Pt. 703 12 CFR Ch. VII (1–1–18 Edition)

under the gross-up approach, a credit union fund’s permissible investments (excluding must apply the risk weight required under derivative contracts that are used for hedg- paragraph (a)(2) of this appendix to the cred- ing rather than speculative purposes and it equivalent amount calculated in para- that do not constitute a material portion of graph (a)(3) of this appendix. the fund’s exposures). (5) Securitization exposure defined. For pur- (4) Alternative modified look-through ap- poses of this this paragraph (a), proach. Under the alternative modified look- ‘‘securitization exposure’’ means: through approach, a credit union may assign (i) A credit exposure that arises from a the credit union’s exposure amount to an in- securitization; or vestment fund on a pro rata basis to dif- (ii) An exposure that directly or indirectly ferent risk weight categories under subpart references a securitization exposure de- A of this part based on the investment limits scribed in paragraph (a)(5)(i) of this appen- in the fund’s prospectus, partnership agree- dix. ment, or similar contract that defines the (6) Securitization defined. For purposes of fund’s permissible investments. The risk- this paragraph (a), ‘‘securitization’’ means a weighted asset amount for the credit union’s transaction in which: exposure to the investment fund equals the (i) The credit risk associated with the un- sum of each portion of the exposure amount derlying exposures has been separated into assigned to an exposure type multiplied by at least two tranches reflecting different lev- the applicable risk weight under subpart A of els of seniority; this part. If the sum of the investment limits (ii) Performance of the securitization expo- for all exposure types within the fund ex- sures depends upon the performance of the ceeds 100 percent, the credit union must as- underlying exposures; and sume that the fund invests to the maximum (iii) All or substantially all of the under- extent permitted under its investment limits lying exposures are financial exposures (such in the exposure type with the highest appli- as loans, receivables, asset-backed securi- cable risk weight under subpart A of this ties, mortgage-backed securities, or other part and continues to make investments in debt securities). order of the exposure type with the next (b) Look-through approaches.—(1) Applica- highest applicable risk weight under subpart bility. Section 702.104(c)(3)(iii)(B) provides A of this part until the maximum total in- that, a credit union may use one of the look- vestment level is reached. If more than one through approaches in this appendix to de- exposure type applies to an exposure, the termine the risk weight of the exposure credit union must use the highest applicable amount of any investment fund, or the hold- risk weight. A credit union may exclude de- ing of separate account insurance. rivative contracts held by the fund that are (2) Full look-through approach. (i) General. A used for hedging rather than for speculative credit union that is able to calculate a risk- purposes and do not constitute a material weighted asset amount for its proportional portion of the fund’s exposures. ownership share of each exposure held by the investment fund may set the risk-weighted EFFECTIVE DATE NOTE: At 80 FR 66722, Oct. asset amount of the credit union’s exposure 29, 2015, appendix A to part 702 was added, ef- to the fund equal to the product of: fective Jan. 1, 2019. (A) The aggregate risk-weighted asset amounts of the exposures held by the fund as if they were held directly by the credit PART 703—INVESTMENT AND union; and DEPOSIT ACTIVITIES (B) The credit union’s proportional owner- ship share of the fund. Subpart A—General Investment and (ii) Holding report. To calculate the risk- Deposit Activities weighted amount under paragraph (b)(2)(i) of this appendix, a credit union should: Sec. (A) Use the most recently issued invest- 703.1 Purpose and scope. ment fund holding report; and 703.2 Definitions. (B) Use an investment fund holding report 703.3 Investment policies. that reflects holding that are not older than 703.4 Recordkeeping and documentation re- 6-months from the quarter-end effective date quirements. (as defined in § 702.101(c)(1). 703.5 Discretionary control over invest- (3) Simple modified look-through approach. ments and investment advisers. Under the simple modified look-through ap- 703.6 Credit analysis. proach, the risk-weighted asset amount for a 703.7 Notice of non-compliant investments. credit union’s exposure to an investment 703.8 Broker-dealers. fund equals the exposure amount multiplied 703.9 Safekeeping of investments. by the highest risk weight that applies to 703.10 Monitoring non-security investments. any exposure the fund is permitted to hold 703.11 Valuing securities. under the prospectus, partnership agree- 703.12 Monitoring securities. ment, or similar agreement that defines the 703.13 Permissible investment activities.

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703.14 Permissible investments. (1) Investment in loans to members 703.15 Prohibited investment activities. and related activities, which is gov- 703.16 Prohibited investments. erned by §§ 701.21, 701.22, 701.23, and part 703.17 Conflicts of interest. 723 of this chapter; 703.18 Grandfathered investments. 703.19 Investment pilot program. (2) The purchase of real estate-se- 703.20 Request for additional authority. cured loans pursuant to Section 107(15)(A) of the Act, which is governed Subpart B—Derivatives Authority by § 701.23 of this chapter, except those real estate-secured loans purchased as 703.100 Purpose and scope. 703.101 Definitions. a part of an investment repurchase 703.102 Permissible derivatives. transaction, which is governed by 703.103 Derivative authority. §§ 703.13 and 703.14 of this chapter; 703.104 Requirements for derivative (3) Investment in credit union service counterparty agreements, collateral and organizations, which is governed by margining. part 712 of this chapter; 703.105 Reporting requirements. (4) Investment in fixed assets, which 703.106 Operational support requirements. is governed by § 701.36 of this chapter; 703.107 External service providers. 703.108 Eligibility. (5) Investment by corporate credit 703.109 Applying for derivatives authority. unions, which is governed by part 704 of 703.110 Application content. this chapter. 703.111 NCUA approval. (6) Investment activity by State- 703.112 Applying for additional products or chartered credit unions, except as pro- characteristics. vided in §§ 741.3(a)(2) and 741.219 of this 703.113 Pilot program participants with ac- chapter; or tive derivatives positions. (7) Funding a Charitable Donation 703.114 Regulatory violation. Account pursuant to § 721.3(b) of this APPENDIX TO SUBPART B OF PART 703—EXAM- chapter. PLES OF DERIVATIVE LIMIT AUTHORITY CALCULATIONS [68 FR 32960, June 3, 2003, as amended at 69 FR 27828, May 17, 2004; 71 FR 76124, Dec. 20, AUTHORITY: 12 U.S.C. 1757(7), 1757(8), 1757(15). 2006; 78 FR 76730, Dec. 19, 2013] SOURCE: 68 FR 32960, June 3, 2003, unless § 703.2 Definitions. otherwise noted. The following definitions apply to this part: Subpart A—General Investment Adjusted trading means selling an in- and Deposit Activities vestment to a counterparty at a price above its current fair value and simul- § 703.1 Purpose and scope. taneously purchasing or committing to (a) This part interprets several of the purchase from the counterparty an- provisions of Sections 107(7), 107(8), and other investment at a price above its 107(15) of the Federal Credit Union Act current fair value. (Act), 12 U.S.C. 1757(7), 1757(8), 1757(15), Associated personnel means a person which list those securities, deposits, engaged in the investment banking or and other obligations in which a Fed- securities business who is directly or eral credit union may invest. Part 703 indirectly controlled by a National As- identifies certain investments and de- sociation of Securities Dealers (NASD) posit activities permissible under the member, whether or not this person is Act and prescribes regulations gov- registered or exempt from registration erning those investments and deposit with NASD. Associated personnel in- activities on the basis of safety and cludes every sole proprietor, partner, soundness concerns. Additionally, part officer, director, or branch manager of 703 identifies and prohibits certain in- any NASD member. vestments and deposit activities. In- Banker’s acceptance means a time vestments and deposit activities that draft that is drawn on and accepted by are permissible under the Act and not a bank and that represents an irrev- prohibited or otherwise regulated by ocable obligation of the bank. part 703 remain permissible for Federal Bank note means a direct, uncondi- credit unions. tional, and unsecured general obliga- (b) This part does not apply to: tion of a bank that ranks equally with

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all other senior unsecured indebtedness European financial options contract of the bank, except deposit liabilities means an option that can be exercised and other obligations that are subject only on its expiration date. to any priorities or preferences. Exchangeable Collateralized Mortgage Borrowing repurchase transaction Obligation means a class of a means a transaction in which the Fed- collateralized mortgage obligation eral credit union agrees to sell a secu- (CMO) that, at the time of purchase, rity to a counterparty and to repur- represents beneficial ownership inter- chase the same or an identical security ests in a combination of two or more from that counterparty at a specified underlying classes of the same CMO future date and at a specified price. structure. The holder of an exchange- Call means an option that gives the able CMO may pay a fee and take deliv- holder the right to buy a specified ery of the underlying classes of the quantity of a security at a specified CMO. price during a fixed time period. Fair value means the price that would Collateralized Mortgage Obligation be received to sell an asset, or paid to (CMO) means a multi-class mortgage transfer a liability, in an orderly trans- related security. action between market participants at Collective investment fund means a the measurement date, as defined by fund maintained by a national bank GAAP. under 12 CFR part 9 (Comptroller of the Financial options contract means an Currency’s regulations). agreement to make or take delivery of a standardized financial instrument Commercial mortgage related security upon demand by the holder of the con- means a mortgage related security, as tract as specified in the agreement. defined below, except that it is Forward sales commitment means an collateralized entirely by commercial agreement to sell an asset at a price real estate, such as a warehouse or of- and future date specified in the agree- fice building, or a multi-family dwell- ment. ing consisting of more than four units. Immediate family member means a means the party on the Counterparty spouse or other family member living other side of the transaction. in the same household. Custodial Agreement means a contract Independent qualified agent means an in which one party agrees to hold secu- agent independent of an investment re- rities in safekeeping for others. purchase counterparty that does not Delivery versus payment means pay- receive a transaction fee from the ment for an investment must occur si- counterparty and has at least two multaneously with its delivery. years experience assessing the value of Derivative means a financial contract mortgage loans. which derives its value from the value Industry-recognized information pro- and performance of some other under- vider means an organization that ob- lying financial instrument or variable, tains compensation by providing infor- such as an index or interest rate. mation to investors and receives no Embedded option means a char- compensation for the purchase or sale acteristic of an investment that gives of investments. the issuer or holder the right to alter Interest rate lock commitment means an the level and timing of the cash flows agreement by a credit union to hold a of the investment. Embedded options certain interest rate and points for a include call and put provisions and in- specified amount of time while a pro- terest rate caps and floors. Since a pre- spective borrower’s application is proc- payment option in a mortgage is a type essed. of call provision, a mortgage-backed Investment means any security, obli- security composed of mortgages that gation, account, deposit, or other item may be prepaid is an example of an in- authorized for purchase by a Federal vestment with an embedded option. credit union under Sections 107(7), Eurodollar deposit means a U.S. dol- 107(8), or 107(15) of the Act, or this part, lar-denominated deposit in a foreign other than loans to members. branch of a United States depository Investment grade means the issuer of a institution. security has an adequate capacity to

