Final_12CFR703_SubptB_79FR5228

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
Authority: 12 U.S.C. 1851.

Board of Governors of the Federal
Reserve

§ 75.16

Authority and Issuance
For the reasons set forth in the
Common Preamble, the Board of
Governors of the Federal Reserve
System is adding the text of the
common rule as set forth at the end of
the Common Preamble as § 248.16 to
part 248, 12 CFR chapter II.

8. Section 75.16 is added as set forth
at the end of the Common Preamble.

■

Securities and Exchange Commission
Authority and Issuance

PART 248—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS (Regulation VV)
3. The authority for part 248
continues to read as follows:

■

Authority: 12 U.S.C. 1851, 12 U.S.C. 221
et seq., 12 U.S.C. 1818, 12 U.S.C. 1841 et seq.,
and 12 U.S.C. 3103 et seq.
§ 248.16

[Amended]

Federal Deposit Insurance Corporation
Authority and Issuance
For the reasons set forth in the
Common Preamble, the Federal Deposit
Insurance Corporation is adding the text
of the common rule as set forth at the
end of the Common Preamble as
§ 351.16 to part 351, chapter III of Title
12, Code of Federal Regulations.
PART 351—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
5. The authority for part 351
continues to read as follows:

■

Authority: 12 U.S.C. 1851; 1811 et seq.;
3101 et seq.; and 5412.
[Amended]

6. Section 351.16 is added as set forth
at the end of the Common Preamble.

■

Commodity Futures Trading
Commission

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For the reasons set forth in the
Common Preamble, the Securities and
Exchange Commission is adding the text
of the common rule as set forth at the
end of the Common Preamble as
§ 255.16 to part 255, chapter II of Title
17, Code of Federal Regulations.
PART 255—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
9. The authority for part 255
continues to read as follows:

■

4. Section 248.16 is added as set forth
at the end of the Common Preamble.

■

§ 351.16

[Amended]

Authority and Issuance
For the reasons set forth in the
Common Preamble, the Commodity
Futures Trading Commission is adding
the text of the common rule as set forth
at the end of the Common Preamble as
§ 75.16 to part 75, chapter I of Title 17,
Code of Federal Regulations.

Authority: 12 U.S.C. 1851.
§ 255.16

[Amended]

10. Section 255.16 is added as set
forth at the end of the Common
Preamble.

■

Dated: January 14, 2014.
Thomas J. Curry,
Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System, January 14, 2014.
Robert deV. Frierson,
Secretary of the Board.
Dated at Washington, DC this 13th day of
January 2014.
By delegated authority from the Board of
Directors of the Federal Deposit Insurance
Corporation.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: January 17, 2014.
By the Securities and Exchange
Commission.
Elizabeth M. Murphy,
Secretary.
Issued in Washington, DC, on January 15,
2014, by the Commodity Futures Trading
Commission.
Melissa D. Jurgens,
Secretary of the Commodity Futures Trading
Commission.
Note: The following appendices will not
appear in the Code of Federal Regulations.

PART 75—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
7. The authority for part 75 continues
to read as follows:

■

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Commodity Futures Trading
Commission (CFTC) Appendices to
Treatment of Certain Collateralized
Debt Obligations Backed Primarily by
Trust Preferred Securities With Regard
to Prohibitions and Restrictions on
Certain Interests in, and Relationships
With, Hedge Funds and Private Equity
Funds—Commission Voting Summary
and Statements of Commissioners
Appendix 1—Commodity Futures
Trading Commission Voting Summary
On this matter, Acting Chairman
Wetjen and Commissioner Chilton voted
in the affirmative, and Commissioner
O’Malia concurred.
Appendix 2—Statement of CFTC Acting
Chairman Mark P. Wetjen
I support the interim final rule
adopted by the CFTC and the other
Volcker Rule agencies. The Commission
believed it was important to join the
other agencies in ensuring community
banks are protected, as Congress
directed, from restrictions in the
Volcker Rule intended to lower the risk
of large financial institutions.
Appendix 3—Statement of Concurrence
by CFTC Commissioner Scott D. O’Malia
I support the interim final rule
adopted by the Commission and the
OCC, Federal Reserve Board, FDIC, and
SEC (‘‘Agencies’’). When an unintended
consequence of a regulation is
discovered, it is imperative that it be
expeditiously corrected to avoid
unintentional harm to affected parties.
Broken rules must be fixed, and I
applaud the work of the Agencies to
quickly respond to the public’s concerns
and comments regarding the holding of
TruPS CDOs by community banks
affected by the Volcker Rule.
[FR Doc. 2014–02019 Filed 1–30–14; 8:45 am]
BILLING CODE 6210–01–P; 6741–01–P; 6351–01–P;
8011–01–P; 4810–33–P

NATIONAL CREDIT UNION
ADMINISTRATION
12 CFR Parts 703, 715, and 741
RIN 3133–AD90

Derivatives
National Credit Union
Administration (NCUA).
ACTION: Final rule.
AGENCY:

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

SUMMARY:

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
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

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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

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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.
Æ 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.
Æ The fair value threshold, if
breached, will require a participating

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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 § 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 (§ 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

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to the rule, the Board has significantly
revised this section.
(1) Applicability to FISCUs (§ 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 onequarter 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 § 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 (§ 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 (§ 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 nonleveraged, 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

Interest rate swaps .........................................................................................................
Interest rate caps.
Interest rate floors ..........................................................................................................
Basis swaps.
Treasury futures.

