent with changes made to the permissible derivatives
section, the Board has included in the final rule a description of how
a credit union applies for additional derivatives and characteristics
which it did not request in its initial application. This section
requires that a credit union seeking an additional derivative type or
characteristic submit an application to the applicable field director.
The application must include a list of the additional derivatives and
characteristics that the credit union is applying for, and
justification and explanation of the need for each of the additional
derivatives and/or characteristics. NCUA's goal is to issue a decision
on a credit union's application for additional derivatives or
characteristics within 60 days from date of receipt of the credit
union's request. The Board believes this application system will allow
NCUA to grant authority for additional derivatives only to credit
unions that need and can manage these additional derivatives and
characteristics, while providing credit unions with additional
variations of derivatives transactions to mitigate their IRR. Similar
to appeal rights granted in the final rule relative to entry level
applications, if NCUA denies an application for additional derivatives
and characteristics, a credit union may appeal any denial to the Board
within 60 days of the denial from the field director.
(n) Pilot Program Participants (Sec. 703.113)
The proposed rule required that any credit union in NCUA's
derivatives pilot program comply with the requirements of the rule
within 12 months from its effective date. Any credit union that fails
to comply within 12 months must stop entering into new derivatives
transactions and, within 30 days, present a corrective action plan to
the appropriate field director, explaining how it will come into
compliance or safely unwind its program.
Several commenters addressed the issue of pilot program
participants being required to apply for derivatives authority. All of
these commenters argued that pilot program participants should be
grandfathered into the rule without going through the application
process. Commenters maintained that NCUA has been evaluating these
credit unions for a considerable amount of time and, therefore, a
separate application review process is not needed.
The Board believes the requirement for a pilot program credit union
to apply for authority helps to ensure a continued safe and sound
program in compliance with the final rule. Therefore, the Board is
adopting the proposed section on pilot program credit unions without
amendment.
(o) Regulatory Violation (Sec. 703.114)
The Board included a section in the proposed rule that provided a
system of corrective action for a credit union with derivatives
authority that fails to comply with the rule or has safety and
soundness concerns. This corrective action system included a cessation
of new transactions and a corrective action plan from the credit union
to the applicable field director. The Board did not receive any
comments on this section of the rule. However, the Board is amending
this section to further explain the steps that a credit union must take
if it fails to meet the requirements of this final rule or its approved
strategy.
(1) Suspension
A credit union that no longer complies with the requirements of the
final rule must immediately suspend all new derivatives activities.
However, a credit union may terminate existing transactions. In
addition, NCUA may permit a credit union to enter into new offsetting
transactions if part of a corrective action strategy. The Board
recognizes that it may be necessary for a credit union to terminate
existing positions as a way to immediately come into compliance with
the limits in the rule. Further, the Board believes that offsetting
transactions are another means of coming into compliance with the
limits in the rule. Offsetting transactions involve entering into
another derivatives transaction that operates in the opposite way as a
current position. For example, if a credit union has a pay-fixed swap,
the offsetting position would be a receive-fixed swap with similar
terms. These transactions essentially offset the risk of each other if
constructed effectively. However, because this strategy involves
entering into new transactions for credit unions that are already
exceeding one of the rule's limits, the Board believes it is important
for NCUA to approve these actions.
A credit union seeking to use offsetting transactions must make
this request in its notice to the appropriate field director. As
explained in the final
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rule, a credit union must notify NCUA within three days from the date
of the regulatory violation. In addition to including a request for
offsetting transactions, if applicable, the notice must also provide a
description of the violation and the immediate steps the credit union
is taking. This notice will allow NCUA to begin working with the credit
union to develop a corrective action plan for remedying the violation.
Within 15 days from the date the credit union provides a notice of
violation, it must submit a corrective action plan to NCUA. This
corrective action plan, to which NCUA must agree, must describe in
detail how the credit union will remedy the violation. A credit union
that submits a satisfactory corrective action plan must comply with
that plan until it has remedied its violation. A credit union may enter
into any new derivatives transactions while it is under a corrective
action plan. The Board believes this structure will help to protect the
NCUSIF and the credit union from continuing and compounding violations.
(2) Revocation
In addition to a suspension of activities, NCUA may also revoke a
credit union's authority granted under this final rule. Revocation will
require the credit union to immediately cease any new derivatives
transactions and may require the termination of existing positions. The
Board notes that NCUA will only require the termination of existing
positions if it determines that doing so would not pose a safety and
soundness concern. The Board believes it is necessary for NCUA to have
the power to revoke authority for credit unions that demonstrate that
they are not capable of successfully managing a derivatives program
safely and soundly.
(3) Appeals
A credit union may appeal NCUA's revocation of its authority or
NCUA's determination to require the termination of existing positions.
The Board believes the finality of both of these actions and the impact
they will have on the credit union and its members warrants additional
scrutiny through an appeals process to the Board. Further, as a credit
union may not enter into any new derivatives transactions during the
pendency of an appeal, the Board does not believe the time associated
with the appeals process will raise any additional safety and soundness
concerns.
(p) Fees
In the proposed rule the Board specifically requested comment on
including a fee structure for those credit unions that apply for
derivatives. The Board considered having a fee structure that included
an application and/or a supervision fee just for those credit unions
utilizing derivatives.
Most of the commenters addressed the imposition of application and/
or supervision fees. All of these commenters argued that NCUA should
not charge a separate fee, in any form, for derivatives authority. Some
commenters questioned the actual agency costs associated with
derivatives, while other commenters believed the suggested fees would
establish a negative precedent. All of the commenters on this subject
argued that the fees suggested by the Board would make derivatives cost
prohibitive, and that, by reducing risk to the share insurance fund,
credit unions with derivatives would actually be saving the agency and
the industry money.
In response to those comments, the Board is not instituting a fee
structure for derivatives. While the Board notes that derivatives
authority is cost and labor intensive for the agency, it does not
believe singling out derivatives for an authority-based fee is
appropriate at this time.
(q) Changes to Part 715
The proposed rule included an amendment to part 715, which
clarifies that all credit unions engaging in derivatives must have a
financial statement audit, regardless of asset size. As noted above,
the Board is retaining this requirement in the final rule. Therefore,
the Board is also adopting the proposed changes to part 715 without
amendment.
(r) Changes to Part 741
The proposed rule contained changes to Part 741 to reflect
application of the rule to FISCUs. The final rule will not apply to
FISCUs, so the Board is only amending this section to require that any
FISCU engaging in derivatives provide NCUA with written notice at least
30 days before it begins engaging in derivatives transactions.
