CUNA Regulatory Comment Call

August 1, 2007

EXECUTIVE SUMMARY

• The NCUA Board issued an Advanced Notice of Proposed Rulemaking on amending its investment rules to permit natural person federal credit unions (FCUs) and corporate credit unions (corporates) to make certain investments denominated in foreign currency.
• The Board is considering whether to permit FCUs and corporates to invest foreign currency in deposits and instruments issued by federally insured banks, corporates, and government- sponsored enterprises (GSEs) domiciled in the U.S. or its territories.
• Credit unions would have to establish an appropriate process to measure, monitor and control foreign exchange risk with these investments.
• NCUA is considering establishing a maximum limit on the out-of-balance amount when assets and liabilities denominated in a particular foreign currency are not in balance.
• Credit unions would be required to manage other risks these investments pose, such as credit risk, interest rate risk, liquidity risk, transaction risk, compliance risk, strategic risk, and reputation risk.
• NCUA is also considering requiring credit unions to develop an exit strategy to facilitate divestiture of all investments in a particular currency.
• Additional reporting would be required to adequately monitor foreign currency exposure.
• The need to establish certain internal controls, policies, and procedures would likely be addressed to manage these investments.
• It is likely that there would be an approval process for an FCU or corporate to engage in foreign currency denominated investments and deposits.
• You may access a copy of NCUA’s proposed rule here.
• Comments are due to NCUA by October 30, 2007. Please submit your comments to CUNA by October 19, 2007. Please feel free to fax your responses to CUNA at 202-638-7052 or e-mail them to CUNA Deputy General Counsel Mary Dunn at mdunn@cuna.com. You may also contact her at 800-356-9655, ext. 6736.

BACKGROUND

In 2006, NCUA amended its share insurance rule to permit federally insured credit unions to accept member shares denominated in foreign currency but did not address foreign currency denominated investments. The ability to accept member shares denominated in foreign currency without authority to make foreign currency denominated investments may place some credit unions at a competitive disadvantage.

While the Federal Credit Union Act does not expressly restrict federal credit unions (FCUs) and corporate credit unions (corporates) to making investments in U.S. dollars, NCUA imposes this limitation by regulation under Parts 703 and 704.

Although not expressly prohibiting foreign currency denominated investments, the general investment rule for FCUs ties variable rate investments to a domestic interest rate, which limits FCU investment authority to U.S. dollars. The corporate regulation, however, expressly states corporates may only make investments denominated in U.S. dollars.

DISCUSSION

In this ANPR, the NCUA Board is considering whether to permit FCUs and corporates to make limited investments denominated in foreign currency as a complementary authority to the change in the share insurance rule. The authority would allow FCUs and corporates to invest funds from the foreign denominated share accounts that are now permissible.

The Board is considering whether to permit FCUs and corporates to invest foreign currency in deposits and instruments issued by federally insured banks, corporates, and government-sponsored enterprises (GSEs) domiciled in the U.S. or its territories. NCUA believes limiting foreign currency investments in this way would substantially mitigate exposure to the potential instability of a foreign country and avoid settlement risks arising from international payment systems.

Credit unions would have to establish an appropriate process to measure, monitor and control foreign exchange risk with these investments. For example, maintaining a balance between foreign currency denominated assets and the member shares denominated in foreign currencies may mitigate foreign exchange risk.

NCUA is also considering establishing a maximum limit on the out-of-balance amount when assets and liabilities denominated in a particular foreign currency are not in balance. For example, if an out- of-balance amount is set at ten percent, an FCU with $10 million in net worth would be required to maintain an amount of foreign currency denominated assets in a given foreign currency within $1 million of the amount of liabilities in that same foreign currency.

Credit unions would also be required to manage other risks these investments pose, such as credit risk, interest rate risk, liquidity risk, transaction risk, compliance risk, strategic risk, and reputation risk. NCUA believes a regulation would need to address obligor or concentration limits to address credit risk. Any limit on credit risk may include requirements for a counterparty and the instrument or investment type.

