§ 703.106 - Operational support requirements.

§ 703.106 Operational support requirements.

(a) Required experience and competencies. A Federal credit union operating with derivatives authority using Derivative transactions subject to this subpart must internally possess the following experience and competencies:

(1) Board.

(i) Before entering into

any derivatives transactions, and annually thereafter,

the initial Derivatives transaction, a Federal credit union's board members must receive training that provides a general understanding of

derivatives

Derivative transactions, and the knowledge required to provide strategic oversight of the Federal credit union's

derivatives program. This requirement includes understanding how derivatives fit into

Derivatives program.

(ii) Any person that becomes a board member after the initial Derivatives transaction must receive the same training, updated if necessary, as required by paragraph (a)(1)(i) of this section.

(iii) At least annually after the initial Derivatives transaction, as part of the Derivatives reporting requirement in § 703.105(a), the Federal credit union's

business model and risk management process. The

Senior Executive Officers must brief the board members on the Federal credit union

must maintain evidence of this training, in accordance with its document retention policy, until its next NCUA examination

's use of Derivatives to manage Interest Rate Risk.

(2) Senior executive officersExecutive Officers. A Federal credit union's senior executive officers Senior Executive Officers must be able to understand, approve, and provide oversight for the derivatives activitiesDerivatives program. These individuals must have a comprehensive understanding of how derivatives the Derivative transactions fit into the Federal credit union's business model and risk Interest Rate Risk management process.

(3) Qualified derivatives Derivatives personnel. To engage in derivatives the Derivative transactions, a Federal credit union must employ staff with experience in the following areas:

(i) Asset/liability risk management. Staff must be qualified to understand and oversee asset/liability risk management, including the appropriate role of derivatives. This requirement includes identifying and assessing risk in transactions, developing asset/liability risk management strategies, testing the effectiveness of asset/liability risk management, determining the effectiveness of managing interest rate risk under a range of stressed rates and statement of financial condition scenarios, and evaluating the relative effectiveness of alternative strategiesthe transactions subject to this subpart. Staff must also be qualified to understand and undertake or oversee the appropriate modeling and analytics related to scope of risk to earnings and economic value over the expected maturity of derivatives positionsNet Economic Value and Earnings at Risk;

(ii) Accounting and financial reporting. Staff must be qualified to understand and oversee appropriate accounting and financial reporting for derivatives transactions Derivatives in accordance with GAAP;

(iii) Derivatives execution and oversight. Staff must be qualified to undertake or oversee Derivative trade executions; and

(iv) Counterparty, collateral, and margining Margin management. Staff must be qualified to evaluate counterpartyCounterparty, collateral, and margining Margin risk as described in § 703.104 of this subpart.

(b) Required management review and internal controls structure. To effectively manage its derivatives activitiesthe transactions subject to this subpart, a Federal credit union must assess the effectiveness of its management and internal controls structure. At a minimum, the internal controls structure must include:

(1) Transaction supportreview. Before executing any derivatives Derivatives transaction, a Federal credit union must identify and document the circumstances that lead to the decision to hedgeexecute the Derivatives transaction, specify the derivatives strategy the Federal credit union will employ, and demonstrate the economic effectiveness of the hedgetransaction;

(2) Internal controls review. For Within the first two years year after commencing its derivatives programfirst Derivatives transaction, a Federal credit union must have an internal controls review that is focused on the integration and introduction of derivatives functionsthe program, and ensure the timely identification of weaknesses in internal controls, accounting, and all operational and oversight processes. This review must be performed by an independent external unit or, if applicable, the Federal credit union's internal auditor. The review must ensure the timely identification of weaknesses in internal controls, modeling methodologies, risk, and all operational and oversight processes;

(3) Financial statement audit. Any Federal credit union engaging in derivatives Derivative transactions pursuant to this subpart must obtain an annual financial statement audit, as defined in § 715.2(d) of this chapter, and be compliant with GAAP for all derivativesDerivatives-related accounting and reporting;

(4) Process and responsibility framework. A Collateral management review. Before executing its first Derivative transaction, a Federal credit union must maintain a written and schematic description (e.g., flow chart or organizational chart) of the derivatives management process in its derivatives policies and procedures. The description must include the roles of staff, qualified personnel, external service providers, senior executive officers, the board of directors, and any others involved in the derivatives program;

(5

establish a collateral management process that monitors the Federal credit union's collateral and Margining requirements and ensures that its transactions are collateralized in accordance with the collateral requirements of this subpart and the Federal credit union's Master Services Agreement with its Counterparty;

(5) Liquidity review. Before executing its first Derivative transaction, a Federal credit union must establish 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. The Federal credit union must, 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 must establish effective controls for liquidity exposures arising from both market or product liquidity and instrument cash flows; and

(6) Separation of duties. A Federal credit union's process, whether conducted internally or by an

external service provider

External Service Provider, must have appropriate separation of duties for the following functions defined in

paragraph

subsection (a)(3) of this section:

(i) Asset/liability risk management;

(ii) Accounting and financial reporting;

(iii) Derivatives execution and oversight; and

(iv)

Collateral

Counterparty,

counterparty,

collateral and

margining

Margin management.

(c) Legal review. A Federal credit union with derivatives authority must hire or engage legal counsel to reasonably ensure that all derivatives contracts adequately protect the legal and business interests of the Federal credit union. The Federal credit union's counsel must have legal expertise with derivatives contracts and related matters.

(d)

Policies and procedures. A Federal credit union

with derivatives authority

using Derivatives, permitted under this subpart, must operate according to comprehensive written policies and procedures for control, measurement, and management of

derivatives

Derivative transactions. At a minimum, the policies and procedures must address the requirements of this subpart

, except for those in §§ 703.108 through 703.114,

and any additional limitations imposed by the Federal credit union's board of directors. A Federal credit union's board of directors must review the policies and procedures described in this section at least annually and update them when necessary.