(a) Purpose. This subpart grants Federal credit unions limited authority to enter into Derivatives only for the purpose of managing Interest Rate Risk.

(b) Scope. This subpart applies to all Federal credit unions. Except as provided in § 741.219, this rule does not apply to federally insured, state-chartered credit unions.

(c) Prior approvals. Any Federal credit union with an active approval, under the prior version of this subpart, on June 25, 2021 is subject to the provisions of this subpart and is no longer subject to the restrictions, limits, or terms contained in the Federal credit union's approved application.

(d) Pending Approvals. Any application for Derivatives authority pending on June 25, 2021, except for such applications submitted by a Federal credit union that would be subject to the requirements of § 703.108(b), is deemed to be withdrawn and such applicant is subject to the provisions of this subpart.

For purposes of this subpart:

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.

Derivative means a financial contract that 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 (CFTC) in 17 CFR 1.3.

Domestic interest rates means interest rates derived in the United States and are U.S. dollar-denominated.

Earnings at Risk means the changes to earnings, typically in the short term (for example, 12 to 36 months), caused by changes in interest rates.

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.

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.

Futures Commission Merchant (FCM) has the meaning as defined by the CFTC in 17 CFR 1.3.

Interest Rate Risk means the current and prospective risk to a credit union's capital and earnings arising from movements in interest rates.

Introducing Broker means a futures brokerage firm that deals directly with the client, while the trade execution is done by an FCM.

Margin means the minimum amount of eligible collateral, as defined in § 703.104(c), that must be deposited between parties to a Derivatives transaction, as detailed in a Master Services Agreement.

Master Services Agreement means a document agreed upon between two parties that sets out standard terms that apply to all transactions entered into between those parties. The most common form of a Master Services Agreement for Derivatives is an International Swap Dealer Association Master Agreement.

Net Economic Value means the measurement of changes in the economic value of Net Worth caused by changes in interest rates.

Net Worth has the meaning specified in part 702 of this chapter.

Non-cleared means transactions that do not go through a Derivatives Clearing Organization

Regional Director means an NCUA Regional Director or the Director of the Office of National Examinations and Supervision.

Senior Executive Officer has the meaning specified in § 701.14 of this chapter and includes any other similar employee that is directly within the chain of command for the oversight of a Federal credit union's Derivatives program.

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 CFTC in 17 CFR 1.3.

Threshold Amount means an unsecured credit exposure that a party to a Derivatives transaction is prepared to accept before requesting additional eligible collateral, as defined in § 703.104(c), from the other party.

Trade Date means the date that a Derivatives order (new transactions, terminations, or assignments) is executed with a Counterparty.

(a) Under this subpart, a Federal credit union may only enter into Derivatives that have the following characteristics:

(1) Are for the purpose of managing Interest Rate Risk;

(2) Denominated in U.S. dollars;

(3) Based on Domestic Interest Rates or the U.S. dollar-denominated London Interbank Offered Rate (LIBOR);

(4) A contract maturity equal to or less than 15 years, as of the Trade Date; and

(5) Not used to create Structured Liability Offerings for members or nonmembers.

(b) A Federal credit union may not engage in embedded options required under U.S. Generally Accepted Accounting Principles (GAAP) to be accounted for separately from the host contract.

To enter into Derivative transactions under this subpart, a Federal credit union must:

(a) Have an executed Master Services Agreement with a Counterparty. Such agreement must be reviewed by counsel with expertise in similar types of transactions to ensure the agreement reasonably protects the interests of the Federal credit union;

(b) Use only the following Counterparties:

(1) For exchange-traded and cleared Derivatives: Swap Dealers, Introducing Brokers, and/or FCMs that are current registrants of the CFTC; or

(2) For Non-cleared Derivative transactions: Swap Dealers that are current registrants of the CFTC.

(c) Utilize contracted Margin requirements with a maximum Margin threshold amount of $250,000; and

(d) For Non-cleared Derivative transactions, accept as eligible collateral, for Margin requirements, only the following: Cash (U.S. dollars), U.S. Treasuries, government-sponsored enterprise debt, U.S. government agency debt, government-sponsored enterprise residential mortgage-backed security pass-through securities, and U.S. government agency residential mortgage-backed security pass-through securities.

(a) Board reporting. At least quarterly, a Federal credit union's Senior Executive Officers must deliver a comprehensive Derivatives report, as described in paragraph (c) of this section to the Federal credit union's board of directors.

