[Federal Register Volume 68, Number 106 (Tuesday, June 3, 2003)]
[Rules and Regulations]
[Pages 32958-32967]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-13660]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 703 and 742


Investment and Deposit Activities and Regulatory Flexibility 
Program

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: NCUA is amending its rule regarding the investment activities 
of Federal Credit Unions (FCUs). The amendments clarify and reformat 
the rule to make it easier to read and locate information. The 
amendments expand FCU investment authority to include purchasing 
equity-linked options for certain purposes and exempt RegFlex eligible 
FCUs from several investment restrictions. NCUA is also amending the 
Regulatory Flexibility Program to conform to the revisions to the 
investment rule.

Dates: The final rule is effective July 3, 2003.

For Further Information Contact: Scott Hunt, Senior Investment Officer, 
Office of Strategic Program Support and Planning (OSPSP) at the above 
address or telephone (703) 518-6620; Dan Gordon, Senior Investment 
Officer, OSPSP at the above address or telephone; Kim Iverson, Program 
Officer, Office of Examination and Insurance, at the above address or 
telephone (703) 518-6360; or Frank Kressman, Staff Attorney, Office of 
General Counsel, at the above address or telephone (703) 518-6540.

Supplementary Information:

A. Background

    NCUA identified part 703 of its rules as in need of revision. To 
that end, NCUA issued an advance notice of proposed rulemaking (ANPR) 
on October 18, 2001. 66 FR 54168 (October 26, 2001). After considering 
the comments to the ANPR submitted by 38 commenters, NCUA issued a 
proposed rule on December 19, 2002. 67 FR 78996 (December 27, 2002). 
NCUA received 14 comment letters regarding the proposed rule: five from 
FCUs, one from a State credit union, five from financial services 
entities, and three from credit union trade organizations. The comments 
were generally supportive of the proposal.

B. Summary of Comments

1. Broker-dealers and Safekeeping of Investments

    Throughout the rulemaking process, NCUA has expressed concern about 
the purchase of some brokered certificates of deposit (CDs). Deceptive 
practices or outright fraud on the part of some broker-dealers and 
safekeepers have caused losses for FCUs. NCUA does not believe, 
however, that more stringent standards on broker-dealers or 
safekeepers, such as those contemplated by the ANPR, would prevent 
losses. NCUA believes continued guidance to FCUs and prudent due 
diligence by FCUs is the best course of action. Therefore, NCUA is not 
making any substantive changes to broker-dealer and safekeeping 
requirements in this regard. The commenters generally supported this 
position.
    The proposed rule permits the use of depository institutions whose 
broker-dealer activities are regulated by a State regulatory agency. 
This provides FCUs with greater access to broker-dealers. NCUA also 
believes additional broker-dealer competition promotes improved 
service, better execution, and reduced costs. The commenters supported 
this proposal. The Board adopts this proposed revision in the final 
rule.
    Former Sec.  703.50(c) exempts CD finders from the broker-dealer 
requirements. It was always NCUA's intent to carry this exemption 
forward in proposed Sec.  703.8 as indicated in the preamble to the 
proposed rule. 67 FR 78996, 78996-97 (December 27, 2002). Specifically, 
if an FCU purchases a CD or share certificate directly from a bank, 
credit union, or other depository institution that issues the 
certificate, the FCU will not be bound by the broker-dealer 
requirements. This exemption was inadvertently omitted in the 
regulatory language in Sec.  703.8 of the proposed rule through a 
clerical error. As stated in the proposal's preamble, NCUA indicated it 
was making no changes to the broker-dealer section of the rule in this 
regard. Thus, the inclusion of this exemption in the final rule will 
not change the requirements pertaining to the use of broker-dealers.
    To be consistent with the broker-dealer requirements, the proposed 
rule added a due diligence requirement that calls for an FCU to review 
a safekeeper's financial condition, in addition to its registration 
status, and retain the documentation used to approve a safekeeper. NCUA 
believes these requirements represent prudent, minimum practices that 
FCUs should follow when evaluating a safekeeper. In addition, the 
proposed rule permitted State-regulated trust companies to be 
safekeepers for FCUs. NCUA recognizes these firms can provide a sound 
alternative for FCUs.
    The commenters overwhelmingly concurred with this aspect of the 
proposed rule. NCUA adopts this proposal in the final rule.

2. Expanded Investment Authorities

    The Federal Credit Union Act (Act) enumerates FCU investment 
powers. 12 U.S.C. 1757(7), (8), and (15). NCUA has adopted regulatory 
prohibitions against certain investments and investment activities 
permitted by the Act on the basis of safety and soundness concerns. In 
revising the rule, NCUA has explored ways to expand FCU investment 
powers. Generally, those investments currently prohibited by regulation 
exhibit high risks or are unsuitable for many FCUs, such as stripped 
mortgage-backed securities or variable rate investments tied to non-
domestic interest rates.
    As one means of expanding investment powers, the proposed rule 
permits some FCUs to purchase commercial mortgage related securities 
(CMRS), subject to certain restrictions. Specifically, the proposed 
rule limits the purchase of CMRS, which are not otherwise permitted by 
Sec.  107(7)(E) of the Act, 12 U.S.C. 1757(7)(E), to RegFlex eligible 
FCUs. 12 CFR part 742. Further, a RegFlex eligible FCU may purchase 
CMRS if the CMRS: (1) Are rated in one of the two highest rating 
categories by at least one nationally-recognized statistical rating 
organization; (2) otherwise meet the definitions of mortgage related 
security as defined in 15 U.S.C. 78c(a)(41) and CMRS as defined in 
proposed Sec.  703.2; and (3) have an underlying pool of loans 
containing more than 50 loans with no one loan representing more than 
10 percent of the pool. A RegFlex eligible FCU is limited to purchasing 
CMRS in an aggregate amount of up to 50 percent of its net worth. Most 
commenters supported NCUA's proposal to permit RegFlex eligible FCUs to 
purchase