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meet the financial commitments under Official means any member of a Fed- the security for the projected life of eral credit union’s board of directors, the asset or exposure, even under ad- credit committee, supervisory com- verse economic conditions. An issuer mittee, or investment-related com- has an adequate capacity to meet fi- mittee. nancial commitments if the risk of de- Ordinary care means the degree of fault by the obligor is low and the full care, which an ordinarily prudent and and timely repayment of principal and competent person engaged in the same interest on the security is expected. A line of business or endeavor should ex- Federal credit union may consider any ercise under similar circumstances. or all of the following factors, to the Pair-off transaction means an invest- extent appropriate, with respect to the ment purchase transaction that is credit risk of a security: Credit closed or sold on, or before the settle- spreads; securities-related research; in- ment date. In a pair-off, an investor ternal or external credit risk assess- commits to purchase an investment, ments; default statistics; inclusion on but then pairs-off the purchase with a an index; priorities and enhancements; sale of the same investment before or price, yield, and/or volume; and asset on the settlement date. class-specific factors. This list of fac- Put means an option that gives the tors is not meant to be exhaustive or holder the right to sell a specified mutually exclusive. quantity of a security at a specified Investment repurchase transaction price during a fixed time period. means a transaction in which an inves- Registered investment company means tor agrees to purchase a security from an investment company that is reg- a counterparty and to resell the same istered with the Securities and Ex- or an identical security to that change Commission under the Invest- counterparty at a specified future date ment Company Act of 1940 (15 U.S.C. and at a specified price. 80a). Examples of registered invest- Maturity means the date the last ment companies are mutual funds and principal amount of a security is sched- unit investment trusts. uled to come due and does not mean Regular way settlement means delivery the call date or the weighted average of a security from a seller to a buyer life of a security. within the time frame that the securi- Mortgage related security means a se- ties industry has established for imme- curity as defined in section 3(a)(41) of diate delivery of that type of security. the Securities Exchange Act of 1934 (15 For example, regular way settlement of U.S.C. 78c(a)(41)). a Treasury security includes settle- Mortgage servicing rights means a con- ment on the trade date (cash), the busi- tractual obligation to perform mort- ness day following the trade date (reg- gage servicing and the right to receive ular way), and the second business day compensation for performing those following the trade date (skip day). services. Mortgage servicing is the ad- Residual interest means the remainder ministration of a mortgage loan, in- cash flows from collateralized mort- cluding collecting monthly payments gage obligations/real estate mortgage and fees, providing recordkeeping and investment conduits (CMOs/REMICs), escrow functions, and, if necessary cur- or other mortgage-backed security ing defaults and foreclosing. transaction, after payments due bond- Negotiable instrument means an in- holders and trust administrative ex- strument that may be freely trans- penses have been satisfied. ferred from the purchaser to another Securities lending means lending a se- person or entity by delivery, or en- curity to a counterparty, either di- dorsement and delivery, with full legal rectly or through an agent, and accept- title becoming vested in the transferee. ing collateral in return. Net worth means the retained earn- Security means a share, participation, ings balance of the credit union at or other interest in property or in an quarter end as determined under gen- enterprise of the issuer or an obliga- erally accepted accounting principles tion of the issuer that: and as further defined in § 702.2(f) of (1) Either is represented by an instru- this chapter. ment issued in bearer or registered

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form or, if not represented by an in- is redeemed at face value on a specified strument, is registered in books main- maturity date. tained to record transfers by or on be- [68 FR 32960, June 3, 2003, as amended at 69 half of the issuer; FR 39831, July 1, 2004; 71 FR 76124, Dec. 20, (2) Is of a type commonly dealt in on 2006; 77 FR 74109, Dec. 13, 2012; 79 FR 5241, securities exchanges or markets or, Jan. 31, 2014] when represented by an instrument, is commonly recognized in any area in § 703.3 Investment policies. which it is issued or dealt in as a me- A Federal credit union’s board of di- dium for investment; and rectors must establish written invest- (3) Either is one of a class or series or ment policies consistent with the Act, by its terms is divisible into a class or this part, and other applicable laws and series of shares, participations, inter- regulations and must review the policy ests, or obligations. at least annually. These policies may be part of a broader, asset-liability Senior management employee means a management policy. Written invest- Federal credit union’s chief executive ment policies must address the fol- officer (typically this individual holds lowing: the title of President or Treasurer/ (a) The purposes and objectives of the Manager), an assistant chief executive Federal credit union’s investment ac- officer, and the chief financial officer. tivities; Small business related security means a (b) The characteristics of the invest- security as defined in section 3(a)(53) of ments the Federal credit union may the securities Exchange Act of 1934 (15 make including the issuer, maturity, U.S.C. 78c(a)(53)). This definition does index, cap, floor, coupon rate, coupon not include Small Business Adminis- formula, call provision, average life, tration securities permissible under and interest rate risk; section 107(7) of the Federal Credit (c) How the Federal credit union will Union Act. manage interest rate risk; Weighted average life means the (d) How the Federal credit union will weighted-average time to the return of manage liquidity risk; a dollar of principal, calculated by (e) How the Federal credit union will multiplying each portion of principal manage credit risk including specifi- received by the time at which it is ex- cally listing institutions, issuers, and pected to be received (based on a rea- counterparties that may be used, or sonable and supportable estimate of criteria for their selection, and limits that time) and then summing and di- on the amounts that may be invested viding by the total amount of prin- with each; cipal. (f) How the Federal credit union will manage concentration risk, which can When-issued trading of securities result from dealing with a single or re- means the buying and selling of securi- lated issuers, lack of geographic dis- ties in the period between the an- tribution, holding obligations with nouncement of an offering and the similar characteristics like maturities issuance and payment date of the secu- and indexes, holding bonds having the rities. same trustee, and holding securitized Yankee dollar deposit means a deposit loans having the same originator, in a United States branch of a foreign packager, or guarantor; bank licensed to do business in the (g) Who has investment authority State in which it is located, or a de- and the extent of that authority. Those posit in a State-chartered, foreign con- with authority must be qualified by trolled bank. education or experience to assess the Zero coupon investment means an in- risk characteristics of investments and vestment that makes no periodic inter- investment transactions. Only officials est payments but instead is sold at a or employees of the Federal credit discount from its face value. The hold- union may be voting members of an in- er of a zero coupon investment realizes vestment-related committee; the rate of return through the gradual (h) The broker-dealers the Federal appreciation of the investment, which credit union may use;

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(i) The safekeepers the Federal credit (d) A Federal credit union must ob- union may use; tain an individual confirmation state- (j) How the Federal credit union will ment from each broker-dealer for each handle an investment that, after pur- investment purchased or sold. chase, is outside of board policy or fails [68 FR 32960, June 3, 2003, as amended at 69 a requirement of this part; and FR 27828, May 17, 2004; 72 FR 30246, May 31, (k) How the Federal credit union will 2007] conduct investment trading activities, if applicable, including addressing: § 703.5 Discretionary control over in- (1) Who has purchase and sale author- vestments and investment advisers. ity; (a) Except as provided in paragraph (2) Limits on trading account size; (b) of this section, a Federal credit (3) Allocation of cash flow to trading union must retain discretionary con- accounts; trol over its purchase and sale of in- (4) Stop loss or sale provisions; vestments. A Federal credit union has (5) Dollar size limitations of specific not delegated discretionary control to types, quantity and maturity to be an investment adviser when the Fed- purchased; eral credit union reviews all rec- (6) Limits on the length of time an ommendations from investment advis- investment may be inventoried in a ers and is required to authorize a rec- trading account; and ommended purchase or sale transaction (7) Internal controls, including seg- before its execution. regation of duties. (b)(1) A Federal credit union may del- egate discretionary control over the § 703.4 Recordkeeping and documenta- purchase and sale of investments to a tion requirements. person other than a Federal credit (a) Federal credit unions with assets union official or employee: of $10,000,000 or greater must comply (i) Provided the person is an invest- with all generally accepted accounting ment adviser registered with the Secu- principles applicable to reports or rities and Exchange Commission under statements required to be filed with the Investment Advisers Act of 1940 (15 NCUA. Federal credit unions with as- U.S.C. 80b); and sets less than $10,000,000 are encouraged (ii) In an amount up to 100 percent of to do the same, but are not required to its net worth in the aggregate at the do so. time of delegation. (b) A Federal credit union must (2) At least annually, the Federal maintain documentation for each in- credit union must adjust the amount of vestment transaction for as long as it funds held under discretionary control holds the investment and until the doc- to comply with the 100 percent of net umentation has been audited in accord- worth cap. The Federal credit union’s ance with § 715.4 of this chapter and ex- board of directors must receive notice amined by NCUA. The documentation as soon as possible, but no later than should include, where applicable, bids the next regularly scheduled board and prices at purchase and sale and for meeting, of the amount exceeding the periodic updates, relevant disclosure net worth cap and notify in writing the documents or a description of the secu- appropriate regional director within 5 rity from an industry-recognized infor- days after the board meeting. The cred- mation provider, financial data, and it union must develop a plan to comply tests and reports required by the Fed- with the cap within a reasonable period eral credit union’s investment policy of time. and this part. (3) Before transacting business with (c) A Federal credit union must an investment adviser, a Federal credit maintain documentation its board of union must analyze his or her back- directors used to approve a broker- ground and information available from dealer or a safekeeper for as long as the State or Federal securities regulators, broker-dealer or safekeeper is approved including any enforcement actions and until the documentation has been against the adviser, associated per- audited in accordance with § 715.4 of sonnel, and the firm for which the ad- this chapter and examined by NCUA. viser works.