IV. Regulatory Procedures
a. Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
of any significant economic impact any proposed regulation may have on
a substantial number of small entities (primarily those under $50
million in assets).\1\ The final rule allows credit unions to enter
into certain derivatives transactions to reduce IRR. Since the final
rule requires credit unions seeking derivatives authority to have at
least $250 million in assets, it will not have a significant economic
impact on a substantial number of small credit unions.
---------------------------------------------------------------------------
\1\ 5 U.S.C. 603(a).
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b. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in
which an agency by rule creates a new paperwork burden on regulated
entities or increases an existing burden.\2\ For purposes of the PRA, a
paperwork burden may take the form of a reporting or recordkeeping
requirement, both referred to as information collections. The proposed
changes to part 703 impose new information collection requirements. As
required by the PRA, NCUA is submitting a copy of this final rule to
OMB for its review and approval. NCUA also submitted a copy of the
proposed rule to OMB for review.
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\2\ 44 U.S.C. 3507(d); 5 CFR part 1320.
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1. Estimated PRA Burden
For the purposes of calculating the PRA burden, NCUA estimates that
43 credit unions will apply for and be granted derivatives authority.
NCUA estimates for the final rule were modified from the proposed
rule's estimates based on rule changes and feedback received during the
comment period.
NCUA will grant entry limit authority to qualifying credit unions
that NCUA recognizes meet the requirements of this rule. After a one
year period of continuous risk mitigation with interest rate
derivatives and no safety and soundness issues related to the activity,
the credit union will be considered to have standard limit authority.
Certain credit unions with experience mitigating risk with interest
rate derivatives may be granted standard limit authority at the time of
application. NCUA estimates that:
10 credit unions will qualify for and be granted standard
limit authority;
33 credit unions will apply for and be granted entry limit
authority;
Section 703.106(d) of the rule requires a credit union to operate
according to written, comprehensive policies and procedures for
control, measurement, and management of derivatives transactions. To do
so, a credit union must first develop such policies and procedures.
NCUA estimates that on average it will take a credit union seeking
derivatives authority an average of 50 hours to develop appropriate
policies and procedures. This is a one-time recordkeeping burden.
[[Page 5240]]
Section 703.106(d) of the rule requires a credit union's board of
directors to review the derivatives policies and procedures annually
and update them when necessary. NCUA estimates this ongoing
recordkeeping burden will take an average of 10 hours per year per
respondent.
Section 703.105(a) of the rule requires a credit union's senior
executive officers to provide a quarterly, comprehensive derivatives
report to the credit union's board of directors. Section 703.105(b)
requires that at least monthly, credit union staff must deliver a
comprehensive derivatives report to the credit union's senior executive
officers. NCUA estimates this ongoing recordkeeping burden will take an
average of 2 hours per respective reporting cycle (total of 8 hours per
year for board reporting and 24 hours per year for senior management
reporting).
Section 703.106(a)(1) of the rule requires that a credit union
retain evidence of annual derivatives training for its board of
directors. NCUA estimates this ongoing recordkeeping requirement will
take an average of 4 hours per year per respondent.
Section 703.106(b)(1) of the rule requires that a credit union
maintain a written and schematic description of the derivatives
decision process. NCUA estimates that the one-time recordkeeping burden
of creating the description will take 12.5 hours on average. The
ongoing burden of maintaining the description will take 2 hours per
year per respondent.
Section 703.106(b)(2) requires that for the first two years after
commencement of its derivatives program, a credit union must have an
internal controls review focused on the integration and introduction of
derivatives functions. This review must be performed by an independent
external unit or, if applicable, the credit union's internal auditor.
NCUA estimates that an internal controls review for a credit union's
derivatives program will cost approximately $50,000 each year for the
first two years.
Section 703.106(b)(3) of the rule requires a credit union engaging
in derivatives transactions to obtain an annual financial statement
audit by a certified public accountant. Section 715.5(a) of NCUA's
Regulations already requires FCUs with assets of $500 million or
greater to obtain an annual financial statement audit. Currently,
approximately 60 credit unions with assets between $250 million and
$500 million that meet the proposed CAMEL ratings requirements do not
obtain annual financial statement audits. Due to the overhead costs
associated with derivatives activity, NCUA estimates that ten percent,
or six, of these credit unions will apply for and be granted
derivatives authority. NCUA further estimates that a financial
statement audit for a credit union of this size would cost
approximately $50,000.
Section 703.106(b)(4) of the rule requires a credit union, before
executing any derivatives transaction, to identify and document the
circumstances leading to the decision to hedge, specify the derivatives
strategy the credit union will employ, and demonstrate the economic
effectiveness of the hedge. NCUA estimates a credit union will execute
an average of 2 transactions per year and that it will take an average
of 2 hours per transaction to complete the pre-execution analysis. This
results in an ongoing recordkeeping burden of 4 hours per year per
respondent.
Sections 703.109, 703.110 and of the rule require a credit union
seeking derivatives authority to submit a detailed application to NCUA.
NCUA estimates that this one-time recordkeeping burden will take an
average of 50 hours per respondent to prepare. This estimate does not
include developing policies and procedures for operating a derivatives
program and creating and maintaining a written and schematic
description of the derivatives decision process, as those recordkeeping
requirements are already accounted for above.
Section 703.114 of the proposed rule requires a credit union that
no longer meets the requirements of subpart B of part 703 to submit a
corrective action plan to NCUA. NCUA estimates that 3 credit unions may
have to submit an action plan each year and that a plan will take an
average of 10 hours to prepare.
Section 741.219 requires a FISCU to notify NCUA in writing at least
30 days before it begins engaging in derivatives. This notice will be a
one-time burden. NCUA estimates that 30 FISCUs will have to prepare
this notice, and that the notice will take an average of 0.5 hours to
prepare.
Summary of Collection Burden
Written policies and procedures: 43 credit unions x 50 hours =
2,150 hours (one-time burden).
Board review of policies and procedures: 43 credit unions x 10
hours = 430 hours.
Derivatives reporting: 43 credit unions x 32 hours = 1,376 hours.
Evidence of board training: 43 credit unions x 4 hours = 172 hours.
Derivatives process description: 43 credit unions x 12.5 hours =
537.5 hours (one-time burden).
43 credit unions x 2 hours = 86 hours.
Independent internal controls review: 43 credit unions x $50,000/
year for 2 years $4,300,000 (one-time burden).
Financial statement audit: 6 credit unions x $50,000 = $300,000.
Pre-execution analysis: 43 credit unions x 4 hours = 172 hours.