[[Page 32959]]

CMRS with certain limitations. NCUA adopts this proposal as final.
    A few commenters suggested NCUA should adopt additional 
requirements or restrictions to address sound risk management practices 
for CMRS. NCUA believes no changes are necessary in this regard, but 
reminds FCUs that former Sec.  703.30 already requires FCUs to develop 
investment policies that address credit, liquidity, interest rate, and 
concentration risks. 12 CFR 703.30. The policy must also stipulate the 
characteristics of any investments that are suitable for the FCU. These 
requirements carry over to the final rule. Thus, FCUs that purchase 
CMRS must develop sound risk management policies and construct limits 
that represent the FCU board's risk tolerance.
    NCUA also proposed to permit FCUs to purchase equity options for 
the sole purpose of offering dividends based on the performance of an 
equity index. This proposal evolved from the experience gained 
monitoring an investment pilot program. The pilot program enabled NCUA 
to review the demands and risks associated with such a program before 
developing a regulation. Commenters agreed that the proposed regulatory 
language was prudent and would not pose any undue burden on FCUs. NCUA 
adopts the proposal.
    NCUA has determined that other currently prohibited investments 
should remain prohibited due to the complexity of the instruments or 
the difficulty in managing their associated risks. However, NCUA 
encourages FCUs that believe they possess the skills and resources to 
manage such investments to apply for a pilot program. The commenters 
generally supported this approach to expanding investment powers. NCUA 
remains committed to publishing standards for pilot programs that have 
been approved to facilitate future applications. These guidelines will 
be available on the NCUA website or by contacting the appropriate NCUA 
regional office. Additionally, investment pilot program applicants are 
encouraged to submit alternative proposals for NCUA's consideration.

3. Discretionary Control of Investments and Investment Advisers

    Former Sec.  703.40(c)(6) authorizes an FCU to delegate to an 
outside third party discretionary control over the purchase and sale of 
investments, up to 100 percent of the FCU's net capital at the time of 
delegation. 12 CFR 703.40(c)(6). RegFlex eligible FCUs are exempt from 
this cap. 12 CFR 742.4.
    NCUA proposed that FCUs conduct an annual evaluation of the amount 
of investments under discretionary control. Further, the proposal 
required an FCU to notify its board of directors and the appropriate 
regional director if the amount under discretionary control exceeds the 
cap at the time of the annual evaluation. An FCU must develop a plan to 
bring itself into compliance with the cap within a reasonable period of 
time.
    Generally, commenters supported this proposal, although a few 
commenters suggested that NCUA permit all FCUs to exceed the cap, not 
just RegFlex eligible FCUs. These commenters stated that FCUs not 
meeting RegFlex eligibility may benefit most from having an investment 
professional manage an FCU's investments. NCUA has determined not to 
lift the cap for FCUs ineligible for RegFlex. NCUA notes that an FCU 
currently not meeting RegFlex eligibility requirements may petition its 
regional director for a RegFlex designation. The Board adopts the 
proposed revisions.
    Commenters also questioned whether it was reasonable for an FCU 
board to be required to notify the appropriate regional director of any 
violation of the cap within five business days of exceeding the cap. 
NCUA believes this is reasonable. The regulation stipulates that an FCU 
only notify its regional director within five business days. An FCU is 
not required to submit a plan to bring it into compliance within this 
time frame. An FCU must develop a plan within a reasonable period of 
time after notification. A reasonable period of time will be decided by 
the regional director after considering an FCU's circumstances, 
including the materiality of the breach and the risk to the FCU's 
earnings and capital.
    In response to a commenter's question, NCUA clarifies that mutual 
funds are not included in the calculation of funds under discretionary 
control.
    As part of the background check of an investment advisor, the 
proposed rule required that an FCU analyze the background of the firm 
for whom an investment adviser works, in addition to the investment 
adviser and his or her associated personnel. No commenters objected to 
this requirement. This proposed change is adopted in the final rule. 
Several commenters urged NCUA to clarify the meaning of ``associated 
personnel'' as it is used in proposed Sec. Sec.  703.5 and 703.8. NCUA 
notes that the proposed rule included a definition for ``associated 
personnel'' in proposed Sec.  703.2 and it is adopted in the final.