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(c) A Federal credit union may not dealer activities are regulated by a compensate an investment adviser with Federal or State regulatory agency. discretionary control over the purchase (b) Before purchasing an investment and sale of investments on a per trans- through a broker-dealer, a Federal action basis or based on capital gains, credit union must analyze and annu- capital appreciation, net income, per- ally update the following: formance relative to an index, or any (1) The background of any sales rep- other incentive basis. resentative with whom the Federal (d) A Federal credit union must ob- credit union is doing business; tain a report from its investment ad- (2) Information available from State viser at least monthly that details the or Federal securities regulators and se- investments under the adviser’s con- curities industry self-regulatory orga- trol and their performance. nizations, such as the National Asso- ciation of Securities Dealers and the § 703.6 Credit analysis. North American Securities Adminis- A Federal credit union must conduct trators Association, about any enforce- and document a credit analysis on an ment actions against the broker-deal- investment and the issuing entity be- er, its affiliates, or associated per- fore purchasing it, except for invest- sonnel; and ments issued or fully guaranteed as to (3) If the broker-dealer is acting as principal and interest by the U.S. gov- the Federal credit union’s ernment or its agencies, enterprises, or counterparty, the ability of the broker- corporations or fully insured (including dealer and its subsidiaries or affiliates accumulated interest) by the National to fulfill commitments, as evidenced Credit Union Administration or the by capital strength, liquidity, and op- Federal Deposit Insurance Corporation. erating results. The Federal credit A Federal credit union must update union should consider current financial this analysis at least annually for as data, annual reports, external assess- long as it holds the investment. ments of creditworthiness, relevant disclosure documents, and other § 703.7 Notice of non-compliant invest- sources of financial information. ments. (c) The requirements of paragraph (a) A Federal credit union’s board of di- of this section do not apply when the rectors must receive notice as soon as Federal credit union purchases a cer- possible, but no later than the next tificate of deposit or share certificate regularly scheduled board meeting, of directly from a bank, credit union, or any investment that either is outside other depository institution. of board policy after purchase or has [68 FR 32960, June 3, 2003, as amended at 69 failed a requirement of this part. The FR 39831, July 1, 2004; 77 FR 74109, Dec. 13, board of directors must document its 2012] action regarding the investment in the minutes of the board meeting, includ- § 703.9 Safekeeping of investments. ing a detailed explanation of any deci- (a) A Federal credit union’s pur- sion not to sell it. The Federal credit chased investments and repurchase col- union must notify in writing the appro- lateral must be in the Federal credit priate regional director of an invest- union’s possession, recorded as owned ment that has failed a requirement of by the Federal credit union through this part within 5 days after the board the Federal Reserve Book-Entry Sys- meeting. tem, or held by a board-approved safekeeper under a written custodial § 703.8 Broker-dealers. agreement that requires the safekeeper (a) A Federal credit union may pur- to exercise, at least, ordinary care. chase and sell investments through a (b) Any safekeeper used by a Federal broker-dealer as long as the broker- credit union must be regulated and su- dealer is registered as a broker-dealer pervised by either the Securities and with the Securities and Exchange Com- Exchange Commission, a Federal or mission under the Securities Exchange State depository institution regulatory Act of 1934 (15 U.S.C. 78a et seq.) or is a agency, or a State trust company regu- depository institution whose broker- latory agency.

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(c) A Federal credit union must ob- new issues purchased at par or at origi- tain and reconcile monthly a state- nal issue discount. ment of purchased investments and re- (b) At least monthly, a Federal credit purchase collateral held in safe- union must determine the fair value of keeping. each security it holds. It may deter- (d) Annually, the Federal credit mine fair value by obtaining a price union must analyze the ability of the quotation on the security from an in- safekeeper to fulfill its custodial re- dustry-recognized information pro- sponsibilities, as evidenced by capital vider, a broker-dealer, or a safekeeper. strength, liquidity, and operating re- (c) At least annually, the Federal sults. The Federal credit union should credit union’s supervisory committee consider current financial data, annual or its external auditor must independ- reports, external assessments of credit- ently assess the reliability of monthly worthiness, relevant disclosure docu- price quotations received from a ments, and other sources of financial broker-dealer or safekeeper. The Fed- information. eral credit union’s supervisory com- [68 FR 32960, June 3, 2003, as amended at 69 mittee or external auditor must follow FR 39831, July 1, 2004; 77 FR 74109, Dec. 13, generally accepted auditing standards, 2012] which require either re-computation or reference to market quotations. § 703.10 Monitoring non-security in- (d) If a Federal credit union is unable vestments. to obtain a price quotation required by (a) At least quarterly, a Federal cred- this section for a particular security, it union must prepare a written report then it may obtain a quotation for a listing all of its shares and deposits in security with substantially similar banks, credit unions, and other deposi- characteristics. tory institutions, that have one or more of the following features: § 703.12 Monitoring securities. (1) Embedded options; (a) At least monthly, a Federal credit (2) Remaining maturities greater union must prepare a written report than 3 years; or (3) Coupon formulas that are related setting forth, for each security held, to more than one index or are inversely the fair value and dollar change since related to, or multiples of, an index. the prior month-end, with summary in- (b) The requirement of paragraph (a) formation for the entire portfolio. of this section does not apply to shares (b) At least quarterly, a Federal cred- and deposits that are securities. it union must prepare a written report (c) If a Federal credit union does not setting forth the sum of the fair values have an investment-related committee, of all fixed and variable rate securities then each member of its board of direc- held that have one or more of the fol- tors must receive a copy of the report lowing features: described in paragraph (a) of this sec- (1) Embedded options; tion. If a Federal credit union has an (2) Remaining maturities greater investment-related committee, then than 3 years; or each member of the committee must (3) Coupon formulas that are related receive a copy of the report, and each to more than one index or are inversely member of the board must receive a related to, or multiples of, an index. summary of the information in the re- (c) Where the amount calculated in port. paragraph (b) of this section is greater than a Federal credit union’s net § 703.11 Valuing securities. worth, the report described in that (a) Before purchasing or selling a se- paragraph must provide a reasonable curity, a Federal credit union must ob- and supportable estimate of the poten- tain either price quotations on the se- tial impact, in percentage and dollar curity from at least two broker-dealers terms, of an immediate and sustained or a price quotation on the security parallel shift in market interest rates from an industry-recognized informa- of plus and minus 300 basis points on: tion provider. This requirement to ob- (1) The fair value of each security in tain price quotations does not apply to the Federal credit union’s portfolio;

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(2) The fair value of the Federal cred- (d) Borrowing repurchase transaction. it union’s portfolio as a whole; and A Federal credit union may enter into (3) The Federal credit union’s net a borrowing repurchase transaction so worth. long as: (d) If the Federal credit union does (1) The transaction meets the re- not have an investment-related com- quirements of paragraph (c) of this sec- mittee, then each member of its board tion; of directors must receive a copy of the (2) Any cash the Federal credit union reports described in paragraphs (a) receives is subject to the borrowing through (c) of this section. If the Fed- limit specified in Section 107(9) of the eral credit union has an investment-re- Act, and any investments the Federal lated committee, then each member of credit union purchases with that cash the committee must receive copies of are permissible for Federal credit the reports, and each member of the unions; and board of directors must receive a sum- (3) The investments referenced in mary of the information in the reports. paragraph (d)(2) of this section must mature under the following conditions: § 703.13 Permissible investment activi- (i) No later than the maturity of the ties. borrowing repurchase transaction; (a) Regular way settlement and delivery (ii) No later than thirty days after versus payment basis. A Federal credit the borrowing repurchase transaction, union may only contract for the pur- unless authorized under § 703.20, pro- chase or sale of a security as long as vided the value of all investments pur- the delivery of the security is by reg- chased with maturities later than bor- ular way settlement and the trans- rowing repurchase transactions does action is accomplished on a delivery not exceed 100 percent of the federal versus payment basis. credit union’s net worth; or (b) Federal funds. A Federal credit (iii) At any time later than the matu- union may sell Federal funds to an in- rity of the borrowing repurchase trans- stitution described in Section 107(8) of action, provided the value of all invest- the Act and credit unions, as long as ments purchased with maturities later the interest or other consideration re- than borrowing repurchase trans- ceived from the financial institution is actions does not exceed 100 percent of at the market rate for Federal funds the federal credit union’s net worth transactions. and the credit union received a com- (c) Investment repurchase transaction. posite CAMEL rating of ‘‘1’’ or ‘‘2’’ for A Federal credit union may enter into the last two (2) full examinations and an investment repurchase transaction maintained a net worth classification so long as: of ‘‘well capitalized’’ under part 702 of (1) Any securities the Federal credit this chapter for the six (6) immediately union receives are permissible invest- preceding quarters or, if subject to a ments for Federal credit unions, the risk-based net worth (RBNW) require- Federal credit union, or its agent, ei- ment under part 702 of this chapter, has ther takes physical possession or con- remained ‘‘well capitalized’’ for the six trol of the repurchase securities or is (6) immediately preceding quarters recorded as owner of them through the after applying the applicable RBNW re- Federal Reserve Book Entry Securities quirement. Transfer System, the Federal credit (e) Securities lending transaction. A union, or its agent, receives a daily as- Federal credit union may enter into a sessment of their market value, includ- securities lending transaction so long ing accrued interest, and the Federal as: credit union maintains adequate mar- (1) The Federal credit union receives gins that reflect a risk assessment of written confirmation of the loan; the securities and the term of the (2) Any collateral the Federal credit transaction; and union receives is a legal investment for (2) The Federal credit union has en- Federal credit unions, the Federal tered into signed contracts with all ap- credit union, or its agent, obtains a proved counterparties. first priority security interest in the