(b) Senior Executive Officer and asset liability or similarly functioning committee. At least monthly, Federal credit union staff must deliver a comprehensive Derivatives report, as described in paragraph (c) of this section to the Federal credit union's Senior Executive Officers and, if applicable, the Federal credit union's asset liability or similarly functioning committee.

(c) Comprehensive Derivatives management 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, and the planned remediation of such noncompliance;

(2) An itemization of the Federal credit union's individual transactions subject to this subpart, the current values of such transactions, and each individual transaction's intended use for Interest Rate Risk mitigation; and

(3) A comprehensive view of the Federal credit union's risk reports, including, but not limited to, Interest Rate Risk calculations with details of the transactions subject to this subpart.

(d) Retention requirement. Reports required by this section must, at a minimum, be retained in accordance with the requirements in Appendix A to part 749.

(e) Notification of noncompliance. Notification of any noncompliance as part of the Derivatives management report required in paragraph (c)(1) of this section must be submitted to the applicable Regional Director immediately after it has been submitted to the Federal credit union's board of directors.

(f) NCUA request. The NCUA may, at any time, request the Derivatives management report required by paragraph (c) of this section.

(a) Required experience and competencies. A Federal credit union using Derivative transactions subject to this subpart must internally possess the following experience and competencies:

(1) Board. (i) Before entering into the initial Derivatives transaction, a Federal credit union's board members must receive training that provides a general understanding of Derivative transactions, and the knowledge required to provide strategic oversight of the Federal credit union's Derivatives program.

(ii) Any person that becomes a board member after the initial Derivatives transaction must receive the same training, updated if necessary, as required by paragraph (a)(1)(i) of this section.

(iii) At least annually after the initial Derivatives transaction, as part of the Derivatives reporting requirement in § 703.105(a), the Federal credit union's Senior Executive Officers must brief the board members on the Federal credit union's use of Derivatives to manage Interest Rate Risk.

(2) Senior Executive Officers. A Federal credit union's Senior Executive Officers must be able to understand, approve, and provide oversight for the Derivatives program. These individuals must have a comprehensive understanding of how the Derivative transactions fit into the Federal credit union's Interest Rate Risk management process.

(3) Qualified Derivatives personnel. To engage in the Derivative 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 the transactions subject to this subpart. Staff must also be qualified to understand and undertake or oversee the appropriate modeling and analytics related to Net Economic Value and Earnings at Risk;

(ii) Accounting and financial reporting. Staff must be qualified to understand and oversee appropriate accounting and financial reporting for Derivatives in accordance GAAP;

(iii) Derivatives execution and oversight. Staff must be qualified to undertake or oversee Derivative trade executions; and

(iv) Counterparty, collateral, and Margin management. Staff must be qualified to evaluate Counterparty, collateral, and Margin risk as described in § 703.104 of this subpart.

(b) Required review and internal controls structure. To effectively manage the transactions subject to this subpart, 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 review. Before executing any Derivatives transaction, a Federal credit union must identify and document the circumstances that lead to the decision to execute the Derivatives transaction, specify the strategy the Federal credit union will employ, and demonstrate the economic effectiveness of the transaction;

(2) Internal controls review. Within the first year after commencing its first Derivatives transaction, a Federal credit union must have an internal controls review that is focused on the integration and introduction of the program, and ensure the timely identification of weaknesses in internal controls, accounting, and all operational and oversight processes. This review must be performed by an independent external unit or, if applicable, the Federal credit union's internal auditor;

(3) Financial statement audit. Any Federal credit union engaging in Derivative 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) Collateral management review. Before executing its first Derivative transaction, a Federal credit union must establish a collateral management process that monitors the Federal credit union's collateral and Margining requirements and ensures that its transactions are collateralized in accordance with the collateral requirements of this subpart and the Federal credit union's Master Services Agreement with its Counterparty;

(5) Liquidity review. Before executing its first Derivative transaction, a Federal credit union must establish a liquidity review process to analyze and measure potential liquidity needs related to its Derivatives program and the additional collateral requirements due to changes in interest rates. The Federal credit union must, as part of its liquidity risk management, calculate and track contingent liquidity needs in the event a 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; and

(6) 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 subsection (a)(3) of this section:

(i) Asset/liability risk management;

(ii) Accounting and financial reporting;

(iii) Derivatives execution and oversight; and

(iv) Counterparty, collateral and Margin management.

(c) Policies and procedures. A Federal credit union using Derivatives, permitted under this subpart, must operate according to comprehensive written policies and procedures for control, measurement, and management of Derivative transactions. At a minimum, the policies and procedures must address the requirements of this subpart 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 at least annually and update them when necessary.