4. Borrowing Repurchase Transaction

    Borrowing repurchase transactions, formerly referred to as reverse 
repurchase transactions, enable an FCU to sell securities under an 
agreement to repurchase in order to borrow funds. 12 CFR 703.100(j). 
Section 703.100(j)(2) prohibits an FCU from purchasing an investment 
with the proceeds from a reverse repurchase agreement if the purchased 
investment matures after the maturity of the reverse repurchase 
agreement. 12 CFR 703.100(j)(2). NCUA proposed to permit RegFlex 
eligible FCUs to purchase securities with maturities exceeding the 
maturity of the borrowing repurchase transaction in an amount not to 
exceed the FCU's net worth.
    Most of the commenters supported the proposal. Three commenters 
objected to the proposed rule because they believed there should be no 
restrictions on the maturity of any investment purchased by any FCU. 
These commenters indicated there are no similar restrictions applicable 
to other types of borrowing. NCUA believes the limitation is prudent 
and does not unduly impede any FCU's ability to manage its balance 
sheet and, therefore, adopts the proposed revision in the final rule.

5. Investment Repurchase Transaction

    The proposed rule changed the term ``repurchase transactions'' to 
``investment repurchase transactions'' and revised the requirements for 
investment repurchase transactions to be consistent with those of 
securities lending transactions. Other than these revisions, the 
proposal did not make any substantive amendments in this regard. No 
commenter objected. NCUA adopts the proposed revisions.

6. Securities Lending Transaction

    Former Sec.  703.100(k) addresses securities lending transactions 
and requires an FCU to take a perfected first priority security 
interest in all collateral the FCU receives. 12 CFR 703.100(k). 
Proposed Sec.  703.13 removes the word ``perfected'', but still 
requires a first priority security interest through possession or 
control of the collateral. In addition, the proposed rule clarifies 
that an FCU's agent may act in its place in these transactions. No 
commenter objected. NCUA adopts the proposed revisions as final.

7. Recordkeeping and Generally Accepted Accounting Principles

    The Act provides that the accounting principles applicable to 
reports or statements required to be filed with NCUA by insured credit 
unions, except

[[Page 32960]]

those with total assets of less than $10 million, must be uniform and 
consistent with generally accepted accounting principles (GAAP). 12 
U.S.C. 1782a(a)(6)(C). NCUA proposed to revise part 703 to clarify that 
FCUs having total assets of $10 million or more must comply with all 
GAAP provisions related to the accounting principles applicable to 
reports or statements required to be filed with NCUA, not just selected 
ones. While not mandatory for FCUs with total assets of less than $10 
million, NCUA encourages them also to comply with GAAP or to account 
for their investments consistent with the NCUA Accounting Manual for 
Federal Credit Unions, which can be found on the NCUA website. No 
commenters objected. NCUA adopts this amendment.

8. Net Worth

    To be consistent with changes in the Act and NCUA's rules, NCUA 
proposed to replace the term ``net capital'' with ``net worth.'' No 
commenter objected to this change. NCUA adopts it in the final rule.

9. Format

    The proposal changed the question and answer format to a more 
traditional format to make the rule easier to read and more conducive 
to finding information quickly. Many commenters supported this 
amendment and no commenters objected to it. NCUA adopts it in the final 
rule.

10. State-Chartered Credit Unions

    One commenter noted that State-chartered credit unions that make 
investments that are impermissible for FCUs must reserve for those non-
conforming investments. 12 CFR 741.3. The commenter questioned whether 
State-chartered credit unions need to reserve for non-conforming 
investments that are permissible for RegFlex eligible FCUs. NCUA 
believes that, if a State-chartered credit union meets all the criteria 
for RegFlex eligibility as detailed in Sec.  742.2, then it is not 
required to reserve for non-conforming investments that are permissible 
for RegFlex eligible FCUs. 12 CFR 742.2. If at any time a State-
chartered credit union fails to meet the RegFlex eligibility criteria, 
then it must reserve for any non-conforming investments it owns.
    Another commenter urged NCUA to revise proposed Sec.  703.1, the 
purpose and scope section, to clarify that State-chartered credit 
unions, in addition to complying with the reserve requirement for non-
conforming investments in Sec.  741.3, must also comply with the 
requirements of part 703 concerning transacting business with corporate 
credit unions, as provided in Sec.  741.219. 12 CFR 741.219. NCUA 
believes it will be helpful to include this reference in the purpose 
and scope section and is including it in the final rule as a technical 
correction.

11. Other Technical Corrections

    Proposed Sec.  703.16(a) incorrectly references Sec.  703.14(h). 
The correct and intended reference, reflected in the final rule, is to 
Sec.  703.14(g).
    Proposed Sec.  703.3(g) stated that only ``those individuals with 
investment authority may be voting members of an investment-related 
committee.'' (Emphasis added.) The former version of the rule requires 
that only ``officials and employees of the Federal credit union may be 
voting members of an investment-related committee.'' (Emphasis added.) 
This was an unintended change in language. NCUA received no comment on 
this but wishes to clarify that the prior language in part 703 remains 
unchanged as intended by the proposal.

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a proposed rule may have on 
a substantial number of small credit unions (those under $1 million in 
assets). This rule clarifies the investment authority granted to FCUs 
and conforms the Regulatory Flexibility Program to the investment rule. 
The final amendments will not have a significant economic impact on a 
substantial number of small credit unions and, therefore, a regulatory 
flexibility analysis is not required.