Application: 43 credit unions x 50 hours = 2,150 hours (one-time
burden).
Corrective action plan: 3 credit unions x 10 hours = 30 hours.
FISCU notice: 30 credit unions x 0.5 hours = 15 hours (one-time
burden).
Total Annual Hours Burden: 7,118.5 (4,852.5 one-time only).
Total Annual Cost Burden: $4,600,000 ($4,300,000 one-time only).
(c) Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their actions on state and local interests.
NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5),
voluntarily complies with the executive order to adhere to fundamental
federalism principles. This final rule applies only to FCUs, and only
requires a FISCU to notify NCUA in writing at least 30 days before it
begins engaging in derivatives transactions. Accordingly, the rule will
not have substantial direct effects on the States, on the relationship
between the national government and the States, or on the distribution
of power and responsibilities among the various levels of government.
NCUA has, therefore, determined that this proposal does not constitute
a policy that has federalism implications for purposes of the executive
order.
(d) Assessment of Federal Regulations and Policies on Families
NCUA has determined that this final rule will not affect family
well-being within the meaning of Sec. 654 of the Treasury and General
Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 2681
(1998).
List of Subjects
12 CFR Part 703
Credit unions, Investments.
12 CFR Part 715
Audits, Credit unions, Supervisory committees.
12 CFR Part 741
Credit, Credit Unions, Reporting and recordkeeping requirements,
Share insurance.
[[Page 5241]]
By the National Credit Union Administration Board, on January
23, 2014.
Gerard Poliquin,
Secretary of the Board.
For the reasons discussed above, the National Credit Union
Administration is amending parts 703, 715, and 741 as follows:
PART 703--INVESTMENT AND DEPOSIT ACTIVITIES
0
1. The authority citation for part 703 continues to read as follows:
Authority: 12 U.S.C. 1757(7), 1757(8), 1757 (15).
0
2. In part 703, designate Sec. Sec. 703.1 through 703.20 as subpart A
under the following heading:
Subpart A--General Investment and Deposit Activities
* * * * *
0
3. Amend Sec. 703.2 by revising the definitions of ``derivative'' and
``fair value'' and adding definitions of ``forward sales commitment''
and ``interest rate lock commitment'' to read as follows:
Sec. 703.2 Definitions.
* * * * *
Derivative means a financial contract which derives its value from
the value and performance of some other underlying financial instrument
or variable, such as an index or interest rate.
* * * * *
Fair value means the price that would be received to sell an asset,
or paid to transfer a liability, in an orderly transaction between
market participants at the measurement date, as defined by GAAP.
* * * * *
Forward sales commitment means an agreement to sell an asset at a
price and future date specified in the agreement.
* * * * *
Interest rate lock commitment means an agreement by a credit union
to hold a certain interest rate and points for a specified amount of
time while a prospective borrower's application is processed.
* * * * *
0
4. In Sec. 703.14, add paragraph (k) to read as follows:
Sec. 703.14 Permissible investments.
* * * * *
(k) Derivatives. A Federal credit union may only enter into in the
following derivatives transactions:
(1) Any derivatives permitted under Sec. 701.21(i) of this
chapter, Sec. 703.14(g), or subpart B of this part;
(2) Embedded options not required under generally accepted
accounting principles (GAAP) adopted in the United States to be
accounted for separately from the host contract; and
(3) Interest rate lock commitments or forward sales commitments
made in connection with a loan originated by a Federal credit union.
Sec. 703.16 [Amended]
0
5. In Sec. 703.16, remove paragraph (a) of and redesignate paragraphs
(b) through (d) as (a) through (c), respectively.
0
6. Add subpart B to read as follows:
Subpart B--Derivatives Authority
Sec.
703.100 Purpose and scope.
703.101 Definitions.
703.102 Permissible derivatives.
703.103 Derivative authority.
703.104 Requirements for derivative counterparty agreements,
collateral and margining.
703.105 Reporting requirements.
703.106 Operational support requirements.
703.107 External service providers.
703.108 Eligibility.
703.109 Applying for derivatives authority.
703.110 Application content.
703.111 NCUA approval.
703.112 Applying for additional products or characteristics.
703.113 Pilot program participants with active derivatives
positions.
703.114 Regulatory violation.
Sec. 703.100 Purpose and scope.
(a) Purpose. This subpart allows Federal credit unions to enter
into certain derivatives transactions exclusively for the purpose of
reducing interest rate risk exposure.
(b) Scope. (1) This subpart applies to all Federal credit unions.
Except as provided in Sec. 741.219, this rule does not apply to
federally insured, state-chartered credit unions.
(2) Mutual funds. This subpart does not permit a Federal credit
union to invest in registered investment companies or collective
investment funds under Sec. 703.14(c) of this part, where the
prospectus of the company or fund permit the investment portfolio to
contain derivatives.
Sec. 703.101 Definitions.
For purposes of this subpart:
Amortizing notional amount means a characteristic of a derivative,
in which the notional amount declines on a predetermined fixed basis
over the term of the contract, according to an amortization schedule to
which the parties agree when executing the contract;
Basis swap means an agreement between two parties in which the
parties make periodic payments to each other based on floating rate
indices multiplied by a notional amount;
Cleared swap has the meaning as defined by the Commodity Futures
Trading Commission in 17 CFR 22.1;
Counterparty means a swap dealer, derivatives clearing
organization, or exchange that participates as the other party in a
derivatives transaction with a Federal credit union;
Credit support annex means the terms or rules under which
collateral is posted or transferred between a Federal credit union and
a counterparty to mitigate credit risk that may result from changes in
the fair value of derivatives positions;
Derivative means a financial contract which derives its value from
the value and performance of some other underlying financial instrument
or variable, such as an index or interest rate;
Derivatives clearing organization has the meaning as defined by the
Commodity Futures Trading Commission in 17 CFR 1.3(d);
Economic effectiveness means the extent to which a derivatives
transaction results in offsetting changes in the interest rate risk
that the transaction was, and is, intended to provide;
Exchange means a central financial clearing market where end users
can trade futures, as defined in this section of this subpart;
External service provider means any entity that provides services
to assist a Federal credit union in carrying out its derivatives
program and the requirements of this subpart;
Fair value has the meaning specified in Sec. 703.2 of subpart A of
this part;
Field director means an NCUA Regional Director or the Director of
the Office of National Examinations and Supervision;
Forward start date means an agreement that delays the settlement
date of a derivatives transaction for a specified period of time;
Futures commission merchant (FCM) has the meaning as defined by the
Commodity Futures Trading Commission in 17 CFR 1.3(p);
Futures means a U.S. Treasury note financial contract that
obligates the buyer to take delivery of Treasury notes (or the seller
to deliver Treasury notes) at a predetermined future date and price.