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• Amortizing notional amounts for swaps, caps, and
floors.
• Forward start date for swaps (90-day maximum).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
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

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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

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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 (§ 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

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‘‘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 net worth)

emcdonald on DSK67QTVN1PROD with RULES

Total fair value loss .................................................................................................................................
Weighted Average Remaining Maturity Notional (WARMN) ...................................................................

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.

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(2) Description of Fair Value Loss and
Notional Limits (§ 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

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15
65

Standard limits
(% of net worth)
25
100

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.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
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

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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.

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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

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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 (§ 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 mortgagebacked 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-ofotc-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

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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 EndUser 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.

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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 noncentrally 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 mortgagebacked 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 noncentrally 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.

emcdonald on DSK67QTVN1PROD with RULES

(h) Reporting Requirements (§ 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

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officials receive the reports that are
necessary to oversee the credit union’s
derivatives program.
(i) Operational Requirements (§ 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

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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.

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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

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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)
(§ 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

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emcdonald on DSK67QTVN1PROD with RULES

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 (§ 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

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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 wellmanaged 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 (§ 703.109–§ 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.

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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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to acquire the infrastructure necessary
to operate a derivatives program in
compliance with this final rule.

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.

emcdonald on DSK67QTVN1PROD with RULES

(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

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(m) Application for Additional
Derivatives and Characteristics
(§ 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
(§ 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

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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 (§ 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 receivefixed 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.

emcdonald on DSK67QTVN1PROD with RULES

(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

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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
15

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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.
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.
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 onetime recordkeeping burden.
2 44

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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

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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 × 50 hours = 2,150 hours
(one-time burden).
Board review of policies and
procedures: 43 credit unions × 10 hours
= 430 hours.
Derivatives reporting: 43 credit unions
× 32 hours = 1,376 hours.
Evidence of board training: 43 credit
unions × 4 hours = 172 hours.
Derivatives process description: 43
credit unions × 12.5 hours = 537.5 hours
(one-time burden).

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43 credit unions × 2 hours = 86 hours.
Independent internal controls review:
43 credit unions × $50,000/year for 2
years $4,300,000 (one-time burden).
Financial statement audit: 6 credit
unions × $50,000 = $300,000.
Pre-execution analysis: 43 credit
unions × 4 hours = 172 hours.
Application: 43 credit unions × 50
hours = 2,150 hours (one-time burden).
Corrective action plan: 3 credit unions
× 10 hours = 30 hours.
FISCU notice: 30 credit unions × 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 § 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.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
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
1. The authority citation for part 703
continues to read as follows:

■

§ 703.16

2. In part 703, designate §§ 703.1
through 703.20 as subpart A under the
following heading:

■

Subpart A—General Investment and
Deposit Activities
*

*

*

*

3. Amend § 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:

■

§ 703.2

Definitions.

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*

*
*
*
*
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.
*
*
*
*
*
■ 4. In § 703.14, add paragraph (k) to
read as follows:
§ 703.14

Permissible investments.

*

*
*
*
*
(k) Derivatives. A Federal credit union
may only enter into in the following
derivatives transactions:

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[Amended]

5. In § 703.16, remove paragraph (a) of
and redesignate paragraphs (b) through
(d) as (a) through (c), respectively.
■ 6. Add subpart B to read as follows:
■

Authority: 12 U.S.C. 1757(7), 1757(8),
1757 (15).

*

(1) Any derivatives permitted under
§ 701.21(i) of this chapter, § 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.

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.
§ 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 § 741.219, this rule does not
apply to federally insured, statechartered 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 § 703.14(c) of this part,
where the prospectus of the company or
fund permit the investment portfolio to
contain derivatives.
§ 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;

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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 § 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;

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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 § 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

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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 § 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 § 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.
§ 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 § 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

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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 § 703.14(a) of subpart A of
this part;
(3) Denominated in U.S. dollars;
(4) Except as provided in § 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.
§ 703.103

Derivative authority.

(a) General authority. A Federal credit
union that is approved for derivatives
authority under § 703.111 of this
subpart may use any of the products and
characteristics, described in
§ 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

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
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.

