Compliance Outlook

Derivatives Authority

Derivative Investment Requirements

A credit union authority to invest in derivatives is limited to and has been granted exclusively for the purpose of reducing interest rate risk exposure.

Derivative Investment DefinitionsDerivative is a financial contract which derives its value from the value and performance of some other underlying financial instrument or variable, such as an index or interest rate.

Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date, as defined by GAAP.

Forward sales commitment is an agreement to sell an asset at a price and future date specified in the agreement.

Interest rate lock commitment means an agreement by a credit union to hold a certain interest rate and points for a specified amount of time while a prospective borrower’s application is processed.

Derivative Investment Requirements

To invest in Derivatives the Credit Union must apply for, receive, and maintain authority from the NCUA for derivative investments. The requirements include:

• An NCUA-assigned composite CAMEL code rating is 1, 2, or 3, with a management component of 1 or 2; and

• Assets of at least $250 million as of its most recent call report.

Derivative Investment RequirementsIf the Credit Union no longer meets the NCUA

requirements or fails to comply with the investment requirements it must:• Immediately stop entering into any new derivatives

transactions until it is in compliance;• Within three business days from the regulatory

violation, provide the appropriate NCUA Field Director notification of the regulatory violation, which will include a description of the violation and the immediate corrective action the Credit Union is taking; and

• Within 15 business days after notifying the appropriate field director, submit a written corrective action plan to the appropriate field director.

Derivative Investment RequirementsOnce a credit union has been granted authority it may

enter into derivative transactions that are limited to:

1. Derivatives permitted under Part 703 Investment and Deposit Activities;

2. Embedded options not required under generally accepted accounting principles (GAAP) adopted in the United States to be accounted for separately from the host contract; and

3. Interest rate lock commitments or forward sales commitments made in connection with a loan originated by a Federal credit union.

Derivative Investment Requirements

The Credit Union must adhere to any limitations imposed by the NCUA for investments in derivatives.

1. Entry Limit Authority2. Standard Limit Authority

Derivative Investment RequirementsTo attain and retain the authority to invest in derivatives

the Credit Union must ensure:

1. Board members are trained;

2. Senior Executives have a comprehensive understanding of how derivatives fit into the Credit Union’s business model and risk management process and can provide oversight; and

3. Staff working with derivatives have experience in asset/liability management, proper accounting and financial reporting, derivatives execution and oversight, and the ability to evaluate counterparty, collateral, and margining risk.

Derivative Investment RequirementsThe credit union is also required to maintain internal

control structures to protect credit union assets including:

1. Transaction Support;

2. Internal Control Review;

3. Financial Statement Audits;

4. A Process and Responsibility Framework;

5. Separation of Duties;

6. Legal Review; and

7. Procedures.

Derivative Investment RequirementsIf the Credit Union uses external service providers the third party

provider can not:

• Act as counterparty to the Credit Union’s derivatives transactions;

• Act as a principal or agent in the transactions; or

• Have discretionary authority to execute any of the Credit Union’s derivatives transactions.

The Credit Union must:

• Confirm that the third party can oversee and manage any service providers it uses.

• Document the use of providers in its process and responsibility framework.

• Perform asset/liability risk management and liquidity risk management functions internally and independently.

Derivative Investment Requirements

The credit union must provide comprehensive derivatives reporting to:

• The Board of Directors quarterly; and

• Executive Management monthly.

Thank you for joining me for this review of the NCUA Derivatives Rule.

Shawn Wolbert, CIA, CUCEDirector CU System Relations

101 S. Washington Square, Suite 900Lansing, MI 48933-1703(800) 262-6285 Ext. 486(734) 658-5427 MobileFollow me on Twitter – Shawn Wolbert @ Go2CUGuru

Derivative Investment Requirements

Resources:

NCUA Derivatives Rule -http://www.ncua.gov/Legal/Documents/Regulations/FIR20140123Derivatives.pdf