Paperwork Reduction Act

    The current Office of Management and Budget control number assigned 
to part 703 is 3133-0133. NCUA has determined that the final rule would 
not increase paperwork requirements under the Paperwork Reduction Act 
of 1995 and regulations of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on State and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies 
with the executive order. The final rule would not have substantial 
direct effects on the States, on the connection between the national 
government and the States, or on the distribution of power and 
responsibilities among the various levels of government. NCUA has 
determined that this final rule does not constitute a policy that has 
federalism implications for purposes of the executive order.

The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    NCUA has determined that this final rule would not affect family 
well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 
2681 (1998).

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Act of 1996 (Pub. L. 104-
121) provides generally for congressional review of agency rules. A 
reporting requirement is triggered in instances where NCUA issues a 
final rule as defined by Section 551 of the Administrative Procedure 
Act. 5 U.S.C. 551. The Office of Management and Budget has determined 
that this rule is not a major rule for purposes of the Small Business 
Regulatory Enforcement Fairness Act of 1996.

List of Subjects

12 CFR part 703

    Credit unions, Investments.

12 CFR part 742

    Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on May 22, 
2003.
Becky Baker,
Secretary of the Board.


0
Accordingly, NCUA amends 12 CFR parts 703 and 742 as follows:

PART 703--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

0
1. The authority citation for part 703 continues to read as follows:

    Authority:  12 U.S.C. 1757(7), 1757(8), 1757(15).


0
2. Revise part 703 to read as follows:

PART 703--INVESTMENT AND DEPOSIT ACTIVITIES

Sec.
703.1 Purpose and scope.
703.2 Definitions.
703.3 Investment policies.

[[Page 32961]]

703.4 Recordkeeping and documentation requirements.
703.5 Discretionary control over investments and investment 
advisers.
703.6 Credit analysis.
703.7 Notice of non-compliant investments.
703.8 Broker-dealers.
703.9 Safekeeping of investments.
703.10 Monitoring non-security investments.
703.11 Valuing securities.
703.12 Monitoring securities.
703.13 Permissible investment activities.
703.14 Permissible investments.
703.15 Prohibited investment activities.
703.16 Prohibited investments.
703.17 Conflicts of interest.
703.18 Grandfathered investments.
703.19 Investment pilot program.


Sec.  703.1  Purpose and scope.

    (a) This part interprets several of the provisions of Sections 
107(7), 107(8), and 107(15) of the Federal Credit Union Act (Act), 12 
U.S.C. 1757(7), 1757(8), 1757(15), which list those securities, 
deposits, and other obligations in which a Federal credit union may 
invest. Part 703 identifies certain investments and deposit activities 
permissible under the Act and prescribes regulations governing those 
investments and deposit activities on the basis of safety and soundness 
concerns. Additionally, part 703 identifies and prohibits certain 
investments and deposit activities. Investments and deposit activities 
that are permissible under the Act and not prohibited or otherwise 
regulated by part 703 remain permissible for Federal credit unions.
    (b) This part does not apply to:
    (1) Investment in loans to members and related activities, which is 
governed by Sec. Sec.  701.21, 701.22, 701.23, and part 723 of this 
chapter;
    (2) The purchase of real estate-secured loans pursuant to Section 
107(15)(A) of the Act, which is governed by Sec.  701.23 of this 
chapter;
    (3) Investment in credit union service organizations, which is 
governed by part 712 of this chapter;
    (4) Investment in fixed assets, which is governed by Sec.  701.36 
of this chapter;
    (5) Investment by corporate credit unions, which is governed by 
part 704 of this chapter; or
    (6) Investment activity by State-chartered credit unions, except as 
provided in Sec.  741.3(a)(3) and Sec.  741.219 of this chapter.


Sec.  703.2  Definitions.

