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4 Things You Should Know About the Recently Amended Derivatives Rule

July 12, 2021

By Chris Shipman, CFA, CFP® Catalyst Strategic Solutions Advisor


4 Things You Should Know About the Recently Amended Derivatives RuleConversation around interest rate derivatives has slowly gained more traction within the credit union industry over the last year. In October 2020, Catalyst Strategic Solutions outlined the benefits of derivatives as an effective tool for managing credit union interest rate risk (IRR). And in the most recent derivatives blog, Catalyst Strategic Solutions Managing Principal Mark DeBree further explained why they might be worth a second look.

Since then, the NCUA Board approved a final rule that modernizes the proposed derivatives rule, making it more of a principles-based approach, while retaining essential safety and soundness components. The amended rule, which took effect June 21, 2021, provides more flexibility for federal credit unions (FCUs) to effectively and efficiently manage IRR. It should be noted, however, that the rule applies only to FCUs. State-chartered credit unions may be required to seek approval from their governing body prior to derivative usage.

Let’s take a closer look at some of the key takeaways of the updated rule.

The latest NCUA-approved changes enact the following:

1. Streamlines the application process for derivative use. FCUs with at least $500 million in assets and a CAMEL rating of 1 or 2 are not required to apply for derivatives usage but must notify their Regional Directors in writing or by email within five business days after entering into their first derivatives transaction. FCUs below $500 million in assets must still complete the derivatives application. Credit unions that don’t qualify for the exemption will need to apply to their Regional Director for approval to use derivatives.

2. Removes reference to specific derivative types and permits FCUs to enter into derivatives that meet the following characteristics of §703.103:

  • For the purpose of managing interest rate risk
  • Denominated in U.S. dollars
  • Based on Domestic Interest Rates or the U.S. dollar-denominated London Interbank Offered Rate (LIBOR)
  • Contract maturity is equal to or less than 15 years, as of the trade date
  • Not used to create Structured Liability Offerings for members or nonmembers

An FCU may not engage in embedded options required under U.S. generally accepted accounting principles (GAAP) to be accounted for separately from the host contract.

3. Clarifies the new operational support requirement for a liquidity review. In addition to existing reporting frequency and other requirements, a liquidity review must also be conducted.

4. Provides expanded pipeline management to all loans.

For a more comprehensive overview of the amended rule, credit unions are encouraged to review the NCUA’s final rule. As NCUA Chairman Todd Harper stated, “This [amended] rule is a timely and appropriate measure that ensures complex federal credit unions can manage a variety of interest rate scenarios. It also provides a way for smaller credit unions, which demonstrate proficiency and obtain regulatory approval, to use simple derivatives to hedge their loan portfolios.”Request a no-obligation consultation

With this amended rule now in effect, why would a credit union consider using derivatives to manage IRR? As we know, the Fed’s actions in March 2020 had a significant impact on lending rates. Rates fell precipitously and continue to remain at or near historic lows. The impact of new origination and refinancing of real estate loans has been and will continue to be felt for several years on both earnings and IRR. A credit union has the option of either retaining the loan(s) on their balance sheet or selling them to the secondary market. The use of derivatives can assist in hedging interest rate risk for both options.

Ultimately, the recent amendment to the NCUA Derivative Rule provides greater access to hedging opportunities for all credit unions. And while hedging is a complex strategy, the proper application can help keep a credit union’s interest rate risk in check.

If you would like more information on IRR management or tailored hedging strategies, Catalyst Strategic Solutions stands ready to support your credit union. We’re here to help you navigate the latest regulations and effectively manage your balance sheet, so contact us today.