Agency proposes a more ‘principles-based’ derivatives rule, more flexibility for FCUs

A derivatives proposal to make the agency’s regulation less prescriptive and more principles-based – and expanding federal credit unions’ (FCUs) authority to purchase and use derivatives as part of their interest-rate risk (IRR) management – was issued for a 60-day public comment period Thursday by the board of the institutions’ federal regulator.

The proposed rule would revise subpart B to Part 703 of the National Credit Union Administration (NCUA) rules and regulations. The NCUA said its proposal would modernize the current rule while retaining key safety and soundness components. It would also reorganize rule content related to loan pipeline management into one section.

Among the proposed changes:

  • eliminate the preapproval process for federal credit unions that are “complex” – that is, having at least $500 million in assets – and have a “management” CAMEL component rating of 1 or 2;
  • eliminate the specific product permissibility; and
  • eliminate the regulatory limits on the amount of derivatives an FCU may purchase.

Under the proposal, FCUs that don’t meet the notification criteria noted above (that is, those under $500 million in assets or a CAMEL management component rating of 3, 4, or 5) would be required to submit an application to the NCUA for derivatives authority that contains content generally consistent with the current rule.

FCUs would, under the proposal, be authorized to use derivatives manage IRR provided that the derivatives have all of the following characteristics:

  • they are denominated in U.S. dollars;
  • they are based off domestic interest rates or dollar-denominated London Interbank Offered Rate (LIBOR) (the agency acknowledged the transition from LIBOR and said the board will monitor this and make any necessary changes to a final derivatives rule);
  • they have a contract maturity equal to or less than 15 years, as of the trade date; and
  • they are not used to create structured liability offerings for members of nonmembers.

“In developing this proposed rule, the Board carefully considered the risks Derivatives pose, contemporary developments in the marketplace, and the NCUA’s experiences with credit unions using Derivatives,” the agency said in its notice. “While using Derivatives to manage IRR, the Board reminds credit unions that Derivatives are not a panacea for managing market risks. Derivatives, when used responsibly, are only a part of a credit union’s IRR framework.”

If the proposal is adopted in final form, the agency said credit unions will still require appropriate risk management by experienced staff, as well as suitable policies, procedures, and management oversight. It noted that “implicit in a principles-based approach is the expectation that FCUs will maintain strong prudential controls around their derivative use at all times.”

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