Futures contracts are standardized to facilitate trading on an
exchange;
Hedge means to enter into a derivatives transaction to mitigate
interest rate risk;
[[Page 5242]]
Interest rate cap means a contract, based on a reference interest
rate, for payment to the purchaser when the reference interest rate
rises above the level specified in the contract;
Interest rate floor means a contract, based on a reference interest
rate, for payment to the purchaser when the reference interest rate
falls below the level specified in the contract;
Interest rate risk means the vulnerability of a Federal credit
union's earnings or economic value to movements in market interest
rates;
Interest rate swap means an agreement to exchange future payments
of interest on a notional amount at specific times and for a specified
time period;
Introducing broker means a futures brokerage firm that deals
directly with the client, while the trade execution is done by a
futures commission merchant;
ISDA protocol means a multilateral contractual amendment mechanism
that has been used to address changes to International Swap and
Derivatives Association (ISDA) standard contracts since 1998;
Leveraged derivative means a derivative where the value of the
transaction does not change in a one to one proportion with the
contractual rate or index;
(x) Margin means the minimum amount of funds that must be deposited
between parties to a derivatives transaction, as detailed in a credit
support annex or clearing arrangement;
Master service agreement means a document agreed upon between two
parties that sets out standard terms that apply to all derivatives
transactions entered into between those parties. Each time the same two
parties enter into a transaction, the terms of the master service
agreement apply automatically and do not need to be re-negotiated. The
most common form of a master service agreement is a master ISDA
agreement;
Minimum transfer amount means the minimum amount of collateral that
a party to a derivatives transaction will require, per transfer, to
cover exposure in excess of the collateral threshold;
Net economic value means the economic value of assets minus the
economic value of liabilities;
Net worth has the meaning specified in Sec. 702.2 of this chapter;
Non-cleared means transactions that do not go through a derivatives
clearing organization;
Notional amount means the contracted amount of a derivatives
contract for swaps and options on which interest payments or other
payments are based. For futures contracts, the notional amount is
represented by the contract size;
Novation means the substitution of an old obligation with a new one
that either replaces an existing obligation with a new obligation or
replaces an original party with a new party;
Reference interest rate means the index or rate to be used as the
variable rate for resetting derivatives transactions;
Reporting date means the end of the business day on the date used
to report positions and fair values for limit compliance (e.g., daily,
month-end, quarter-end and fiscal year-end);
Senior executive officer has the meaning specified in Sec. 701.14
of this chapter and any other similar employee that is directly within
the chain of command for the oversight of a Federal credit union's
derivatives program, as identified in a Federal credit union's process
and responsibility framework, as discussed in Sec. 703.106(b)(1) of
this subpart;
Structured liability offering means a share product created by a
Federal credit union with contractual option features, such as periodic
caps and calls, similar to those found in structured securities or
structured notes;
Swap dealer has the meaning as defined by the Commodity Futures
Trading Commission in 17 CFR 1.3(ggg);
Swap execution facility means a Commodities and Futures Trading
Commission-registered facility that provides a system or platform for
participants to execute cleared derivatives transactions;
Threshold amount means an unsecured credit exposure that a party to
a derivatives transaction is prepared to accept before requesting
additional collateral from the other party;
Trade date means the date that a derivatives order (new
transactions, terminations, or assignments) is executed in the market;
and
Unamortized premium means the balance of the upfront premium
payment that has not been amortized.
Sec. 703.102 Permissible derivatives.
(a) Products and characteristics. A Federal credit union with
derivatives authority may apply to use each of the following products
and characteristics, subject to the limits in Sec. 703.103 of this
subpart:
(1) Interest rate swaps with the following characteristics:
(i) Settle within three business days, unless the Federal credit
union is approved for a forward start date of no more than 90 days from
the trade date; and
(ii) Do not have fluctuating notional amounts, unless the Federal
credit union is approved to use derivatives with amortizing notional
amounts.
(2) Basis swaps with the following characteristics:
(i) Settle within three business days, unless the Federal credit
union is approved for a forward start date of no more than 90 days from
the trade date; and
(ii) Do not have fluctuating notional amounts, unless the Federal
credit union is approved to use derivatives with amortizing notional
amounts.
(3) Purchased interest rate caps with no fluctuating notional
amounts, unless the Federal credit union is approved to use derivatives
with amortizing notional amounts.
(4) Purchased interest rate floors with no fluctuating notional
amounts, unless the Federal credit union is approved to use derivatives
with amortizing notional amounts.
(5) U.S. Treasury note futures (2-, 3-, 5-, and 10-year contracts).
(b) Overall program characteristics. A Federal credit union may
only enter into derivatives, as identified and described in paragraph
(a) of this section, that have the following characteristics:
(1) Not leveraged;
(2) Based on domestic rates, as defined in Sec. 703.14(a) of
subpart A of this part;
(3) Denominated in U.S. dollars;
(4) Except as provided in Sec. 703.14(g) of subpart A of this
part, not used to create structured liability offerings for members or
nonmembers;
(5) Have contract maturity terms of equal to or less than 15 years,
at the trade date; and
(6) Meet the definition of a derivative under GAAP.
Sec. 703.103 Derivative authority.
(a) General authority. A Federal credit union that is approved for
derivatives authority under Sec. 703.111 of this subpart may use any
of the products and characteristics, described in Sec. 703.102(a),
subject to the following limits, which are described in more detail in
Appendix A to this subpart:
(1) Entry limits authority. Unless a Federal credit union is
permitted to use standard limits authority under this subpart, the
aggregate fair value loss (as defined in Appendix A) on all of a
Federal credit union's derivatives positions may not exceed 15 percent
of net worth, and a Federal credit union's weighted average remaining
maturity notional (as defined in Appendix A), may not exceed 65 percent
of net worth.
(2) Standard limits authority. A Federal credit union that is
permitted to use standard limits authority may not exceed an aggregate
fair value loss on all
[[Page 5243]]
of the Federal credit union's derivatives positions of 25 percent of
net worth, and a weighted average remaining maturity notional of 100
percent of net worth, provided:
(i) The Federal credit union has engaged in derivatives at the
entry limits authority for a continuous period of one year (beginning
on the trade date of its first derivatives transaction); and
(ii) The Federal credit union has not been notified in writing by
NCUA of any relevant safety and soundness concerns while engaged in
derivatives at the entry limits authority.