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collateral by taking physical posses- For purposes of this part, the U.S. dol- sion or control of the collateral, or is lar-denominated London Interbank Of- recorded as owner of the collateral fered Rate (LIBOR) is a domestic inter- through the Federal Reserve Book est rate. Entry Securities Transfer System; and (b) Corporate credit union shares or de- the Federal credit union, or its agent, posits. A Federal credit union may pur- receives a daily assessment of the mar- chase shares or deposits in a corporate ket value of the collateral, including credit union, except where the NCUA accrued interest, and maintains ade- Board has notified it that the cor- quate margin that reflects a risk as- porate credit union is not operating in sessment of the collateral and the term compliance with part 704 of this chap- of the loan; ter. A Federal credit union’s aggregate (3) Any cash the Federal credit union amount of perpetual and nonperpetual receives is subject to the borrowing capital, as defined in part 704 of this limit specified in Section 107(9) of the chapter, in one corporate credit union Act, and any investments the Federal is limited to two percent of the federal credit union purchases with that cash credit union’s assets measured at the are permissible for Federal credit time of investment or adjustment. A unions and mature no later than the Federal credit union’s aggregate maturity of the transaction; and amount of contributed capital in all (4) The Federal credit union has exe- corporate credit unions is limited to cuted a written loan and security four percent of assets measured at the agreement with the borrower. time of investment or adjustment. (f)(1) Trading securities. A Federal (c) Registered investment company. A credit union may trade securities, in- Federal credit union may invest in a cluding engaging in when-issued trad- registered investment company or col- ing and pair-off transactions, so long as lective investment fund, as long as the the Federal credit union can show that prospectus of the company or fund re- it has sufficient resources, knowledge, stricts the investment portfolio to in- systems, and procedures to handle the vestments and investment transactions risks. that are permissible for Federal credit (2) A Federal credit union must unions. record any security it purchases or (d) Collateralized mortgage obligation/ sells for trading purposes at fair value real estate mortgage investment conduit. on the trade date. The trade date is the A Federal credit union may invest in a date the Federal credit union commits, fixed or variable rate collateralized orally or in writing, to purchase or sell mortgage obligation/real estate mort- a security. gage investment conduit. (3) At least monthly, the Federal (e) Municipal security. A Federal cred- credit union must give its board of di- it union may purchase and hold a mu- rectors or investment-related com- nicipal security, as defined in section mittee a written report listing all pur- 107(7)(K) of the Act, only if it conducts chase and sale transactions of trading and documents an analysis that rea- securities and the resulting gain or loss sonably concludes the security is at on an individual basis. least investment grade. The Federal [68 FR 32960, June 3, 2003, as amended at 77 credit union must also limit its aggre- FR 31991, May 31, 2012] gate municipal securities holdings to no more than 75 percent of the Federal § 703.14 Permissible investments. credit union’s net worth and limit its (a) Variable rate investment. A federal holdings of municipal securities issued credit union may invest in a variable by any single issuer to no more than 25 rate investment, as long as the index is percent of the Federal credit union’s tied to domestic interest rates. Except net worth. in the case of Treasury Inflation Pro- (f) Instruments issued by institutions tected Securities, the variable rate in- described in Section 107(8) of the Act. A vestment cannot, for example, be tied Federal credit union may invest in the to foreign currencies, foreign interest following instruments issued by an in- rates, domestic or foreign commodity stitution described in Section 107(8) of prices, equity prices, or inflation rates. the Act:

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(1) Yankee dollar deposits; option unless the certificate is re- (2) Eurodollar deposits; deemed prior to maturity; and (3) Banker’s acceptances; (13) The Federal credit union pro- (4) Deposit notes; and vides its board of directors with a (5) Bank notes with weighted average monthly report detailing at a min- maturities of less than 5 years. imum: (g) European financial options contract. (i) The dollar amount of outstanding A Federal credit union may purchase a equity-linked share certificates; European financial options contract or (ii) Their maturities; and a series of European financial options (iii) The fair value of the options as contracts only to fund the payment of determined by an independent third dividends on member share certificates party. where the dividend rate is tied to an (h) Mortgage note repurchase trans- equity index provided: actions. A federal credit union may in- (1) The option and dividend rate are vest in securities that are offered and based on a domestic equity index; sold pursuant to section 4(5) of the Se- (2) Proceeds from the options are curities Act of 1933, 15 U.S.C. 77d(5), used only to fund dividends on the eq- only as a part of an investment repur- uity-linked share certificates; chase agreement under § 703.13(c), sub- (3) Dividends on the share certifi- ject to the following conditions: cates are derived solely from the (1) The aggregate of the investments change in the domestic equity index with any one counterparty is limited over a specified period; to 25 percent of the Federal credit (4) The options’ expiration dates are union’s net worth and 50 percent of its no later than the maturity date of the net worth with all counterparties; share certificate. (2) At the time the Federal credit (5) The certificate may be redeemed union purchases the securities, the prior to the maturity date only upon counterparty, or a party fully guaran- the member’s death or termination of teeing the counterparty, must meet the corresponding option; the minimum credit quality standards (6) The total costs associated with as approved by the Federal credit the purchase of the option is known by union’s board of directors. the Federal credit union prior to ef- (3) The federal credit union must ob- fecting the transaction; tain a daily assessment of the market (7) The options are purchased at the value of the securities under same time the certificate is issued to § 703.13(c)(1) using an independent the member. qualified agent; (8) The counterparty to the trans- (4) The mortgage note repurchase action is a domestic counterparty and transaction is limited to a maximum has been approved by the Federal cred- term of 90 days; it union’s board of directors; (5) All mortgage note repurchase (9) The counterparty to the trans- transactions will be conducted under action meets the minimum credit qual- tri-party custodial agreements; and ity standards as approved by the Fed- (6) A federal credit union must obtain eral credit union’s board of directors. an undivided interest in the securities. (10) Any collateral posted by the (i) Zero-coupon investments. A federal counterparty is a permissible invest- credit union may only purchase a zero- ment for Federal credit unions and is coupon investment with a maturity valued daily by an independent third date that is no greater than 10 years party along with the value of the op- from the related settlement date, un- tion; less authorized under § 703.20 or other- (11) The aggregate amount of equity- wise provided in this paragraph. A fed- linked member share certificates does eral credit union that received a com- not exceed 50 percent of the Federal posite CAMEL rating of ‘‘1’’ or ‘‘2’’ for credit union’s net worth; the last two (2) full examinations and (12) The terms of the share certificate maintained a net worth classification include a guarantee that there can be of ‘‘well capitalized’’ under part 702 of no loss of principal to the member re- this chapter for the six (6) immediately gardless of changes in the value of the preceding quarters or, if subject to a

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risk-based net worth (RBNW) require- principles (GAAP) adopted in the ment under part 702 of this chapter, has United States to be accounted for sepa- remained ‘‘well capitalized’’ for the six rately from the host contract; and (6) immediately preceding quarters (3) Interest rate lock commitments after applying the applicable RBNW re- or forward sales commitments made in quirement, may purchase a zero-cou- connection with a loan originated by a pon investment with a maturity date Federal credit union. that is no greater than 30 years from the related settlement date. [68 FR 32960, June 3, 2003, as amended at 69 FR 39831, July 1, 2004; 71 FR 76124, Dec. 20, (j) Commercial mortgage related security 2006; 75 FR 64826, Oct. 20, 2010; 77 FR 31991, (CMRS). A federal credit union may May 31, 2012; 77 FR 74110, Dec. 13, 2012; 78 FR purchase a CMRS permitted by Section 13213 Feb. 27, 2013; 79 FR 5241, Jan. 31, 2014; 81 107(7)(E) of the Act; and, pursuant to FR 17602, Mar. 30, 2016] Section 107(15)(B) of the Act, a CMRS EFFECTIVE DATE NOTE: At 80 FR 66722, Oct. of an issuer other than a government- 29, 2015, § 703.14 was amended by: 1. in para- sponsored enterprise enumerated in graph (i), removing the words ‘‘net worth Section 107(7)(E) of the Act, provided: classification’’ and adding in their place the (1) The Federal credit union conducts words ‘‘capital classification’’, and removing and documents a credit analysis that the words ‘‘or, if subject to a risk-based net reasonably concludes the CMRS is at worth (RBNW) requirement under part 702 of least investment grade. this chapter, has remained ’well capitalized’ (2) The CMRS meets the definition of for the six (6) immediately preceding quar- ters after applying the applicable RBNW re- mortgage related security as defined in quirement,’’, and 2. in paragraph (j)(4), re- 15 U.S.C. 78c(a)(41) and the definition of moving the words ‘‘net worth classification’’ commercial mortgage related security and adding in their place the words ‘‘capital as defined in § 703.2 of this part; classification’’, and removing the words ‘‘or, (3) The CMRS’s underlying pool of if subject to a risk-based net worth (RBNW) loans contains more than 50 loans with requirement under part 702 of this chapter, no one loan representing more than 10 has remained ’well capitalized’ for the six (6) percent of the pool; and immediately preceding quarters after apply- ing the applicable RBNW requirement,’’, ef- (4) The aggregate amount of private fective Jan. 1, 2019. label CMRS purchased by the federal credit union does not exceed 25 percent § 703.15 Prohibited investment activi- of its net worth, unless authorized ties. under § 703.20 or as otherwise provided A Fed- in this subparagraph. A federal credit Adjusted trading or short sales. eral credit union may not engage in ad- union that has received a composite justed trading or short sales. CAMEL rating of ‘‘1’’ or ‘‘2’’ for the last two (2) full examinations and § 703.16 Prohibited investments. maintained a net worth classification of ‘‘well capitalized’’ under part 702 of (a) Mortgage servicing rights. A Fed- this chapter for the six (6) immediately eral credit union may not purchase preceding quarters or, if subject to a mortgage servicing rights as an invest- risk-based net worth (RBNW) require- ment but may perform mortgage serv- ment under part 702 of this chapter, has icing functions as a financial service remained ‘‘well capitalized’’ for the six for a member as long as the mortgage (6) immediately preceding quarters loan is owned by a member; after applying the applicable RBNW re- (b) Stripped mortgage backed securities quirement, may hold private label (SMBS). A Federal credit union may CMRS in an aggregate amount not to not invest in SMBS or securities that exceed 50% of its net worth. represent interests in SMBS except as (k) Derivatives. A Federal credit described in paragraphs (1) and (3) union may only enter into in the fol- below. lowing derivatives transactions: (1) A Federal credit union may invest (1) Any derivatives permitted under in and hold exchangeable collateralized § 701.21(i) of this chapter, § 703.14(g), or mortgage obligations (exchangeable subpart B of this part; CMOs) representing beneficial owner- (2) Embedded options not required ship interests in one or more interest- under generally accepted accounting only classes of a CMO (IO CMOs) or