(a) General. A Federal credit union using Derivatives may use External Service Providers to support or conduct aspects of its Derivative management program, provided:

(1) The External Service Provider, including affiliates, does not:

(i) Act as a Counterparty to any Derivative transactions that involve the Federal credit union;

(ii) Act as a principal or agent in any Derivative transactions that involve the Federal credit union; or

(iii) Have discretionary authority to execute any of the Federal credit union's Derivative transactions.

(2) The Federal credit union has the internal capacity, experience, and skills to oversee and manage any External Service Providers it uses; and

(3) The Federal credit union documents the specific uses of External Service Providers in its policies and procedures, as described in § 703.106(c) of this subpart.

(b) Relation to § 703.106. This section does not alleviate the responsibility of the Federal credit union to employ qualified staff in accordance with § 703.106 of this subpart.

(a) Notification. A Federal credit union that meets the following requirements must notify the applicable Regional Director in writing or via electronic mail within five business days after entering into its first Derivatives transaction:

(1) The Federal credit union's most recent NCUA Management CAMEL component is a rating of 1 or 2; and

(2) The Federal credit union has assets of at least $500 million as of its most recent call report.

(b) Application. A Federal credit union that does not meet the requirements of paragraphs (a)(1) and/or (2) of this section must obtain approval before engaging in Derivatives under this subpart from its applicable Regional Director, by submitting an application, that, at a minimum, includes the following:

(1) 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;

(2) A list of the Derivatives products and characteristics of such products the Federal credit union is planning to use;

(3) Draft policies and procedures that the Federal credit union has prepared in accordance with § 703.106;

(4) A description of 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, the board of directors, and personnel have the knowledge and experience in accordance with the requirements of this subpart;

(5) 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, as described in § 703.107 of this subpart, it intends to use;

(6) A description of how the Federal credit union will support the operations of Margining and collateral, as described in § 703.104 of this subpart;

(7) A description of how the Federal credit union will comply with the accounting and financial reporting in GAAP; and

(8) Any additional information requested by the Regional Director.

(c) Application review. (1) After the applicable Regional Director has completed his or her review, including any requests for additional information, the Regional Director will notify the Federal credit union in writing of his or her decision. Any denials will include the reason(s) for such denial. A Federal credit union subject to paragraph (b) of this section may not enter into any Derivative transactions under this subpart until it receives approval from the applicable Regional Director. At a Regional Director's discretion, a Federal credit union may reapply if its initial application is denied.

(2) A Federal credit union that receives a denial of its application may appeal such decision in accordance with part 746 of this chapter.

(d) Change in condition—(1) Negative change in condition. A Federal credit union that at any time, experiences a change in negative condition such that it no longer meets the requirements of paragraph (a) of this section or renders its approved application inaccurate must immediately:

(i) Cease entering into any new Derivatives; and

(ii) Notify the applicable Regional Director.

(2) Remedial action for a Federal credit union that experiences a negative change in condition. The applicable Regional Director may take all necessary actions, including, but not limited to, revoking a Federal credit union's authority to engage in Derivatives and/or requiring divesture of current Derivatives. A Federal credit union subject to this paragraph may not enter into new Derivatives unless notified in writing by the applicable Regional Director of its authority to do so.

(3) Positive change in condition for a Federal credit union subject to paragraph (b) of this section. A Federal credit union that is required to submit an application under paragraph (b) of this section that, at any time after approval of such application, meets the requirements of paragraph (a) of this section shall no longer be subject to the requirements included in its approved application, but will continue to be subject to the requirements of this subpart.

(a) Upon determination by the applicable Regional Director, and written notice by the same, a Federal credit union that no longer meets the requirements of this subpart; if applicable, fails to comply with its approved application; or is operating in an unsafe or unsound condition must immediately stop entering into any new Derivative transactions until the Federal credit union is notified by the applicable Regional Director in writing that it is permitted to resume engaging in Derivative transactions under this subpart.

(b) If the applicable Regional Director determines a Federal credit union must take any action under paragraph (a) of this section, he or she will provide the Federal credit union with written notice including the reason(s) for such determination and the remedial actions that are required.

(c) During this period, however, the Federal credit union may terminate existing Derivative transactions. A Regional Director may permit a Federal credit union to enter into offsetting transactions if he or she determines such transactions are part of a corrective action strategy; and

(d) A Federal credit union that receives written notice under this section may appeal such determination in accordance with part 746 of the NCUA's regulations.