(b) Limit description--(1) Fair value limit. The fair value limit
is calculated by aggregating the fair values for all derivatives
positions at the reporting date. If an aggregate loss exists, it must
be less than the limit set forth in this subpart. A further description
of this limit and example calculations are detailed in Appendix A to
this subpart.
(2) Weighted average remaining maturity notional limit. The
weighted average remaining maturity notional limit is calculated by
aggregating the notional amount for all derivatives positions based on
each derivative's pricing sensitivity and maturity. A further
description of this limit and example calculations are detailed in
Appendix A to this subpart.
Sec. 703.104 Requirements for derivative counterparty agreements,
collateral and margining.
(a) A Federal credit union may have exchange-traded, centrally
cleared, or non-cleared derivatives, in accordance with the following:
(1) Exchange-traded and cleared derivatives. A Federal credit
union with derivatives that are exchange-traded or centrally cleared
must:
(i) Comply with the Commodity Futures Trading Commission's rules;
(ii) Use only swap dealers, introducing brokers, and/or futures
commission merchants that are current registrants of the Commodity
Futures Trading Commission; and
(iii) Comply with the margining requirements required by the
futures commission merchant.
(2) Non-cleared derivative transactions. A Federal credit union
with derivatives that are non-cleared must:
(i) Have a master service agreement and credit support annex with
a registered swap dealer that are in accordance with ISDA protocol for
standard bilateral agreements;
(ii) Utilize margining requirements contracted through a credit
support annex and have a minimum transfer amount of $250,000 for daily
margining requirements; and
(iii) Accept as collateral, for margin requirements, only cash
(U.S. dollars), U.S. Treasuries, government-sponsored enterprise debt,
and government-sponsored enterprise residential mortgage-backed
security pass-through securities.
(b) Counterparty, collateral, and margining management. A Federal
credit union must:
(1) Have systems in place to effectively manage collateral and
margining requirements;
(2) Have a collateral management process that monitors the Federal
credit union's collateral and margining requirements daily and ensures
that its derivatives positions are collateralized at all times and in
accordance with the collateral requirements of this subpart and the
Federal credit union's agreement with its counterparty. This includes
the posting, tracking, valuation, and reporting of collateral using
fair value; and
(3) Analyze and measure potential liquidity needs related to its
derivatives program and stemming from additional collateral
requirements due to changes in interest rates. The Federal credit union
must calculate and track contingent liquidity needs in the event a
derivatives transaction needs to be novated or terminated, and must
establish effective controls for liquidity exposures arising from both
market or product liquidity and instrument cash flows.
Sec. 703.105 Reporting requirements.
(a) Board reporting. At least quarterly, a Federal credit union's
senior executive officers must deliver a comprehensive derivatives
report to the Federal credit union's board of directors. The report may
be delivered separately or as part of the standard funds management or
asset/liability report.
(b) Senior executive officer and asset liability committee. At
least monthly, Federal credit union staff must deliver a comprehensive
derivatives report to the Federal credit union's senior executive
officers and, if applicable, the Federal credit union's asset liability
committee.
(c) Comprehensive derivatives report. At a minimum, the reports
required in paragraphs (a) and (b) of this section must include:
(1) Identification of any areas of noncompliance with any
provision of this subpart or the Federal credit union's policies;
(2) Utilization of the limits in Sec. 703.103 and any additional
limits in the Federal credit union's policies;
(3) An itemization of the Federal credit union's individual
positions and aggregate current fair values, and a comparison with the
Federal credit union's fair value loss and notional limit authority, as
described in Appendix A to this subpart;
(4) A comprehensive view of the Federal credit union's statement
of financial condition, including, but not limited to, net economic
value calculations for the Federal credit union's statement of
financial condition done with derivatives included and excluded;
(5) An evaluation of the effectiveness of the derivatives
transactions in mitigating interest rate risk; and
(6) An evaluation of effectiveness of the hedge relationship and
reporting for derivatives in compliance with GAAP.
Sec. 703.106 Operational support requirements.
(a) Required experience and competencies. A Federal credit union
operating with derivatives authority must internally possess the
following experience and competencies:
(1) Board. Before entering into any derivatives transactions, and
annually thereafter, a Federal credit union's board members must
receive training that provides a general understanding of derivatives
and the knowledge required to provide strategic oversight of the
Federal credit union's derivatives program. This requirement includes
understanding how derivatives fit into the Federal credit union's
business model and risk management process. The Federal credit union
must maintain evidence of this training, in accordance with its
document retention policy, until its next NCUA examination.
(2) Senior executive officers. A Federal credit union's senior
executive officers must be able to understand, approve, and provide
oversight for the derivatives activities. These individuals must have a
comprehensive understanding of how derivatives fit into the Federal
credit union's business model and risk management process.
(3) Qualified derivatives personnel. To engage in derivatives
transactions, a Federal credit union must employ staff with experience
in the following areas:
(i) Asset/liability risk management. Staff must be qualified to
understand and oversee asset/liability risk management, including the
appropriate role of derivatives. This requirement includes identifying
and assessing risk in transactions, developing asset/liability risk
management strategies, testing the effectiveness of asset/liability
risk management, determining the effectiveness of managing interest
rate risk under a range of stressed rates and statement of financial
condition
[[Page 5244]]
scenarios, and evaluating the relative effectiveness of alternative
strategies. Staff must also be qualified to understand and undertake or
oversee the appropriate modeling and analytics related to scope of risk
to earnings and economic value over the expected maturity of
derivatives positions;
(ii) Accounting and financial reporting. Staff must be qualified
to understand and oversee appropriate accounting and financial
reporting for derivatives transactions in accordance with GAAP;
(iii) Derivatives execution and oversight. Staff must be qualified
to undertake or oversee trade executions; and
(iv) Counterparty, collateral, and margining management. Staff
must be qualified to evaluate counterparty, collateral, and margining
risk as described in Sec. 703.104 of this subpart.