    The following definitions apply to this part:
    Adjusted trading means selling an investment to a counterparty at a 
price above its current fair value and simultaneously purchasing or 
committing to purchase from the counterparty another investment at a 
price above its current fair value.
    Associated personnel means a person engaged in the investment 
banking or securities business who is directly or indirectly controlled 
by a National Association of Securities Dealers (NASD) member, whether 
or not this person is registered or exempt from registration with NASD. 
Associated personnel includes every sole proprietor, partner, officer, 
director, or branch manager of any NASD member.
    Banker's acceptance means a time draft that is drawn on and 
accepted by a bank and that represents an irrevocable obligation of the 
bank.
    Bank note means a direct, unconditional, and unsecured general 
obligation of a bank that ranks equally with all other senior unsecured 
indebtedness of the bank, except deposit liabilities and other 
obligations that are subject to any priorities or preferences.
    Borrowing repurchase transaction means a transaction in which the 
Federal credit union agrees to sell a security to a counterparty and to 
repurchase the same or an identical security from that counterparty at 
a specified future date and at a specified price.
    Call means an option that gives the holder the right to buy the 
underlying security at a specified price during a fixed time period.
    Collective investment fund means a fund maintained by a national 
bank under 12 CFR part 9 (Comptroller of the Currency's regulations).
    Commercial mortgage related security means a mortgage related 
security, as defined below, except that it is collateralized entirely 
by commercial real estate, such as a warehouse or office building, or a 
multi-family dwelling consisting of more than four units.
    Counterparty means the party on the other side of the transaction.
    Custodial agreement means a contract in which one party agrees to 
exercise ordinary care in protecting the securities held in safekeeping 
for others.
    Delivery versus payment means payment for an investment must occur 
simultaneously with its delivery.
    Deposit note means an obligation of a bank that is similar to a 
certificate of deposit but is rated.
    Derivatives means financial instruments or other contracts whose 
value is based on the performance of an underlying financial asset, 
index or other investment that have the three following 
characteristics:
    (1) It has one or more underlyings and one or more notional amounts 
or payment provisions or both that determine the amount of the 
settlement or settlements, and, in some cases, whether or not a 
settlement is required;
    (2) It requires no initial net investment or an initial net 
investment that is less than would be required for other types of 
contracts that would be expected to have a similar response to changes 
in market factors; and
    (3) Its terms require or permit net settlement, it can readily be 
settled net by means outside the contract, or it provides for delivery 
of an asset that puts the recipient in a position not substantially 
different from net settlement.
    Embedded option means a characteristic of an investment that gives 
the issuer or holder the right to alter the level and timing of the 
cash flows of the investment. Embedded options include call and put 
provisions and interest rate caps and floors. Since a prepayment option 
in a mortgage is a type of call provision, a mortgage-backed security 
composed of mortgages that may be prepaid is an example of an 
investment with an embedded option.
    Eurodollar deposit means a U.S. dollar-denominated deposit in a 
foreign branch of a United States depository institution.
    European financial options contract means an option that can be 
exercised only on its expiration date.
    Fair value means the amount at which an instrument could be 
exchanged in a current, arms-length transaction between willing 
parties, as opposed to a forced or liquidation sale.
    Financial options contract means an agreement to make or take 
delivery of a standardized financial instrument upon demand by the 
holder of the contract as specified in the agreement.
    Immediate family member means a spouse or other family member 
living in the same household.
    Industry-recognized information provider means an organization that 
obtains compensation by providing information to investors and receives 
no compensation for the purchase or sale of investments.
    Investment means any security, obligation, account, deposit, or 
other item authorized for purchase by a Federal credit union under 
Sections 107(7), 107(8), or 107(15) of the Act, or this part, other 
than loans to members.
    Investment repurchase transaction means a transaction in which an 
investor agrees to purchase a security from a counterparty and to 
resell the same or an identical security to that counterparty at a 
specified future date and at a specified price.
    Maturity means the date the last principal amount of a security is

[[Page 32962]]

scheduled to come due and does not mean the call date or the weighted 
average life of a security.
    Mortgage related security means a security as defined in Section 
3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)), 
e.g., a privately-issued security backed by first lien mortgages 
secured by real estate upon which is located a dwelling, mixed 
residential and commercial structure, residential manufactured home, or 
commercial structure, that is rated in one of the two highest rating 
categories by at least one nationally-recognized statistical rating 
organization.
    Mortgage servicing rights means a contractual obligation to perform 
mortgage servicing and the right to receive compensation for performing 
those services. Mortgage servicing is the administration of a mortgage 
loan, including collecting monthly payments and fees, providing 
recordkeeping and escrow functions, and, if necessary curing defaults 
and foreclosing.
    Negotiable instrument means an instrument that may be freely 
transferred from the purchaser to another person or entity by delivery, 
or endorsement and delivery, with full legal title becoming vested in 
the transferee.
    Net worth means the retained earnings balance of the credit union 
at quarter end as determined under generally accepted accounting 
principles and as further defined in Sec.  702.2(f) of this chapter.
    Official means any member of a Federal credit union's board of 
directors, credit committee, supervisory committee, or investment-
related committee.
    Ordinary care means the degree of care, which an ordinarily prudent 
and competent person engaged in the same line of business or endeavor 
should exercise under similar circumstances.
    Pair-off transaction means an investment purchase transaction that 
is closed or sold on, or before the settlement date. In a pair-off, an 
investor commits to purchase an investment, but then pairs-off the 
purchase with a sale of the same investment before or on the settlement 
date.
    Put means a financial options contract that entitles the holder to 
sell, entirely at the holder's option, a specified quantity of a 
security at a specified price at any time until the stated expiration 
date of the contract.
    Registered investment company means an investment company that is 
registered with the Securities and Exchange Commission under the 
Investment Company Act of 1940 (15 U.S.C. 80a). Examples of registered 
investment companies are mutual funds and unit investment trusts.
    Regular way settlement means delivery of a security from a seller 
to a buyer within the time frame that the securities industry has 
established for immediate delivery of that type of security. For 
example, regular way settlement of a Treasury security includes 
settlement on the trade date (cash), the business day following the 
trade date (regular way), and the second business day following the 
trade date (skip day).
    Residual interest means the remainder cash flows from 
collateralized mortgage obligations/real estate mortgage investment 
conduits (CMOs/REMICs), or other mortgage-backed security transaction, 
after payments due bondholders and trust administrative expenses have 
been satisfied.
    Securities lending means lending a security to a counterparty, 
either directly or through an agent, and accepting collateral in 
return.
    Security means a share, participation, or other interest in 
property or in an enterprise of the issuer or an obligation of the 
issuer that:
    (1) Either is represented by an instrument issued in bearer or 
registered form or, if not represented by an instrument, is registered 
in books maintained to record transfers by or on behalf of the issuer;
    (2) Is of a type commonly dealt in on securities exchanges or 
markets or, when represented by an instrument, is commonly recognized 
in any area in which it is issued or dealt in as a medium for 
investment; and
    (3) Either is one of a class or series or by its terms is divisible 
into a class or series of shares, participations, interests, or 
obligations.
    Senior management employee means a Federal credit union's chief 
executive officer (typically this individual holds the title of 
President or Treasurer/Manager), an assistant chief executive officer, 
and the chief financial officer.
    Small business related security means a security as defined in 
Section 3(a)(53) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(53), e.g., a security that is rated in 1 of the 4 highest rating 
categories by at least one nationally recognized statistical rating 
organization, and represents an interest in one or more promissory 
notes or leases of personal property evidencing the obligation of a 
small business concern and originated by an insured depository 
institution, insured credit union, insurance company, or similar 
institution which is supervised and examined by a Federal or State 
authority, or a finance company or leasing company. This definition 
does not include Small Business Administration securities permissible 
under Sec.  107(7) of the Act.
    Weighted average life means the weighted-average time to the return 
of a dollar of principal, calculated by multiplying each portion of 
principal received by the time at which it is expected to be received 
(based on a reasonable and supportable estimate of that time) and then 
summing and dividing by the total amount of principal.
    When-issued trading of securities means the buying and selling of 
securities in the period between the announcement of an offering and 
the issuance and payment date of the securities.
    Yankee dollar deposit means a deposit in a United States branch of 
a foreign bank licensed to do business in the State in which it is 
located, or a deposit in a State-chartered, foreign controlled bank.
    Zero coupon investment means an investment that makes no periodic 
interest payments but instead is sold at a discount from its face 
value. The holder of a zero coupon investment realizes the rate of 
return through the gradual appreciation of the investment, which is 
redeemed at face value on a specified maturity date.