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principal-only classes of a CMO (PO to any other employee, such as an in- CMOs), but only if: vestment officer, if the employee is di- (i) At the time of purchase, the ratio rectly involved in investments, unless of the market price to the remaining the Federal credit union’s board of di- principal balance is between .8 and 1.2, rectors determines that the employee’s meaning that the discount or premium involvement does not present a conflict of the market price to par must be less of interest. This prohibition does not than 20 points; include compensation for employees. (ii) The offering circular or other of- (b) A Federal credit union’s officials ficial information available at the time and employees must conduct all trans- of purchase indicates that the notional actions with business associates or principal on each underlying IO CMO family members that are not specifi- should decline at the same rate as the cally prohibited by paragraph (a) of principal on one or more of the under- this section at arm’s length and in the lying non-IO CMOs, and that the prin- Federal credit union’s best interest. cipal on each underlying PO CMO should decline at the same rate as the § 703.18 Grandfathered investments. principal, or notional principal, on one (a) Subject to safety and soundness or more of the underlying non-PO considerations, a Federal credit union CMOs; and may hold a CMO/REMIC residual, (iii) The credit union staff has the ex- stripped mortgage-backed securities, pertise dealing with exchangeable or zero coupon security with a matu- CMOs to apply the conditions in para- rity greater than 10 years, if it pur- graphs (e)(1)(i) and (e)(1)(ii) of this sec- chased the investment: tion. (1) Before December 2, 1991; or (2) A Federal credit union that in- (2) On or after December 2, 1991, but vests in an exchangeable CMO may ex- before January 1, 1998, if for the pur- ercise the exchange option only if all of pose of reducing interest rate risk and the underlying CMOs are permissible if the Federal credit union meets the investments for that credit union. following: (3) A Federal credit union may accept (i) The Federal credit union has a an exchangeable CMO representing monitoring and reporting system in beneficial ownership interests in one or place that provides the documentation more IO CMOs or PO CMOs as an asset necessary to evaluate the expected and associated with an investment repur- actual performance of the investment chase transaction or as collateral in a under different interest rate scenarios; securities lending transaction. When (ii) The Federal credit union uses the the exchangeable CMO is associated monitoring and reporting system to with one of these two transactions, it conduct and document an analysis that need not conform to the conditions in shows, before purchase, that the pro- paragraphs (e)(1)(i) and (ii) of this sec- posed investment will reduce its inter- tion. est rate risk; (c) Other prohibited investments. A (iii) After purchase, the Federal cred- Federal credit union may not purchase it union evaluates the investment at residual interests in collateralized least quarterly to determine whether mortgage obligations, real estate mort- or not it actually has reduced the in- gage investment conduits, or small terest rate risk; and business related securities. (iv) The Federal credit union ac- [68 FR 32960, June 3, 2003, as amended at 69 counts for the investment consistent FR 39832, July 1, 2004; 77 FR 31991, May 31, with generally accepted accounting 2012; 79 FR 5241, Jan. 31, 2014] principles. (b) A federal credit union may hold a § 703.17 Conflicts of interest. zero-coupon investment with a matu- (a) A Federal credit union’s officials rity greater than 10 years, a borrowing and senior management employees, and repurchase transaction in which the in- their immediate family members, may vestment matures at any time later not receive anything of value in con- than the maturity of the borrowing, or nection with its investment trans- CMRS that cause the credit union’s ag- actions. This prohibition also applies gregate amount of CMRS from issuers

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other than government-sponsored en- (c) A third-party seeking approval of terprises to exceed 25% of its net an investment pilot program must sub- worth, in each case if it purchased the mit a request to the Director of the Of- investment or entered the transaction fice of Capital Markets and Planning under the Regulatory Flexibility Pro- that addresses the following items: gram before July 2, 2012. (1) A complete description of the ac- (c) All grandfathered investments are tivities with specific examples of how a subject to the valuation and moni- credit union will conduct and account toring requirements of §§ 703.10, 703.11, for them, and how they will benefit a and 703.12 of this part. Federal credit union; (2) A description of any risks to a [68 FR 32960, June 3, 2003, as amended at 77 Federal credit union from partici- FR 31991, May 31, 2012] pating in the program; and § 703.19 Investment pilot program. (3) Contracts that must be executed by the Federal credit union. (a) Under the investment pilot pro- (d) A Federal credit union need not gram, NCUA will permit a limited obtain individual written approval to number of Federal credit unions to en- engage in investment activities prohib- gage in investment activities prohib- ited by this part but permitted by stat- ited by this part but permitted by the ute where the activities are part of a Act. third-party investment program that (b) Except as provided in paragraph NCUA has approved under this section. (c) of this section, before a Federal credit union may engage in additional [68 FR 32960, June 3, 2003, as amended at 69 activities it must obtain written ap- FR 39832, July 1, 2004; 70 FR 55517, Sept. 22, 2005] proval from NCUA. To obtain approval, a Federal credit union must submit a § 703.20 Request for additional author- request to its regional director that ad- ity. dresses the following items: (a) Additional authority. A federal (1) Certification that the Federal credit union may submit a written re- credit union is ‘‘well-capitalized’’ quest to its regional director seeking under part 702 of this chapter; expanded authority above the following (2) Board policies approving the ac- limits in this part: tivities and establishing limits on (1) Borrowing repurchase transaction them; maximum maturity mismatch of 30 (3) A complete description of the ac- days under § 703.13(d)(3)(ii). tivities, with specific examples of how (2) Zero-coupon investment 10-year they will benefit the Federal credit maximum maturity under § 703.14(i), up union and how they will be conducted; to a maturity of no more than 30 years. (4) A demonstration of how the ac- (3) CMRS aggregate limit of 25% of tivities will affect the Federal credit net worth under § 703.14(j), up to no union’s financial performance, risk more than 50% of net worth. To obtain profile, and asset-liability management approval for additional authority, the strategies; federal credit union must demonstrate (5) Examples of reports the Federal three consecutive years of effective credit union will generate to monitor CMRS portfolio management and the the activities; ability to evaluate key risk factors. (6) Projections of the associated costs (b) Written request. A federal credit of the activities, including personnel, union desiring additional authority computer, audit, and so forth; must submit a written request to the (7) Descriptions of the internal sys- NCUA regional office having jurisdic- tems that will measure, monitor, and tion over the geographical area in report the activities; which the credit union’s main office is (8) Qualifications of the staff and of- located, that includes the following: ficials responsible for implementing (1) A copy of the credit union’s in- and overseeing the activities; and vestment policy; (9) Internal control procedures that (2) The higher limit sought; will be implemented, including audit (3) An explanation of the need for ad- requirements. ditional authority;

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(4) Documentation supporting the provided in § 741.219, this rule does not credit union’s ability to manage the in- apply to federally insured, state-char- vestment or activity; and tered credit unions. (5) An analysis of the credit union’s (2) Mutual funds. This subpart does prior experience with the investment not permit a Federal credit union to or activity. invest in registered investment compa- (c) Approval process. A regional direc- nies or collective investment funds tor will provide a written determina- under § 703.14(c) of this part, where the tion on a request for expanded author- prospectus of the company or fund per- ity within 60 calendar days after re- mit the investment portfolio to con- ceipt of the request; however, the 60- tain derivatives. day period will not begin until the re- questing credit union has submitted all § 703.101 Definitions. necessary information to the regional For purposes of this subpart: director. The regional director will in- Amortizing notional amount means a form the requesting credit union, in characteristic of a derivative, in which writing, of the date the request was re- the notional amount declines on a pre- ceived and of any additional docu- determined fixed basis over the term of mentation that the regional director the contract, according to an amortiza- requires in support of the request. If tion schedule to which the parties the regional director approves the re- agree when executing the contract; quest, the regional director will estab- Basis swap means an agreement be- lish a limit on the investment or activ- tween two parties in which the parties ity as appropriate and subject to the make periodic payments to each other limitations in this part. If the regional based on floating rate indices multi- director does not notify the credit plied by a notional amount; union of the action taken on its re- Cleared swap has the meaning as de- quest within 60 calendar days of the re- fined by the Commodity Futures Trad- ceipt of the request or the receipt of ing Commission in 17 CFR 22.1; additional requested supporting infor- Counterparty means a swap dealer, de- mation, whichever occurs later, the rivatives clearing organization, or ex- credit union may proceed with its pro- change that participates as the other posed investment or investment activ- party in a derivatives transaction with ity. a Federal credit union; (d) Appeal to NCUA Board. A Federal Credit support annex means the terms credit union may request the regional or rules under which collateral is post- director to reconsider any part of the ed or transferred between a Federal determination made under paragraph credit union and a counterparty to (c) of this section and/or file an appeal mitigate credit risk that may result with the NCUA Board in accordance from changes in the fair value of de- with the procedures set forth in sub- rivatives positions; part B to part 746 of this chapter. Derivative means a financial contract which derives its value from the value [77 FR 31991, May 31, 2012, as amended at 82 and performance of some other under- FR 50293, Oct. 30, 2017] lying financial instrument or variable, such as an index or interest rate; Subpart B—Derivatives Authority Derivatives clearing organization has the meaning as defined by the Com- SOURCE: 79 FR 5241, Jan. 31, 2014, unless modity Futures Trading Commission in otherwise noted. 17 CFR 1.3(d); Economic effectiveness means the ex- § 703.100 Purpose and scope. tent to which a derivatives transaction (a) Purpose. This subpart allows Fed- results in offsetting changes in the in- eral credit unions to enter into certain terest rate risk that the transaction derivatives transactions exclusively for was, and is, intended to provide; the purpose of reducing interest rate Exchange means a central financial risk exposure. clearing market where end users can (b) Scope. (1) This subpart applies to trade futures, as defined in this section all Federal credit unions. Except as of this subpart;

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External service provider means any Association (ISDA) standard contracts entity that provides services to assist a since 1998; Federal credit union in carrying out its Leveraged derivative means a deriva- derivatives program and the require- tive where the value of the transaction ments of this subpart; does not change in a one to one propor- Fair value has the meaning specified tion with the contractual rate or index; in § 703.2 of subpart A of this part; (x) Margin means the minimum Field director means an NCUA Re- amount of funds that must be depos- gional Director or the Director of the ited between parties to a derivatives Office of National Examinations and transaction, as detailed in a credit sup- Supervision; port annex or clearing arrangement; Forward start date means an agree- Master service agreement means a doc- ment that delays the settlement date ument agreed upon between two par- of a derivatives transaction for a speci- ties that sets out standard terms that fied period of time; apply to all derivatives transactions Futures means a U.S. Treasury note entered into between those parties. financial contract that obligates the Each time the same two parties enter buyer to take delivery of Treasury into a transaction, the terms of the notes (or the seller to deliver Treasury master service agreement apply auto- notes) at a predetermined future date matically and do not need to be re-ne- and price. Futures contracts are stand- gotiated. The most common form of a ardized to facilitate trading on an ex- master service agreement is a master change; ISDA agreement; Minimum transfer amount means the Futures commission merchant (FCM) minimum amount of collateral that a has the meaning as defined by the party to a derivatives transaction will Commodity Futures Trading Commis- require, per transfer, to cover exposure sion in 17 CFR 1.3(p); in excess of the collateral threshold; Hedge means to enter into a deriva- Net economic value means the eco- tives transaction to mitigate interest nomic value of assets minus the eco- rate risk; nomic value of liabilities; Interest rate cap means a contract, Net worth has the meaning specified based on a reference interest rate, for in § 702.2 of this chapter; payment to the purchaser when the ref- Non-cleared means transactions that erence interest rate rises above the do not go through a derivatives clear- level specified in the contract; ing organization; Interest rate floor means a contract, Notional amount means the con- based on a reference interest rate, for tracted amount of a derivatives con- payment to the purchaser when the ref- tract for swaps and options on which erence interest rate falls below the interest payments or other payments level specified in the contract; are based. For futures contracts, the Interest rate risk means the vulner- notional amount is represented by the ability of a Federal credit union’s earn- contract size; ings or economic value to movements Novation means the substitution of in market interest rates; an old obligation with a new one that Interest rate swap means an agree- either replaces an existing obligation ment to exchange future payments of with a new obligation or replaces an interest on a notional amount at spe- original party with a new party; cific times and for a specified time pe- Reference interest rate means the riod; index or rate to be used as the variable Introducing broker means a futures rate for resetting derivatives trans- brokerage firm that deals directly with actions; the client, while the trade execution is Reporting date means the end of the done by a futures commission mer- business day on the date used to report chant; positions and fair values for limit com- ISDA protocol means a multilateral pliance (e.g., daily, month-end, quar- contractual amendment mechanism ter-end and fiscal year-end); that has been used to address changes Senior executive officer has the mean- to International Swap and Derivatives ing specified in § 701.14 of this chapter