(b) Required management and internal controls structure. To
effectively manage its derivatives activities, a Federal credit union
must assess the effectiveness of its management and internal controls
structure. At a minimum, the internal controls structure must include:
(1) Transaction support. Before executing any derivatives
transaction, a Federal credit union must identify and document the
circumstances that lead to the decision to hedge, specify the
derivatives strategy the Federal credit union will employ, and
demonstrate the economic effectiveness of the hedge;
(2) Internal controls review. For the first two years after
commencing its derivatives program, a Federal credit union must have an
internal controls review that is focused on the integration and
introduction of derivatives functions. This review must be performed by
an independent external unit or, if applicable, the Federal credit
union's internal auditor. The review must ensure the timely
identification of weaknesses in internal controls, modeling
methodologies, risk, and all operational and oversight processes;
(3) Financial statement audit. Any Federal credit union engaging
in derivatives transactions pursuant to this subpart must obtain an
annual financial statement audit, as defined in Sec. 715.2(d) of this
chapter, and be compliant with GAAP for all derivatives-related
accounting and reporting;
(4) Process and responsibility framework. A Federal credit union
must maintain a written and schematic description (e.g., flow chart or
organizational chart) of the derivatives management process in its
derivatives policies and procedures. The description must include the
roles of staff, qualified personnel, external service providers, senior
executive officers, the board of directors, and any others involved in
the derivatives program;
(5) Separation of duties. A Federal credit union's process,
whether conducted internally or by an external service provider, must
have appropriate separation of duties for the following functions
defined in paragraph (a)(3) of this section:
(i) Asset/liability risk management;
(ii) Accounting and financial reporting;
(iii) Derivatives execution and oversight; and
(iv) Collateral, counterparty, and margining management.
(c) Legal review. A Federal credit union with derivatives authority
must hire or engage legal counsel to reasonably ensure that all
derivatives contracts adequately protect the legal and business
interests of the Federal credit union. The Federal credit union's
counsel must have legal expertise with derivatives contracts and
related matters.
(d) Policies and procedures. A Federal credit union with
derivatives authority must operate according to comprehensive written
policies and procedures for control, measurement, and management of
derivatives transactions. At a minimum, the policies and procedures
must address the requirements of this subpart, except for those in
Sec. Sec. 703.108 through 703.114, and any additional limitations
imposed by the Federal credit union's board of directors. A Federal
credit union's board of directors must review the policies and
procedures described in this section annually and update them when
necessary.
Sec. 703.107 External service providers.
(a) General. A Federal credit union with derivatives authority may
use external service providers to support or conduct aspects of its
derivatives program, provided:
(1) The external service provider, including affiliates, does not:
(i) Act as a counterparty to any derivatives transactions that
involve the Federal credit union;
(ii) Act as a principal or agent in any derivatives transactions
that involve the Federal credit union; or
(iii) Have discretionary authority to execute any of the Federal
credit union's derivatives transactions.
(2) The Federal credit union has the internal capacity, experience,
and skills to oversee and manage any external service providers it
uses; and
(3) The Federal credit union documents the specific uses of
external service providers in its process and responsibility framework,
as described in Sec. 703.106(b)(1) of this subpart and the
application.
(b) Support functions. A Federal credit union must perform the
following functions internally and independently. A Federal credit
union may have assistance and input from an external service provider,
provided the external service provider does not conduct the following
functions in lieu of the Federal credit union:
(1) Asset/liability risk management; and
(2) Liquidity risk management.
Sec. 703.108 Eligibility.
(a) A Federal credit union may apply for derivatives authority
under this subpart if it meets the following criteria:
(1) The Federal credit union's most recent NCUA-assigned composite
CAMEL code rating is 1, 2, or 3, with a management component of 1 or 2;
and
(2) The Federal credit union has assets of at least $250 million as
of its most recent call report.
(b) Notwithstanding paragraph (a)(2) of this section, a Federal
credit union may request permission from the appropriate field director
to apply for derivatives authority, subject to requirements imposed by
the field director. If the field director grants such permission, the
application will be subject to Sec. Sec. 703.109 through 703.111.
Sec. 703.109 Applying for derivatives authority.
An eligible Federal credit union must receive written approval to
use derivatives by submitting a detailed application, consistent with
this subpart and any guidance issued by NCUA. A Federal credit union
must submit its application to the applicable field director.
Sec. 703.110 Application content.
A Federal credit union applying for derivatives authority must
document how it will comply with the requirements of this subpart and
any guidance issued by NCUA, and must include all of the following in
its application:
(a) An interest rate risk mitigation plan that shows how
derivatives are one aspect of the Federal credit union's overall
interest rate risk mitigation strategy, and an analysis showing how the
Federal credit union will use derivatives in conjunction with other on-
balance sheet instruments and strategies to effectively manage its
interest rate risk;
(b) A list of the products and characteristics the Federal credit
union
[[Page 5245]]
is seeking approval to use, a description of how it intends to use the
products and characteristics listed, an analysis of how the products
and characteristics fit within its interest rate risk mitigation plan,
and a justification for each product and characteristic listed;
(c) Draft policies and procedures that the Federal credit union has
prepared in accordance with Sec. 703.106(d) of this subpart;
(d) How the Federal credit union plans to acquire, employ, and/or
create the resources, policies, processes, systems, internal controls,
modeling, experience, and competencies to meet the requirements of this
subpart. This includes a description of how the Federal credit union
will ensure that senior executive officers, board of directors, and
personnel have the knowledge and experience in accordance with the
requirements of this subpart;
(e) A description of how the Federal credit union intends to use
external service providers as part of its derivatives program, and a
list of the name(s) of and service(s) provided by the external service
providers it intends to use;
(f) A description of how the Federal credit union will support the
operations of margining and collateral; and
(g) A description of how the Federal credit union will comply with
GAAP.
Sec. 703.111 NCUA approval.
(a) Interim approval. The field director will notify the Federal
credit union in writing if the field director has approved or denied
its application and, if applicable, the reason(s) for any denial. A
Federal credit union approved for derivatives authority may not enter
into any derivatives transactions until it receives final approval from
NCUA under paragraph (c) of this section.
(b) Notice of readiness. A Federal credit union approved under
paragraph (a) of this section must provide written notification to NCUA
when it is ready to begin using derivatives.
(c) Final approval. NCUA will review every approved Federal credit
union's derivatives program to ensure compliance with this subpart and
evaluate the Federal credit union's implementation of the items in its
application. This supervisory review may be conducted on site. After
NCUA has completed its review, the field director will notify the
Federal credit union in writing if the field director has granted final
approval and the Federal credit union may begin entering into
derivatives transactions. If applicable, the notification will include
the reason(s) for any denial. A Federal credit union may not enter into
any derivatives transactions under this subpart until it receives this
determination from the applicable field director. At a field director's
discretion, a Federal credit union may reapply under this subsection if
the field director has determined that the Federal credit union has
demonstrated compliance with this subpart and its application.
(d) Right to appeal. A Federal credit union may submit a written
appeal to the NCUA Board within 60 days from the date of denial by NCUA
under paragraph (b) or (c) of this section.
Sec. 703.112 Applying for additional products or characteristics.