Sec.  703.3  Investment policies.

    A Federal credit union's board of directors must establish written 
investment policies consistent with the Act, this part, and other 
applicable laws and regulations and must review the policy at least 
annually. These policies may be part of a broader, asset-liability 
management policy. Written investment policies must address the 
following:
    (a) The purposes and objectives of the Federal credit union's 
investment activities;
    (b) The characteristics of the investments the Federal credit union 
may make including the issuer, maturity, index, cap, floor, coupon 
rate, coupon formula, call provision, average life, and interest rate 
risk;
    (c) How the Federal credit union will manage interest rate risk;
    (d) How the Federal credit union will manage liquidity risk;
    (e) How the Federal credit union will manage credit risk including 
specifically listing institutions, issuers, and counterparties that may 
be used, or criteria for their selection, and limits on the amounts 
that may be invested with each;
    (f) How the Federal credit union will manage concentration risk, 
which can result from dealing with a single or

[[Page 32963]]

related issuers, lack of geographic distribution, holding obligations 
with similar characteristics like maturities and indexes, holding bonds 
having the same trustee, and holding securitized loans having the same 
originator, packager, or guarantor;
    (g) Who has investment authority and the extent of that authority. 
Those with authority must be qualified by education or experience to 
assess the risk characteristics of investments and investment 
transactions. Only officials or employees of the Federal credit union 
may be voting members of an investment-related committee;
    (h) The broker-dealers the Federal credit union may use;
    (i) The safekeepers the Federal credit union may use;
    (j) How the Federal credit union will handle an investment that, 
after purchase, is outside of board policy or fails a requirement of 
this part; and
    (k) How the Federal credit union will conduct investment trading 
activities, if applicable, including addressing:
    (1) Who has purchase and sale authority;
    (2) Limits on trading account size;
    (3) Allocation of cash flow to trading accounts;
    (4) Stop loss or sale provisions;
    (5) Dollar size limitations of specific types, quantity and 
maturity to be purchased;
    (6) Limits on the length of time an investment may be inventoried 
in a trading account; and
    (7) Internal controls, including segregation of duties.


Sec.  703.4  Recordkeeping and documentation requirements.

    (a) Federal credit unions with assets of $10,000,000 or greater 
must comply with all generally accepted accounting principles 
applicable to reports or statements required to be filed with NCUA. 
Federal credit unions with assets less than $10,000,000 are encouraged 
to do the same, but are not required to do so. Federal credit unions 
with assets less than $10,000,000 may choose to account for their 
investments consistent with the NCUA Accounting Manual For Federal 
Credit Unions.
    (b) A Federal credit union must maintain documentation for each 
investment transaction for as long as it holds the investment and until 
the documentation has been audited in accordance with Sec.  701.12 of 
this chapter and examined by NCUA. The documentation should include, 
where applicable, bids and prices at purchase and sale and for periodic 
updates, relevant disclosure documents or a description of the security 
from an industry-recognized information provider, financial data, and 
tests and reports required by the Federal credit union's investment 
policy and this part.
    (c) A Federal credit union must maintain documentation its board of 
directors used to approve a broker-dealer or a safekeeper for as long 
as the broker-dealer or safekeeper is approved and until the 
documentation has been audited in accordance with Sec.  701.12 of this 
chapter and examined by NCUA.
    (d) A Federal credit union must obtain an individual confirmation 
statement from each broker-dealer for each investment purchased or 
sold.