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and any other similar employee that is more than 90 days from the trade date; directly within the chain of command and for the oversight of a Federal credit (ii) Do not have fluctuating notional union’s derivatives program, as identi- amounts, unless the Federal credit fied in a Federal credit union’s process union is approved to use derivatives and responsibility framework, as dis- with amortizing notional amounts. cussed in § 703.106(b)(1) of this subpart; (3) Purchased interest rate caps with Structured liability offering means a no fluctuating notional amounts, un- share product created by a Federal less the Federal credit union is ap- credit union with contractual option proved to use derivatives with amor- features, such as periodic caps and tizing notional amounts. calls, similar to those found in struc- (4) Purchased interest rate floors tured securities or structured notes; with no fluctuating notional amounts, Swap dealer has the meaning as de- unless the Federal credit union is ap- fined by the Commodity Futures Trad- proved to use derivatives with amor- ing Commission in 17 CFR 1.3(ggg); tizing notional amounts. Swap execution facility means a Com- (5) U.S. Treasury note futures (2-, 3-, modities and Futures Trading Commis- 5-, and 10-year contracts). sion-registered facility that provides a (b) Overall program characteristics. A system or platform for participants to Federal credit union may only enter execute cleared derivatives trans- into derivatives, as identified and de- actions; scribed in paragraph (a) of this section, Threshold amount means an unsecured that have the following characteristics: credit exposure that a party to a de- (1) Not leveraged; rivatives transaction is prepared to ac- (2) Based on domestic rates, as de- cept before requesting additional col- fined in § 703.14(a) of subpart A of this lateral from the other party; part; (3) Denominated in U.S. dollars; Trade date means the date that a de- (4) Except as provided in § 703.14(g) of rivatives order (new transactions, ter- subpart A of this part, not used to cre- minations, or assignments) is executed ate structured liability offerings for in the market; and members or nonmembers; Unamortized premium means the bal- (5) Have contract maturity terms of ance of the upfront premium payment equal to or less than 15 years, at the that has not been amortized. trade date; and § 703.102 Permissible derivatives. (6) Meet the definition of a derivative under GAAP. (a) Products and characteristics. A Fed- eral credit union with derivatives au- § 703.103 Derivative authority. thority may apply to use each of the (a) General authority. A Federal credit following products and characteristics, union that is approved for derivatives subject to the limits in § 703.103 of this authority under § 703.111 of this subpart subpart: may use any of the products and char- (1) Interest rate swaps with the fol- acteristics, described in § 703.102(a), lowing characteristics: subject to the following limits, which (i) Settle within three business days, are described in more detail in appen- unless the Federal credit union is ap- dix A to this subpart: proved for a forward start date of no (1) Entry limits authority. Unless a more than 90 days from the trade date; Federal credit union is permitted to and use standard limits authority under (ii) Do not have fluctuating notional this subpart, the aggregate fair value amounts, unless the Federal credit loss (as defined in appendix A) on all of union is approved to use derivatives a Federal credit union’s derivatives po- with amortizing notional amounts. sitions may not exceed 15 percent of (2) Basis swaps with the following net worth, and a Federal credit union’s characteristics: weighted average remaining maturity (i) Settle within three business days, notional (as defined in appendix A), unless the Federal credit union is ap- may not exceed 65 percent of net proved for a forward start date of no worth.

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(2) Standard limits authority. A Fed- (iii) Comply with the margining re- eral credit union that is permitted to quirements required by the futures use standard limits authority may not commission merchant. exceed an aggregate fair value loss on (2) Non-cleared derivative transactions. all of the Federal credit union’s deriva- A Federal credit union with derivatives tives positions of 25 percent of net that are non-cleared must: worth, and a weighted average remain- (i) Have a master service agreement ing maturity notional of 100 percent of and credit support annex with a reg- net worth, provided: istered swap dealer that are in accord- (i) The Federal credit union has en- ance with ISDA protocol for standard gaged in derivatives at the entry limits bilateral agreements; authority for a continuous period of (ii) Utilize margining requirements one year (beginning on the trade date contracted through a credit support of its first derivatives transaction); and annex and have a minimum transfer (ii) The Federal credit union has not amount of $250,000 for daily margining been notified in writing by NCUA of requirements; and any relevant safety and soundness con- (iii) Accept as collateral, for margin cerns while engaged in derivatives at requirements, only cash (U.S. dollars), the entry limits authority. U.S. Treasuries, government-sponsored enterprise debt, and government-spon- (b) Limit description—(1) Fair value sored enterprise residential mortgage- limit. The fair value limit is calculated backed security pass-through securi- by aggregating the fair values for all ties. derivatives positions at the reporting (b) Counterparty, collateral, and mar- date. If an aggregate loss exists, it gining management. A Federal credit must be less than the limit set forth in union must: this subpart. A further description of (1) Have systems in place to effec- this limit and example calculations are tively manage collateral and mar- detailed in appendix A to this subpart. gining requirements; (2) Weighted average remaining matu- (2) Have a collateral management rity notional limit. The weighted average process that monitors the Federal cred- remaining maturity notional limit is it union’s collateral and margining re- calculated by aggregating the notional quirements daily and ensures that its amount for all derivatives positions derivatives positions are collateralized based on each derivative’s pricing sen- at all times and in accordance with the sitivity and maturity. A further de- collateral requirements of this subpart scription of this limit and example cal- and the Federal credit union’s agree- culations are detailed in appendix A to ment with its counterparty. This in- this subpart. cludes the posting, tracking, valuation, and reporting of collateral using fair § 703.104 Requirements for derivative value; and counterparty agreements, collateral and margining. (3) Analyze and measure potential li- quidity needs related to its derivatives (a) A Federal credit union may have program and stemming from additional exchange-traded, centrally cleared, or collateral requirements due to changes non-cleared derivatives, in accordance in interest rates. The Federal credit with the following: union must calculate and track contin- (1) Exchange-traded and cleared deriva- gent liquidity needs in the event a de- tives. A Federal credit union with de- rivatives transaction needs to be rivatives that are exchange-traded or novated or terminated, and must estab- centrally cleared must: lish effective controls for liquidity ex- (i) Comply with the Commodity Fu- posures arising from both market or tures Trading Commission’s rules; product liquidity and instrument cash (ii) Use only swap dealers, intro- flows. ducing brokers, and/or futures commis- sion merchants that are current reg- § 703.105 Reporting requirements. istrants of the Commodity Futures (a) Board reporting. At least quar- Trading Commission; and terly, a Federal credit union’s senior

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executive officers must deliver a com- of derivatives and the knowledge re- prehensive derivatives report to the quired to provide strategic oversight of Federal credit union’s board of direc- the Federal credit union’s derivatives tors. The report may be delivered sepa- program. This requirement includes rately or as part of the standard funds understanding how derivatives fit into management or asset/liability report. the Federal credit union’s business (b) Senior executive officer and asset li- model and risk management process. ability committee. At least monthly, The Federal credit union must main- Federal credit union staff must deliver tain evidence of this training, in ac- a comprehensive derivatives report to cordance with its document retention the Federal credit union’s senior execu- policy, until its next NCUA examina- tive officers and, if applicable, the Fed- tion. eral credit union’s asset liability com- (2) Senior executive officers. A Federal mittee. credit union’s senior executive officers (c) Comprehensive derivatives report. At must be able to understand, approve, a minimum, the reports required in and provide oversight for the deriva- paragraphs (a) and (b) of this section tives activities. These individuals must must include: have a comprehensive understanding of (1) Identification of any areas of non- how derivatives fit into the Federal compliance with any provision of this credit union’s business model and risk subpart or the Federal credit union’s management process. policies; (3) Qualified derivatives personnel. To (2) Utilization of the limits in engage in derivatives transactions, a § 703.103 and any additional limits in Federal credit union must employ staff the Federal credit union’s policies; with experience in the following areas: (3) An itemization of the Federal (i) Asset/liability risk management. credit union’s individual positions and Staff must be qualified to understand aggregate current fair values, and a and oversee asset/liability risk man- comparison with the Federal credit agement, including the appropriate union’s fair value loss and notional role of derivatives. This requirement limit authority, as described in appen- includes identifying and assessing risk dix A to this subpart; in transactions, developing asset/liabil- (4) A comprehensive view of the Fed- ity risk management strategies, test- eral credit union’s statement of finan- ing the effectiveness of asset/liability cial condition, including, but not lim- risk management, determining the ef- ited to, net economic value calcula- fectiveness of managing interest rate tions for the Federal credit union’s risk under a range of stressed rates and statement of financial condition done statement of financial condition sce- with derivatives included and excluded; narios, and evaluating the relative ef- (5) An evaluation of the effectiveness fectiveness of alternative strategies. of the derivatives transactions in miti- Staff must also be qualified to under- gating interest rate risk; and stand and undertake or oversee the ap- (6) An evaluation of effectiveness of propriate modeling and analytics re- the hedge relationship and reporting lated to scope of risk to earnings and for derivatives in compliance with economic value over the expected ma- GAAP. turity of derivatives positions; (ii) Accounting and financial reporting. § 703.106 Operational support require- Staff must be qualified to understand ments. and oversee appropriate accounting (a) Required experience and com- and financial reporting for derivatives petencies. A Federal credit union oper- transactions in accordance with GAAP; ating with derivatives authority must (iii) Derivatives execution and over- internally possess the following experi- sight. Staff must be qualified to under- ence and competencies: take or oversee trade executions; and (1) Board. Before entering into any (iv) Counterparty, collateral, and mar- derivatives transactions, and annually gining management. Staff must be quali- thereafter, a Federal credit union’s fied to evaluate counterparty, collat- board members must receive training eral, and margining risk as described in that provides a general understanding § 703.104 of this subpart.