(a) A Federal credit union with derivatives authority may
subsequently apply for approval to use additional products and
characteristics, described in Sec. 703.102 of this subpart, that it
did not request in its initial application, subject to the following:
(1) A Federal credit union must submit an application to NCUA;
(2) A Federal credit union's application must include a list of the
products and/or characteristics for which it is applying; and
(3) A Federal credit union must include a justification for each
product and/or characteristic requested in the application and an
explanation of how the Federal credit union will use each product and/
or characteristic requested.
(b) The field director will notify the Federal credit union in
writing if the field director has approved or denied its application
for additional products or characteristics. If applicable, the
notification will include the reason(s) for denial.
(c) A Federal credit union may appeal any denial of an application
for additional products and/or characteristics in accordance with Sec.
703.111(d).
Sec. 703.113 Pilot program participants with active derivatives
positions.
(a) A Federal credit union with outstanding derivatives positions
under NCUA's derivatives pilot program as of January 1, 2013, must
comply with the requirements of this subpart within 12 months of the
effective date of this subpart, including the requirement to submit an
application for derivatives authority. During the 12-month interim
period, the Federal credit union may continue to operate its
derivatives program in accordance with its pilot program terms and
conditions.
(b) A Federal credit union with outstanding derivatives positions
under NCUA's derivatives pilot program as of January 1, 2013, that does
not comply with the requirements of this subpart within 12 months of
the effective date of this subpart, or does not want to continue
engaging in derivatives transactions, must:
(1) Stop entering into new derivatives transactions; and
(2) Within 30 days, present a corrective action plan to NCUA
describing how the Federal credit union will cure any deficiencies or
wind down its derivatives program.
Sec. 703.114 Regulatory violation.
(a) A Federal credit union with derivatives authority that no
longer meets the requirements of this subpart or fails to comply with
its approved strategy (including employing the resources, policies,
procedures, accounting, and competencies that formed the basis for the
approval) must:
(1) Immediately stop entering into any new derivatives transactions
until the Federal credit union is in compliance with this subpart.
During this period, however, the Federal credit union may terminate
existing derivatives transactions. NCUA may permit a Federal credit
union to enter into offsetting transactions if NCUA determines these
transactions are part of a corrective action strategy.
(2) Within three business days from the regulatory violation,
provide the appropriate field director notification of the regulatory
violation, which must include a description of the violation and the
immediate corrective action the Federal credit union is taking; and
(3) Within 15 business days after notifying the appropriate field
director, submit a written corrective action plan to the appropriate
field director.
(b) NCUA may revoke a Federal credit union's derivatives authority
at any time if a Federal credit union fails to comply with the
requirements of this subpart. Revocation will prohibit a Federal credit
union from executing any new derivatives transactions under this
subpart, and may require the Federal credit union to terminate existing
derivatives transactions if, in the discretion of the applicable field
director, doing so would not pose a safety and soundness concern.
(c) Within 60 days from the date of the related field director's
action, a Federal credit union may appeal the following to the NCUA
Board:
(1) NCUA's revocation of a Federal credit union's derivatives
authority; and
(2) NCUA's order that a Federal credit union terminate existing
derivatives positions.
(d) With respect to an appeal regarding revocation of a Federal
credit
[[Page 5246]]
union's derivatives authority, the Federal credit union may not enter
into any new derivatives transactions until the NCUA Board renders a
final decision on the appeal. The Federal credit union may, however,
elect to terminate existing derivatives positions. With respect to an
appeal regarding an order to terminate a Federal credit union's
existing derivatives positions, the Federal credit union is not
required to terminate any existing positions until the NCUA Board
renders a final decision on the appeal.
Appendix to Subpart B--Examples of Derivative Limit Authority
Calculations
Limit authority. A Federal credit union that is approved for
derivatives authority under Sec. 703.111 may use any of the
products and characteristics described in Sec. 703.102(a), subject
to the following position and risk limits:
Table 1--Authority Limits
----------------------------------------------------------------------------------------------------------------
Entry limits (first 12
Limit authority months of transactions) Standard limits
----------------------------------------------------------------------------------------------------------------
Fair Value Loss (See (a) below)........... 15% of net worth............ 25% of net worth.
Weighted Average Remaining Maturity 65% of net worth............ 100% of net worth.
Notional (WARMN) (See (b) below).
----------------------------------------------------------------------------------------------------------------
(a) Calculating the fair value loss limit for compliance with
this subpart. To demonstrate compliance with the fair value loss
limit authority of this subpart, a Federal credit union must combine
the total fair value (as defined by product group below) of all
derivatives transactions. The fair value loss limit is exclusive to
the derivatives positions (not net of offsetting gains and losses in
the hedged item).
(1) The resulting figure, if a loss, must not exceed the Federal
credit union's authorized fair value loss limit:
(i) Options--the gain or loss is the difference between the fair
value and the unamortized premium at the reporting date;
(ii) Swaps--the gain or loss is the fair value at the reporting
date; and
(iii) Futures--the gain or loss is the difference between the
exchange closing price at the reporting date and the purchase or
sales price.
(2) Example calculations for compliance with this subpart: fair
value loss limit. The table below provides an example of the fair
value loss limit calculations for a sample Federal credit union that
has entry level authority. The sample Federal credit union has a net
worth of $100 million and total assets of $1 billion; its fair value
loss limit is -$15 million (15 percent of net worth).
Table 2--Example Fair Value Loss Calculations
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fair value gains (losses) % of Net
------------------------------------------------------------------------ worth Limit violation
Options Swaps Futures Total (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Scenario A............................. $1,000,000 $2,000,000 $200,000 $3,200,000 3 No.
Scenario B............................. 5,000,000 10,000,000 2,000,000 17,000,000 17 No.
Scenario C............................. 1,000,000 (3,000,000) 250,000 (1,750,000) (2) No.
Scenario D............................. 1,000,000 (20,000,000) (2,000,000) (21,000,000) (21) Yes.
Scenario E............................. (2,000,000) (10,000,000) 1,000,000 (11,000,000) (11) No.
--------------------------------------------------------------------------------------------------------------------------------------------------------
(b) Calculating the WARMN exposure for compliance with this
subpart. The WARMN calculation adjusts the gross notional of a
derivative to take into account its price sensitivity and remaining
maturity. The WARMN limit is correlated to the fair value loss
limit, as described in paragraph (a) of this appendix, for a 300
basis point parallel shift in interest rates. To demonstrate
compliance with the WARMN limit authority of this subpart, a Federal
credit union must calculate the WARMN using the following reference
table, definitions, and calculation steps:
Table 3--Summary of WARMN Calculation
----------------------------------------------------------------------------------------------------------------
Step 1 gross factor Step 2 Step 3 WARM
notional (percent) adjusted notional
----------------------------------------------------------------------------------------------------------------
Options (Caps)................. Current 33 33% of current Time remaining to maturity.
notional notional.