Sec.  703.5  Discretionary control over investments and investment 
advisers.

    (a) Except as provided in paragraph (b) of this section, a Federal 
credit union must retain discretionary control over its purchase and 
sale of investments. A Federal credit union has not delegated 
discretionary control to an investment adviser when the Federal credit 
union reviews all recommendations from investment advisers and is 
required to authorize a recommended purchase or sale transaction before 
its execution.
    (b)(1) A Federal credit union may delegate discretionary control 
over the purchase and sale of investments to a person other than a 
Federal credit union official or employee:
    (i) Provided the person is an investment adviser registered with 
the Securities and Exchange Commission under the Investment Advisers 
Act of 1940 (15 U.S.C. 80b); and
    (ii) In an amount up to 100 percent of its net worth in the 
aggregate at the time of delegation.
    (2) At least annually, the Federal credit union must adjust the 
amount of funds held under discretionary control to comply with the 100 
percent of net worth cap. The Federal credit union's board of directors 
must receive notice as soon as possible, but no later than the next 
regularly scheduled board meeting, of the amount exceeding the net 
worth cap and notify in writing the appropriate regional director 
within 5 days after the board meeting. The credit union must develop a 
plan to comply with the cap within a reasonable period of time.
    (3) Before transacting business with an investment adviser, a 
Federal credit union must analyze his or her background and information 
available from State or Federal securities regulators, including any 
enforcement actions against the adviser, associated personnel, and the 
firm for which the adviser works.
    (c) A Federal credit union may not compensate an investment adviser 
with discretionary control over the purchase and sale of investments on 
a per transaction basis or based on capital gains, capital 
appreciation, net income, performance relative to an index, or any 
other incentive basis.
    (d) A Federal credit union must obtain a report from its investment 
adviser at least monthly that details the investments under the 
adviser's control and their performance.


Sec.  703.6  Credit analysis.

    A Federal credit union must conduct and document a credit analysis 
on an investment and the issuing entity before purchasing it, except 
for investments issued or fully guaranteed as to principal and interest 
by the U.S. government or its agencies, enterprises, or corporations or 
fully insured (including accumulated interest) by the National Credit 
Union Administration or the Federal Deposit Insurance Corporation. A 
Federal credit union must update this analysis at least annually for as 
long as it holds the investment.


Sec.  703.7  Notice of non-compliant investments.

    A Federal credit union's board of directors must receive notice as 
soon as possible, but no later than the next regularly scheduled board 
meeting, of any investment that either is outside of board policy after 
purchase or has failed a requirement of this part. The board of 
directors must document its action regarding the investment in the 
minutes of the board meeting, including a detailed explanation of any 
decision not to sell it. The Federal credit union must notify in 
writing the appropriate regional director of an investment that has 
failed a requirement of this part within 5 days after the board 
meeting.


Sec.  703.8  Broker-dealers.

    (a) A Federal credit union may purchase and sell investments 
through a broker-dealer as long as the broker-dealer is registered as a 
broker-dealer with the Securities and Exchange Commission under the 
Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or is a 
depository institution whose broker-dealer activities are regulated by 
a Federal or State regulatory agency.
    (b) Before purchasing an investment through a broker-dealer, a 
Federal credit union must analyze and annually update the following:
    (1) The background of any sales representative with whom the 
Federal credit union is doing business;
    (2) Information available from State or Federal securities 
regulators and securities industry self-regulatory

[[Page 32964]]

organizations, such as the National Association of Securities Dealers 
and the North American Securities Administrators Association, about any 
enforcement actions against the broker-dealer, its affiliates, or 
associated personnel; and
    (3) If the broker-dealer is acting as the Federal credit union's 
counterparty, the ability of the broker-dealer and its subsidiaries or 
affiliates to fulfill commitments, as evidenced by capital strength, 
liquidity, and operating results. The Federal credit union should 
consider current financial data, annual reports, reports of nationally-
recognized statistical rating agencies, relevant disclosure documents, 
and other sources of financial information.
    (c) The requirements of paragraph (a) of this section do not apply 
when the Federal credit union purchases a certificate of deposit or 
share certificate directly from a bank, credit union, or other 
depository institution.


Sec.  703.9  Safekeeping of investments.

    (a) A Federal credit union's purchased investments and repurchase 
collateral must be in the Federal credit union's possession, recorded 
as owned by the Federal credit union through the Federal Reserve Book-
Entry System, or held by a board-approved safekeeper under a written 
custodial agreement that requires the safekeeper to exercise, at least, 
ordinary care.
    (b) Any safekeeper used by a Federal credit union must be regulated 
and supervised by either the Securities and Exchange Commission, a 
Federal or State depository institution regulatory agency, or a State 
trust company regulatory agency.
    (c) A Federal credit union must obtain and reconcile monthly a 
statement of purchased investments and repurchase collateral held in 
safekeeping.
    (d) Annually, the Federal credit union must analyze the ability of 
the safekeeper to fulfill its custodial responsibilities, as evidenced 
by capital strength, liquidity, and operating results. The Federal 
credit union should consider current financial data, annual reports, 
reports of nationally-recognized statistical rating agencies, relevant 
disclosure documents, and other sources of financial information.