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(b) Required management and internal (ii) Accounting and financial report- controls structure. To effectively man- ing; age its derivatives activities, a Federal (iii) Derivatives execution and over- credit union must assess the effective- sight; and ness of its management and internal (iv) Collateral, counterparty, and controls structure. At a minimum, the margining management. internal controls structure must in- (c) Legal review. A Federal credit clude: union with derivatives authority must (1) Transaction support. Before exe- hire or engage legal counsel to reason- cuting any derivatives transaction, a ably ensure that all derivatives con- Federal credit union must identify and tracts adequately protect the legal and document the circumstances that lead business interests of the Federal credit to the decision to hedge, specify the de- union. The Federal credit union’s coun- rivatives strategy the Federal credit sel must have legal expertise with de- union will employ, and demonstrate rivatives contracts and related mat- the economic effectiveness of the ters. hedge; (d) Policies and procedures. A Federal (2) Internal controls review. For the credit union with derivatives authority first two years after commencing its must operate according to comprehen- derivatives program, a Federal credit sive written policies and procedures for union must have an internal controls control, measurement, and manage- review that is focused on the integra- ment of derivatives transactions. At a tion and introduction of derivatives minimum, the policies and procedures functions. This review must be per- must address the requirements of this formed by an independent external unit subpart, except for those in §§ 703.108 or, if applicable, the Federal credit through 703.114, and any additional union’s internal auditor. The review limitations imposed by the Federal must ensure the timely identification credit union’s board of directors. A of weaknesses in internal controls, Federal credit union’s board of direc- modeling methodologies, risk, and all tors must review the policies and pro- operational and oversight processes; cedures described in this section annu- (3) Financial statement audit. Any Fed- ally and update them when necessary. eral credit union engaging in deriva- tives transactions pursuant to this sub- § 703.107 External service providers. part must obtain an annual financial statement audit, as defined in § 715.2(d) (a) General. A Federal credit union of this chapter, and be compliant with with derivatives authority may use ex- GAAP for all derivatives-related ac- ternal service providers to support or counting and reporting; conduct aspects of its derivatives pro- (4) Process and responsibility frame- gram, provided: work. A Federal credit union must (1) The external service provider, in- maintain a written and schematic de- cluding affiliates, does not: scription (e.g., flow chart or organiza- (i) Act as a counterparty to any de- tional chart) of the derivatives man- rivatives transactions that involve the agement process in its derivatives poli- Federal credit union; cies and procedures. The description (ii) Act as a principal or agent in any must include the roles of staff, quali- derivatives transactions that involve fied personnel, external service pro- the Federal credit union; or viders, senior executive officers, the (iii) Have discretionary authority to board of directors, and any others in- execute any of the Federal credit volved in the derivatives program; union’s derivatives transactions. (5) Separation of duties. A Federal (2) The Federal credit union has the credit union’s process, whether con- internal capacity, experience, and ducted internally or by an external skills to oversee and manage any exter- service provider, must have appro- nal service providers it uses; and priate separation of duties for the fol- (3) The Federal credit union docu- lowing functions defined in paragraph ments the specific uses of external (a)(3) of this section: service providers in its process and re- (i) Asset/liability risk management; sponsibility framework, as described in

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§ 703.106(b)(1) of this subpart and the ap- the Federal credit union will use de- plication. rivatives in conjunction with other on- (b) Support functions. A Federal credit balance sheet instruments and strate- union must perform the following func- gies to effectively manage its interest tions internally and independently. A rate risk; Federal credit union may have assist- (b) A list of the products and charac- ance and input from an external serv- teristics the Federal credit union is ice provider, provided the external seeking approval to use, a description service provider does not conduct the of how it intends to use the products following functions in lieu of the Fed- and characteristics listed, an analysis eral credit union: of how the products and characteristics (1) Asset/liability risk management; fit within its interest rate risk mitiga- and tion plan, and a justification for each (2) Liquidity risk management. product and characteristic listed; (c) Draft policies and procedures that § 703.108 Eligibility. the Federal credit union has prepared (a) A Federal credit union may apply in accordance with § 703.106(d) of this for derivatives authority under this subpart; subpart if it meets the following cri- (d) How the Federal credit union teria: plans to acquire, employ, and/or create (1) The Federal credit union’s most the resources, policies, processes, sys- recent NCUA-assigned composite tems, internal controls, modeling, ex- CAMEL code rating is 1, 2, or 3, with a perience, and competencies to meet the management component of 1 or 2; and requirements of this subpart. This in- (2) The Federal credit union has as- cludes a description of how the Federal sets of at least $250 million as of its credit union will ensure that senior ex- most recent call report. ecutive officers, board of directors, and (b) Notwithstanding paragraph (a)(2) personnel have the knowledge and ex- of this section, a Federal credit union perience in accordance with the re- may request permission from the ap- quirements of this subpart; propriate field director to apply for de- (e) A description of how the Federal rivatives authority, subject to require- credit union intends to use external ments imposed by the field director. If service providers as part of its deriva- the field director grants such permis- tives program, and a list of the name(s) sion, the application will be subject to of and service(s) provided by the exter- §§ 703.109 through 703.111. nal service providers it intends to use; § 703.109 Applying for derivatives au- (f) A description of how the Federal thority. credit union will support the oper- An eligible Federal credit union must ations of margining and collateral; and receive written approval to use deriva- (g) A description of how the Federal tives by submitting a detailed applica- credit union will comply with GAAP. tion, consistent with this subpart and any guidance issued by NCUA. A Fed- § 703.111 NCUA approval. eral credit union must submit its appli- (a) Interim approval. The field direc- cation to the applicable field director. tor will notify the Federal credit union in writing if the field director has ap- § 703.110 Application content. proved or denied its application and, if A Federal credit union applying for applicable, the reason(s) for any denial. derivatives authority must document A Federal credit union approved for de- how it will comply with the require- rivatives authority may not enter into ments of this subpart and any guidance any derivatives transactions until it issued by NCUA, and must include all receives final approval from NCUA of the following in its application: under paragraph (c) of this section. (a) An interest rate risk mitigation (b) Notice of readiness. A Federal cred- plan that shows how derivatives are it union approved under paragraph (a) one aspect of the Federal credit union’s of this section must provide written overall interest rate risk mitigation notification to NCUA when it is ready strategy, and an analysis showing how to begin using derivatives.

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(c) Final approval. NCUA will review (b) The field director will notify the every approved Federal credit union’s Federal credit union in writing if the derivatives program to ensure compli- field director has approved or denied ance with this subpart and evaluate its application for additional products the Federal credit union’s implementa- or characteristics. If applicable, the tion of the items in its application. notification will include the reason(s) This supervisory review may be con- for denial. ducted on site. After NCUA has com- (c) A Federal credit union may re- pleted its review, the field director will quest the regional director to recon- notify the Federal credit union in writ- sider a denial of an application for ad- ing if the field director has granted ditional products or characteristics final approval and the Federal credit and/or file an appeal with the NCUA union may begin entering into deriva- Board in accordance with the proce- tives transactions. If applicable, the dures set forth in subpart B to part 746 notification will include the reason(s) of this chapter. for any denial. A Federal credit union [79 FR 5241, Jan. 31, 2014, as amended at 82 may not enter into any derivatives FR 50293, Oct. 30, 2017] transactions under this subpart until it receives this determination from the § 703.113 Pilot program participants applicable field director. At a field di- with active derivatives positions. rector’s discretion, a Federal credit (a) A Federal credit union with out- union may reapply under this sub- standing derivatives positions under section if the field director has deter- NCUA’s derivatives pilot program as of mined that the Federal credit union January 1, 2013, must comply with the has demonstrated compliance with this requirements of this subpart within 12 subpart and its application. months of the effective date of this (d) Right to appeal. A Federal credit subpart, including the requirement to union may request the field director to submit an application for derivatives reconsider a determination made under authority. During the 12-month in- paragraph (a) or (c) of this section and/ terim period, the Federal credit union or file an appeal with the NCUA Board may continue to operate its derivatives in accordance with the procedures set program in accordance with its pilot forth in subpart B to part 746 of this program terms and conditions. chapter. (b) A Federal credit union with out- [79 FR 5241, Jan. 31, 2014, as amended at 82 standing derivatives positions under FR 50293, Oct. 30, 2017] NCUA’s derivatives pilot program as of January 1, 2013, that does not comply § 703.112 Applying for additional prod- with the requirements of this subpart ucts or characteristics. within 12 months of the effective date (a) A Federal credit union with de- of this subpart, or does not want to rivatives authority may subsequently continue engaging in derivatives trans- apply for approval to use additional actions, must: products and characteristics, fescribed (1) Stop entering into new derivatives in § 703.102 of this subpart, that it did transactions; and not request in its initial application, (2) Within 30 days, present a correc- subject to the following: tive action plan to NCUA describing (1) A Federal credit union must sub- how the Federal credit union will cure mit an application to NCUA; any deficiencies or wind down its de- (2) A Federal credit union’s applica- rivatives program. tion must include a list of the products and/or characteristics for which it is § 703.114 Regulatory violation. applying; and (a) A Federal credit union with de- (3) A Federal credit union must in- rivatives authority that no longer clude a justification for each product meets the requirements of this subpart and/or characteristic requested in the or fails to comply with its approved application and an explanation of how strategy (including employing the re- the Federal credit union will use each sources, policies, procedures, account- product and/or characteristic re- ing, and competencies that formed the quested. basis for the approval) must:

