N.D. Admin. Code 13-03-22-16

Current through Supplement No. 394, October, 2024

Section 13-03-22-16 - Derivatives

1. A state-chartered credit union may enter into derivatives that:

a. Are for the purpose of managing interest rate risk;

b. Denominated in United States dollars;

c. Based on domestic interests; and

d. Not used to create structured liability offerings for members or nonmembers.

2. A state-chartered credit union may not engage in embedded options required under generally accepted accounting principles to be accounted for separately from the host contract.

3. To enter into derivative transactions, a credit union must:

a. Have an executed master services agreement with a counterparty. Such agreement must be reviewed by legal counsel with expertise in similar types of transactions to ensure the agreement reasonably protects the interest of the credit union;

b. Use only the following counterparties:

(1) For exchange-traded and cleared derivatives: swap dealers, introducing brokers, or futures commission merchants, or both, that are current registrants of the commodity futures trading commission; or

(2) For noncleared derivative transactions: swap dealers that are current registrants of the commodity futures trading commission.

(3) Commercial loan customers for the purpose of limiting the interest rate risk associated with their specific loan transactions.

c. Utilize contracted margin requirements with a maximum margin threshold amount of two hundred fifty thousand dollars; and

d. For noncleared derivative transactions, accept as eligible collateral, for margin requirements, only the following: cash (United States dollars), United States treasuries, government-sponsored enterprise debt, United States government agency debt, government-sponsored enterprise residential mortgage-backed security passthrough securities, and United States government agency residential mortgage-backed security passthrough securities.

e. Operate according to comprehensive written policies and procedures for control, measurement, and management of derivative transactions. At a minimum, the policies and procedures must address the requirements of this rule and any additional limitations imposed by the credit union's board of directors. A credit union's board of directors shall review the policies and procedures described in this section at least annually and update them when necessary.

4. A credit union engaging in derivative transactions must have sufficient reporting on the activity to include:

a. Board reporting. At least quarterly, a credit union's senior executive officers shall deliver a comprehensive derivatives report, as described in subdivision c to the credit union's board of directors.

b. Senior executive officer and asset liability or similarly functioning committee. At least monthly, credit union staff shall deliver a comprehensive derivatives report, as described in subdivision c to the credit union's senior executive officers and, if applicable, the credit union's asset liability or similarly functioning committee.

c. Comprehensive derivatives management report. At a minimum, the reports required in subdivisions a and b must include:

(1) Identification of any areas of noncompliance with any provision of this section or the credit union's policies, and the planned remediation of such noncompliance;

(2) An itemization of the credit union's individual transactions subject to this section, the current values of such transactions, and each individual transaction's intended use for interest rate risk mitigation; and

(3) A comprehensive view of the credit union's risk reports, including interest rate risk calculations with details of the transactions subject to this section.

d. Prepurchase due diligence. Before executing any derivatives transaction, management shall identify and document the circumstances that lead to the decision to execute the derivatives transaction, specify the strategy management will employ, and demonstrate the economic effectiveness of the transaction.

e. Retention requirement. Reports required by this section must, at a minimum, be retained for as long as it holds the derivative and until the documentation has been examined in accordance with North Dakota Century Code section 6-06-08.

f. Management shall notify the commissioner within five days of entering its first derivatives contract.

g. Notification of noncompliance. Notification of any noncompliance as part of the derivatives management report required in paragraph 1 of subdivision c must be submitted to the commissioner and to the credit union's board of directors within thirty days.

5. Personnel and processes required to manage a derivatives program include:

a. A credit union using derivative transactions must internally possess the following experience and competencies:

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

(2) Any person that becomes a board member after the initial derivatives transaction must receive the same training, updated if necessary, as required by paragraph 1.

b. A credit union's senior executive officers must be able to understand, approve, and provide oversight for the derivatives program. These individuals must have a comprehensive understanding of how the derivative transactions fit into the credit union's interest rate risk management process.

c. To engage in the derivative transactions, a credit union must employ staff with experience in the following areas:

(1) Staff must be qualified to understand and oversee asset/liability risk management, including the appropriate role of the transactions subject to this section. Staff must be qualified to understand and undertake or oversee the appropriate modeling and analytics related to net economic value and earnings at risk;

(2) Staff must be qualified to understand and oversee appropriate accounting and financial reporting for derivatives in accordance with generally accepted accounting principles;

(3) Staff must be qualified to undertake or oversee derivative trade executions; and

(4) Staff must be qualified to evaluate counterparty, collateral, and margin risk as described in subdivisions b and c of subsection 3.

d. To effectively manage the transactions subject to this section, management shall ensure that effective accounting, review processes, and internal controls have been established, to include:

(1) Within the first year after commencing its first derivatives transaction, management shall have an internal controls review that is focused on the integration and introduction of the program, and ensure the timely identification of weaknesses in internal controls, accounting, and all operational and oversight processes. This review must be performed by a qualified independent entity;

(2) Any credit union engaging in derivative transactions pursuant to this section must obtain an annual opinion audit and be compliant with generally accepted accounting principles for all derivatives-related accounting and reporting;

(3) Before executing its first derivative transaction, management shall establish a collateral management process that monitors the credit union's collateral and margining requirements and ensures that its transactions are collateralized in accordance with the collateral requirements of this section and the credit union's master services agreement with its counterparty;

(4) Before executing its first derivative transaction, management shall establish and document a liquidity review process to analyze and measure potential liquidity needs related to its derivatives program and the additional collateral requirements due to changes in interest rates. Management shall, as part of its liquidity risk management, calculate and track contingent liquidity needs in the event a transaction needs to be novated or terminated, and shall establish effective controls for liquidity exposures arising from both market or product liquidity and instrument cash flows; and

(5) Appropriate controls and segregation of duties.

6. A credit union using derivatives may use external service providers to support or conduct aspects of its derivative management program, provided:

a. The external service provider, including affiliates, does not:

(1) Act as a counterparty to any derivative transactions that involve the credit union;

(2) Act as a principal or agent in any derivative transactions that involve the credit union; or

(3) Have discretionary authority to execute any of the credit union's derivative transactions.

b. The credit union has the internal capacity, experience, and skills to oversee and manage any external service providers it uses;

c. Management documents the specific uses of external service providers in its policies and procedures; and

d. The credit union retains internal staff to meet the requirements of subsection 5.

7. If a credit union has violated any part of this section, is or has engaged in unsafe or unsound practices, or is in unsafe or unsound condition, the commissioner may provide written notice to the credit union prohibiting them from entering into new derivatives transactions, effective upon receipt of the notice. The commissioner may also require divesture of derivative products. The credit union can appeal this prohibition or divesture to the state credit union board, and must provide written notice of their intent to appeal to the department within twenty days of receipt of the prohibition or divesture requirement as outlined in North Dakota Century Code section 6-01-04.2.

N.D. Admin Code 13-03-22-16

Adopted by Administrative Rules Supplement 2022-384, April 2022, effective 4/1/2022.

General Authority: NDCC 6-01-04

Law Implemented: NDCC 6-06-06