NCUA is particularly concerned about a credit union’s ability to liquidate foreign currency denominated investments. Liquidity risk relates to the available market for the instruments or activities in which FCUs and corporates invest with foreign currency.

NCUA is also considering requiring credit unions to develop an exit strategy to facilitate divestiture of all investments in a particular currency. A notification requirement to members may be required of any conversion of their shares from foreign currency to U.S. dollars. An exit strategy:

• would provide for stress testing and the means to evaluate the performance of foreign currency investments;
• should commensurate with the level of risk exposure; and
• identify triggering events or scenarios that would alert credit unions as to when divestiture would be appropriate or necessary.

It is likely that a regulation would need to address information systems and technology risks, such as a requirement to demonstrate that FCUs and corporates can effectively mange the inherent risks of running multiple balance sheets in various denominations while simultaneously presenting consolidated information to NCUA.

Additional reporting would also be required to adequately monitor foreign currency exposure both on an individual credit union basis and an industry-wide basis. This would likely include revising call reports and requiring additional interim reporting of credit unions engaging in this activity.

A regulation would likely address the need to establish certain internal controls, policies, and procedures to manage these investments. This would include potential conflict of interest issues and staff qualifications, such as having knowledgeable, experienced staff to manage foreign currency investment portfolios.

NCUA also believes because of the staff expertise and internal systems requirements, it is likely that there would be an approval process for an FCU or corporate to engage in foreign currency denominated investments and deposits. The approval process could be patterned on the requirements for corporates to obtain expanded authorities under part 704 or by another method.

1. Should FCUs or corporates be permitted to invest foreign currency in vehicles other than deposits and instruments issued by federally insured banks, corporates, and GSEs domiciled in the U.S. or its territories permissible under the Federal Credit Union Act?
   
   a. Yes _____
   b. No _____
   Please explain.
   
   

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2. What do you believe are appropriate foreign exchange risk limits?
   
   

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3. How would an FCU or corporate measure, monitor, and control the foreign exchange risk of each currency in which it invests and accepts deposits?
   
   

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4. An FCU or corporate should be able to evaluate the volatility of each currency in which it invests and takes deposits. Should the Board limit the currencies in which investments may be denominated? What do you believe are appropriate limits per foreign currency and aggregate limits across all foreign currencies?
   
   

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5. NCUA expects credit unions to establish appropriate processes for controlling various risks including credit risk, interest rate risk, liquidity risk, transaction risk, compliance risk, strategic risk and reputation risk. What provisions should a regulation have to control these risks?
   
   

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   a. Should NCUA impose a limit on credit ratings or other requirements to control credit risk?
   Please explain.
   
   

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   b. NCUA is specifically requesting comments on liquidity risk in general and the requirements or limits that would reasonably constrain it.
   
   

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6. NCUA is considering developing an exit strategy to facilitate divestiture of all investments in a particular currency. Please comment on a potential investment policy as well as any exit strategy requirements you believe would mitigate risk.
   
   

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7. Do you believe bond coverage should be available to absorb potential losses from these investments?
   
   

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8. What notice should members be given in the event that their shares are converted from foreign currency to U.S. dollars?
   
   

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9. How can FCUs and corporates best demonstrate their ability to effectively manage the risks of running multiple balance sheets in various denominations while simultaneously presenting consolidated information to NCUA?
   
   

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10. What data should NCUA collect regarding credit unions’ information systems and investments denominated in foreign currency? How often should the data be collected?
    
    

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11. Should NCUA regulate the qualifications of credit union employees involved in these types of investments? Should employing third parties to meet the experience requirements be permissible?
    
    

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12. Would the conflict of interest provision in the member business loan rules be an appropriate model for a provision in the rule governing foreign currency investments?
    
    

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13. The NCUA Board believes an approval process would be necessary for an FCU or corporate to engage in these investments. What do you believe would be an appropriate mechanism for an approval process?
    
    

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14. Please provide any additional comments you wish.
    
    

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