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(1) Immediately stop entering into sider a revocation of derivatives au- any new derivatives transactions until thority or an order to terminate exist- the Federal credit union is in compli- ing derivatives positions and/or file an ance with this subpart. During this pe- appeal with the NCUA Board in accord- riod, however, the Federal credit union ance with the procedures set forth in may terminate existing derivatives subpart B to part 746 of this chapter. transactions. NCUA may permit a Fed- (d) With respect to an appeal regard- eral credit union to enter into offset- ing revocation of a Federal credit ting transactions if NCUA determines union’s derivatives authority, the Fed- these transactions are part of a correc- eral credit union may not enter into tive action strategy. any new derivatives transactions until (2) Within three business days from the NCUA Board renders a final deci- the regulatory violation, provide the sion on the appeal. The Federal credit appropriate field director notification union may, however, elect to terminate of the regulatory violation, which must existing derivatives positions. With re- include a description of the violation spect to an appeal regarding an order and the immediate corrective action to terminate a Federal credit union’s the Federal credit union is taking; and existing derivatives positions, the Fed- (3) Within 15 business days after noti- eral credit union is not required to ter- fying the appropriate field director, minate any existing positions until the submit a written corrective action plan NCUA Board renders a final decision on to the appropriate field director. the appeal. (b) NCUA may revoke a Federal cred- (3) Through the originator’s initial it union’s derivatives authority at any written communication with a con- time if a Federal credit union fails to sumer, if any, whether on paper or comply with the requirements of this electronically. subpart. Revocation will prohibit a [79 FR 5241, Jan. 31, 2014, as amended at 82 Federal credit union from executing FR 50293, Oct. 30, 2017] any new derivatives transactions under this subpart, and may require the Fed- APPENDIX TO SUBPART B—EXAMPLES OF eral credit union to terminate existing DERIVATIVE LIMIT AUTHORITY CAL- derivatives transactions if, in the dis- CULATIONS cretion of the applicable field director, Limit authority. A Federal credit union that doing so would not pose a safety and is approved for derivatives authority under soundness concern. § 703.111 may use any of the products and (c) A Federal credit union may re- characteristics described in § 703.102(a), sub- quest the regional director to recon- ject to the following position and risk limits:

TABLE 1—AUTHORITY LIMITS

Entry limits (first 12 months of Limit authority transactions) Standard limits

Fair Value Loss (See (a) below) ...... 15% of net worth ...... 25% of net worth. Weighted Average Remaining Maturity Notional (WARMN) 65% of net worth ...... 100% of net worth. (See (b) below).

(a) Calculating the fair value loss limit for (i) Options—the gain or loss is the dif- compliance with this subpart. To demonstrate ference between the fair value and the compliance with the fair value loss limit au- unamortized premium at the reporting date; thority of this subpart, a Federal credit (ii) Swaps—the gain or loss is the fair value union must combine the total fair value (as at the reporting date; and defined by product group below) of all de- (iii) Futures—the gain or loss is the dif- rivatives transactions. The fair value loss ference between the exchange closing price limit is exclusive to the derivatives positions at the reporting date and the purchase or (not net of offsetting gains and losses in the sales price. hedged item). (2) Example calculations for compliance with (1) The resulting figure, if a loss, must not this subpart: fair value loss limit. The table below provides an example of the fair value exceed the Federal credit union’s authorized loss limit calculations for a sample Federal fair value loss limit: credit union that has entry level authority.

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The sample Federal credit union has a net billion; its fair value loss limit is ¥$15 mil- worth of $100 million and total assets of $1 lion (15 percent of net worth).

TABLE 2—EXAMPLE FAIR VALUE LOSS CALCULATIONS

Fair value gains (losses) % of Net Limit worth viola- Options Swaps Futures Total (percent) tion

Scenario A ...... $1,000,000 $2,000,000 $200,000 $3,200,000 3 No. Scenario B ...... 5,000,000 10,000,000 2,000,000 17,000,000 17 No. Scenario C ...... 1,000,000 (3,000,000) 250,000 (1,750,000) (2) No. Scenario D ...... 1,000,000 (20,000,000) (2,000,000) (21,000,000) (21) Yes. Scenario E ...... (2,000,000) (10,000,000) 1,000,000 (11,000,000) (11) No.

(b) Calculating the WARMN exposure for this appendix, for a 300 basis point parallel compliance with this subpart. The WARMN shift in interest rates. To demonstrate com- calculation adjusts the gross notional of a pliance with the WARMN limit authority of derivative to take into account its price sen- this subpart, a Federal credit union must sitivity and remaining maturity. The calculate the WARMN using the following WARMN limit is correlated to the fair value reference table, definitions, and calculation loss limit, as described in paragraph (a) of steps:

TABLE 3—SUMMARY OF WARMN CALCULATION

Adjustment Product Step #1 gross factor Step #2 Step #3 notional (percent) adjusted notional WARM

Options (Caps) ...... Current 33 33% of current notional .. Time remaining to maturity. notional Options (Floors) ...... Current 33 33% of current notional .. Time remaining to maturity. notional Swaps ...... Current 100 100% of current notional Time remaining to maturity. notional Futures ...... Contract size 100 100% of contract size .... Underlying contract. Sum = Total Adjusted Sum = Overall WARM Notional.

Step #4 WARMN = Adjusted Notional x (WARM/10)

(1) Step #1—Calculate the gross notional of all an interest rate cap with a $1 million no- outstanding derivative transactions. (i) For op- tional amount has an adjusted gross notional tions and swaps, all gross notional amounts of $330,000 ($1,000,000 × 0.33 + $330,000). must be absolute, with no netting (i.e., off- (ii) For interest rate swaps and Treasury setting a pay-fixed transaction with a re- futures, the derivative adjustment factor is ceive-fixed transaction). The gross notional 100 percent. For example, an interest rate for derivatives transactions with amortizing swap with a $1 million notional amount has notional amounts is the current contracted an adjusted gross notional of $1,000,000 notional amount, in accordance with the am- ($1,000,000 × 1.00 = $1,000,000). ortization schedule. (iii) The total adjusted notional for all de- (ii) For futures, the gross notional is the rivatives positions is the sum of (i) and (ii) underlying contract size as designated by the above. Chicago Mercantile Exchange (CME) product (3) Step #3—Produce the weighted average re- specifications (e.g., a five-year Treasury note futures contract will use $100,000 for each maining time to maturity (WARM) for all de- contract purchased or sold and reported here rivatives positions. (i) For interest rate caps, on a gross basis for limit purposes.) interest rate floors, and interest rate swaps, (2) Step #2—Convert each gross notional by its the remaining maturity is the time left be- derivative adjustment factor to produce an ad- tween the reporting date and the contracted justed gross notional. The derivative adjust- maturity date, expressed in years (round up ment factor approximates the price sensi- to two decimals); tivity for each of the product groups in order (ii) For Treasury futures, the remaining to weight the notional amount by sensitivity maturity is the underlying deliverable before weighting for maturity. Treasury note’s maximum maturity (e.g., a (i) For cap and floor options, the derivative five-year Treasury note future has a five- adjustment factor is 33 percent. For example, year remaining maturity); and

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(iii) Determine the WARM using the ad- tional, described in paragraph (c)(2) of this justed gross notional, as set forth in sub- appendix. section (2) of this section, and the remaining (5) Compare WARMN calculation to the time to maturity as defined for each product WARNM limit for compliance. The total in step group above in paragraphs (b)(3)(i) and (ii) of four (4) must be less than the limit in para- this appendix. graph (a)(1)(ii) or (a)(2)(ii) of this appendix, (4) Step #4—Produce the WARMN by con- as applicable. verting the WARM to a percentage and then (6) Example calculations for compliance with multiplying the percentage by the total adjusted this subpart: WARMN. The table below pro- gross notional. (i) Divide the WARM, as cal- vides an illustrative example of the WARMN culated in paragraph (b)(3) of this appendix, limit calculations for a sample Federal cred- by ten to convert it to a percentage (e.g., 7.75 it union that has entry level authority. The WARMN is translated to 77.5 percent); and sample Federal credit union has a net worth (ii) Multiply the WARM converted to a per- of $100 million and total assets of $1 billion; centage, as described in paragraph (c)(4)(i) of its notional limit authority is $65 million (65 this appendix, by total adjusted gross no- percent of net worth).

TABLE 4—EXAMPLE WARMN LIMIT CALCULATION

Options Swaps Futures Total

Gross Notional (Step #1) ...... $100,000,000 $50,000,000 $5,000,000 $155,000,000 Adjustment Factor ...... 33% 100% 100% Adjusted Notional (Step #2) ...... $33,000,000 $50,000,000 $5,000,000 $88,000,000 Weighted Average Remaining Maturity (WARM) (Step #3)...... 7.00 8.50 5.00 7.74

Weighted Average Remaining Matu- 1 $68,100,000 rity Notional (WARMN) (Step #4): Notional Limit Authority (65% of net $65,000,000 worth) Under/(Over) Notional Limit Authority ($3,100,000) 1 (77.4% of Step #3.)

PART 704—CORPORATE CREDIT APPENDIX C TO PART 704—RISK-BASED CAP- UNIONS ITAL CREDIT RISK-WEIGHT CATEGORIES AUTHORITY: 12 U.S.C. 1766(a), 1781, 1789.

Sec. SOURCE: 62 FR 12938, Mar. 19, 1997, unless 704.1 Scope. otherwise noted. 704.2 Definitions. 704.3 Corporate credit union capital. 704.4 Prompt corrective action § 704.1 Scope. 704.5 Investments. (a) This part establishes special rules 704.6 Credit risk management. for all federally insured corporate cred- 704.7 Lending. it unions. Non federally insured cor- 704.8 Asset and liability management. 704.9 Liquidity management. porate credit unions must agree, by 704.10 Investment action plan. written contract, to both adhere to the 704.11 Corporate Credit Union Service Orga- requirements of this part and submit nizations (Corporate CUSOs). to examinations, as determined by 704.12 Permissible services. NCUA, as a condition of receiving 704.13 Board responsibilities. shares or deposits from federally in- 704.14 Representation. 704.15 Audit and reporting requirements. sured credit unions. This part grants 704.16 Contracts/written agreements. certain additional authorities to fed- 704.17 State-chartered corporate credit eral corporate credit unions. Except to unions. the extent that they are inconsistent 704.18 Fidelity bond coverage. with this part, other provisions of 704.19 Disclosure of executive compensa- NCUA’s Rules and Regulations (12 CFR tion. chapter VII) and the Federal Credit 704.21 Enterprise risk management. 704.22 Membership fees. Union Act apply to federally chartered corporate credit unions and federally APPENDIX A TO PART 704—CAPITAL PRIORITIZATION AND MODEL FORMS insured state-chartered corporate cred- APPENDIX B TO PART 704—EXPANDED AU- it unions to the same extent that they THORITIES AND REQUIREMENTS apply to other federally chartered and

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