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§ 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

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(iii) Accept as collateral, for margin
requirements, only cash (U.S. dollars),
U.S. Treasuries, government-sponsored
enterprise debt, and governmentsponsored 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.
§ 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
§ 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

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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.
§ 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

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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 § 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 § 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

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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 §§ 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.
§ 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

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service providers in its process and
responsibility framework, as described
in § 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.
§ 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 §§ 703.109 through 703.111.
§ 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.
§ 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

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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 § 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.

emcdonald on DSK67QTVN1PROD with RULES

§ 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

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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.
§ 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 § 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
§ 703.111(d).
§ 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

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5245

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.
§ 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

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations

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
§ 703.111 may use any of the products and
characteristics described in § 703.102(a),
subject to the following position and risk
limits:

TABLE 1—AUTHORITY LIMITS
Limit authority

Entry limits (first 12 months of transactions)

Fair Value Loss (See (a) below) .......................................................................
Weighted Average Remaining Maturity Notional (WARMN) (See (b) below) ..

15% of net worth .....................................
65% of net worth .....................................

(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

Standard limits
25% of net worth.
100% of net worth.

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)
Options
Scenario
Scenario
Scenario
Scenario
Scenario

A
B
C
D
E

.....................................
.....................................
.....................................
.....................................
.....................................

Swaps

$1,000,000
5,000,000
1,000,000
1,000,000
(2,000,000)

(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

Futures

$2,000,000
10,000,000
(3,000,000)
(20,000,000)
(10,000,000)

Total

$200,000
2,000,000
250,000
(2,000,000)
1,000,000

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 Net
worth
(percent)

$3,200,000
17,000,000
(1,750,000)
(21,000,000)
(11,000,000)

Limit
violation

3
17
(2)
(21)
(11)

No.
No.
No.
Yes.
No.

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
notional

Product
Options (Caps) .......................................................
Options (Floors) .....................................................
Swaps .....................................................................
Futures ...................................................................

Adjustment
factor
(percent)

Current
notional
Current
notional
Current
notional
Contract size

Step #2
adjusted notional

Step #3
WARM

33

33% of current notional .................

33

33% of current notional .................

100

100% of current notional ...............

100

100% of contract size ....................
Sum = Total Adjusted Notional .....

Time remaining to
maturity.
Time remaining to
maturity.
Time remaining to
maturity.
Underlying contract.
Sum = Overall
WARM

emcdonald on DSK67QTVN1PROD with RULES

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

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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

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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.)

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
(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 × 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 × 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
Gross Notional (Step #1) .................................................................
Adjustment Factor ............................................................................
Adjusted Notional (Step #2) ............................................................
Weighted Average Remaining Maturity (WARM) (Step #3) ............

1 (77.4%

Swaps

$100,000,000
33%
$33,000,000
7.00

$50,000,000
100%
$50,000,000
8.50

$5,000,000
100%
$5,000,000
5.00

$155,000,000
............................
$88,000,000
7.74

Weighted Average Remaining Maturity Notional (WARMN) (Step #4):
Notional Limit Authority (65% of net
worth)
Under/(Over) Notional Limit Authority

1 $68,100,000

PART 741—REQUIREMENTS FOR
INSURANCE

$65,000,000
($3,100,000)

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.

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 § 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.
*
*
*
*
*

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Federal Aviation Administration
14 CFR Part 39

Authority: 12 U.S.C. 1757, 1766(a), 1781–
1790, and 1790d; 31 U.S.C. 3717.

[Docket No. FAA–2013–0501; Directorate
Identifier 2011–SW–036–AD; Amendment
39–17732; AD 2014–02–04]

10. Revise § 741.219 to read as
follows:

RIN 2120–AA64

§ 741.219

Airworthiness Directives; Eurocopter
France Helicopters

■

8. In § 715.5, revise paragraph (a) to
read as follows:

■

DEPARTMENT OF TRANSPORTATION

9. The authority citation for part 741
is revised to read as follows:

■

emcdonald on DSK67QTVN1PROD with RULES

Total

of Step #3.)

PART 715—SUPERVISORY
COMMITTEE AUDITS AND
VERIFICATIONS

§ 715.5

Futures

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

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Federal Aviation
Administration (FAA), DOT.
ACTION: Final rule.
AGENCY:

We are adopting a new
airworthiness directive (AD) for
Eurocopter France (Eurocopter) Model
EC 155B and EC155B1 helicopters. This
AD requires repetitively inspecting the
lower and upper front and rear fittings
(fittings) that attach the upper fin to the
fenestron for a crack and, if there is a
crack, removing all four fittings from
service. This AD also requires, within a
specified time, removing all fittings
from service, and the fittings would not
be eligible to be installed on any

SUMMARY:

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