Options (Floors)............... Current 33 33% of current Time remaining to maturity.
notional notional.
Swaps.......................... Current 100 100% of current Time remaining to maturity.
notional notional.
Futures........................ Contract size 100 100% of contract Underlying contract.
size.
.............. .............. Sum = Total Sum = Overall WARM
Adjusted Notional.
----------------------------------------------------------------------------------------------------------------
Step 4 WARMN = Adjusted Notional x (WARM/10)
----------------------------------------------------------------------------------------------------------------
(1) Step #1--Calculate the gross notional of all outstanding
derivative transactions. (i) For options and swaps, all gross
notional amounts must be absolute, with no netting (i.e., offsetting
a pay-fixed transaction with a receive-fixed transaction). The gross
notional for derivatives transactions with amortizing notional
amounts is the current contracted notional amount, in accordance
with the amortization schedule.
(ii) For futures, the gross notional is the underlying contract
size as designated by the Chicago Mercantile Exchange (CME) product
specifications (e.g., a five-year Treasury note futures contract
will use $100,000 for each contract purchased or sold and reported
here on a gross basis for limit purposes.)
[[Page 5247]]
(2) Step #2--Convert each gross notional by its derivative
adjustment factor to produce an adjusted gross notional. The
derivative adjustment factor approximates the price sensitivity for
each of the product groups in order to weight the notional amount by
sensitivity before weighting for maturity.
(i) For cap and floor options, the derivative adjustment factor
is 33 percent. For example, an interest rate cap with a $1 million
notional amount has an adjusted gross notional of $330,000
($1,000,000 x 0.33 + $330,000).
(ii) For interest rate swaps and Treasury futures, the
derivative adjustment factor is 100 percent. For example, an
interest rate swap with a $1 million notional amount has an adjusted
gross notional of $1,000,000 ($1,000,000 x 1.00 = $1,000,000).
(iii) The total adjusted notional for all derivatives positions
is the sum of (i) and (ii) above.
(3) Step #3--Produce the weighted average remaining time to
maturity (WARM) for all derivatives positions. (i) For interest rate
caps, interest rate floors, and interest rate swaps, the remaining
maturity is the time left between the reporting date and the
contracted maturity date, expressed in years (round up to two
decimals);
(ii) For Treasury futures, the remaining maturity is the
underlying deliverable Treasury note's maximum maturity (e.g., a
five-year Treasury note future has a five-year remaining maturity);
and
(iii) Determine the WARM using the adjusted gross notional, as
set forth in subsection (2) of this section, and the remaining time
to maturity as defined for each product group above in paragraphs
(b)(3)(i) and (ii) of this appendix.
(4) Step #4--Produce the WARMN by converting the WARM to a
percentage and then multiplying the percentage by the total adjusted
gross notional. (i) Divide the WARM, as calculated in paragraph
(b)(3) of this appendix, by ten to convert it to a percentage (e.g.,
7.75 WARMN is translated to 77.5 percent); and
(ii) Multiply the WARM converted to a percentage, as described
in paragraph (c)(4)(i) of this appendix, by total adjusted gross
notional, described in paragraph (c)(2) of this appendix.
(5) Compare WARMN calculation to the WARNM limit for compliance.
The total in step four (4) must be less than the limit in paragraph
(a)(1)(ii) or (a)(2)(ii) of this appendix, as applicable.
(6) Example calculations for compliance with this subpart:
WARMN. The table below provides an illustrative example of the WARMN
limit calculations for a sample Federal credit union that has entry
level authority. The sample Federal credit union has a net worth of
$100 million and total assets of $1 billion; its notional limit
authority is $65 million (65 percent of net worth).
Table 4--Example WARMN Limit Calculation
----------------------------------------------------------------------------------------------------------------
Options Swaps Futures Total
----------------------------------------------------------------------------------------------------------------
Gross Notional (Step 1)........ $100,000,000 $50,000,000 $5,000,000 $155,000,000
Adjustment Factor....................... 33% 100% 100% ................
Adjusted Notional (Step 2)..... $33,000,000 $50,000,000 $5,000,000 $88,000,000
Weighted Average Remaining Maturity 7.00 8.50 5.00 7.74
(WARM) (Step 3)...............
----------------------------------------------------------------------------------------------------------------
Weighted Average Remaining \1\ $68,100,000
Maturity Notional (WARMN) (Step
4):
Notional Limit Authority (65% of $65,000,000
net worth)
Under/(Over) Notional Limit ($3,100,000)
Authority
----------------------------------------------------------------------------------------------------------------
\1\ (77.4% of Step 3.)
PART 715--SUPERVISORY COMMITTEE AUDITS AND VERIFICATIONS
0
7. The authority citation for part 715 continues to read as follows:
Authority: 12 U.S.C. 1757, 1766(a), and 1781-1790; 31 U.S.C.
3717.
0
8. In Sec. 715.5, revise paragraph (a) to read as follows:
Sec. 715.5 Audit of Federal Credit Unions.
(a) Total assets of $500 million or greater. To fulfill its
Supervisory Committee audit responsibility, a Federal credit union
having total assets of $500 million or greater, except as provided in
Sec. 703.106(b)(3) of this chapter, must obtain an annual audit of its
financial statements performed in accordance with Generally Accepted
Auditing Standards by an independent person who is licensed to do so by
the State or jurisdiction in which the credit union is principally
located.
* * * * *
PART 741--REQUIREMENTS FOR INSURANCE
0
9. The authority citation for part 741 is revised to read as follows:
Authority: 12 U.S.C. 1757, 1766(a), 1781-1790, and 1790d; 31
U.S.C. 3717.
0
10. Revise Sec. 741.219 to read as follows:
Sec. 741.219 Investment requirements.
(a) Any credit union which is insured pursuant to Title II of the
Act must adhere to the requirements stated in part 703 of this chapter
concerning transacting business with corporate credit unions.
(b) Any credit union which is insured pursuant to Title II of the
Act must notify the applicable NCUA Regional Director or the Director
of the Office of National Examinations and Supervision in writing at
least 30 days before it begins engaging in derivatives.
[FR Doc. 2014-01703 Filed 1-30-14; 8:45 am]
BILLING CODE 7535-01-P