Sec.  703.10  Monitoring non-security investments.

    (a) At least quarterly, a Federal credit union must prepare a 
written report listing all of its shares and deposits in banks, credit 
unions, and other depository institutions, that have one or more of the 
following features:
    (1) Embedded options;
    (2) Remaining maturities greater than 3 years; or
    (3) Coupon formulas that are related to more than one index or are 
inversely related to, or multiples of, an index.
    (b) The requirement of paragraph (a) of this section does not apply 
to shares and deposits that are securities.
    (c) If a Federal credit union does not have an investment-related 
committee, then each member of its board of directors must receive a 
copy of the report described in paragraph (a) of this section. If a 
Federal credit union has an investment-related committee, then each 
member of the committee must receive a copy of the report, and each 
member of the board must receive a summary of the information in the 
report.


Sec.  703.11  Valuing securities.

    (a) Before purchasing or selling a security, a Federal credit union 
must obtain either price quotations on the security from at least two 
broker-dealers or a price quotation on the security from an industry-
recognized information provider. This requirement to obtain price 
quotations does not apply to new issues purchased at par or at original 
issue discount.
    (b) At least monthly, a Federal credit union must determine the 
fair value of each security it holds. It may determine fair value by 
obtaining a price quotation on the security from an industry-recognized 
information provider, a broker-dealer, or a safekeeper.
    (c) At least annually, the Federal credit union's supervisory 
committee or its external auditor must independently assess the 
reliability of monthly price quotations received from a broker-dealer 
or safekeeper. The Federal credit union's supervisory committee or 
external auditor must follow generally accepted auditing standards, 
which require either re-computation or reference to market quotations.
    (d) If a Federal credit union is unable to obtain a price quotation 
required by this section for a particular security, then it may obtain 
a quotation for a security with substantially similar characteristics.


Sec.  703.12  Monitoring securities.

    (a) At least monthly, a Federal credit union must prepare a written 
report setting forth, for each security held, the fair value and dollar 
change since the prior month-end, with summary information for the 
entire portfolio.
    (b) At least quarterly, a Federal credit union must prepare a 
written report setting forth the sum of the fair values of all fixed 
and variable rate securities held that have one or more of the 
following features:
    (1) Embedded options;
    (2) Remaining maturities greater than 3 years; or
    (3) Coupon formulas that are related to more than one index or are 
inversely related to, or multiples of, an index.
    (c) Where the amount calculated in paragraph (b) of this section is 
greater than a Federal credit union's net worth, the report described 
in that paragraph must provide a reasonable and supportable estimate of 
the potential impact, in percentage and dollar terms, of an immediate 
and sustained parallel shift in market interest rates of plus and minus 
300 basis points on:
    (1) The fair value of each security in the Federal credit union's 
portfolio;
    (2) The fair value of the Federal credit union's portfolio as a 
whole; and
    (3) The Federal credit union's net worth.
    (d) If the Federal credit union does not have an investment-related 
committee, then each member of its board of directors must receive a 
copy of the reports described in paragraphs (a) through (c) of this 
section. If the Federal credit union has an investment-related 
committee, then each member of the committee must receive copies of the 
reports, and each member of the board of directors must receive a 
summary of the information in the reports.


Sec.  703.13  Permissible investment activities.

    (a) Regular way settlement and delivery versus payment basis. A 
Federal credit union may only contract for the purchase or sale of a 
security as long as the delivery of the security is by regular way 
settlement and the transaction is accomplished on a delivery versus 
payment basis.
    (b) Federal funds. A Federal credit union may sell Federal funds to 
an institution described in Section 107(8) of the Act and credit 
unions, as long as the interest or other consideration received from 
the financial institution is at the market rate for Federal funds 
transactions.
    (c) Investment repurchase transaction. A Federal credit union may 
enter into an investment repurchase transaction so long as:
    (1) Any securities the Federal credit union receives are 
permissible investments for Federal credit unions, the Federal credit 
union, or its agent, either takes physical possession or control of the 
repurchase securities or is recorded as owner of them through the 
Federal Reserve Book Entry Securities Transfer System, the Federal 
credit union, or its agent, receives a daily

[[Page 32965]]

assessment of their market value, including accrued interest, and the 
Federal credit union maintains adequate margins that reflect a risk 
assessment of the securities and the term of the transaction; and
    (2) The Federal credit union has entered into signed contracts with 
all approved counterparties.
    (d) Borrowing repurchase transaction. A Federal credit union may 
enter into a borrowing repurchase transaction so long as:
    (1) The transaction meets the requirements of paragraph (c) of this 
section;
    (2) Any cash the Federal credit union receives is subject to the 
borrowing limit specified in Section 107(9) of the Act, and any 
investments the Federal credit union purchases with that cash are 
permissible for Federal credit unions; and
    (3) The investments referenced in paragraph (d)(2) of this section 
mature no later than the maturity of the borrowing repurchase 
transaction.
    (e) Securities lending transaction. A Federal credit union may 
enter into a securities lending transaction so long as:
    (1) The Federal credit union receives written confirmation of the 
loan;
    (2) Any collateral the Federal credit union receives is a legal 
investment for Federal credit unions, the Federal credit union, or its 
agent, obtains a first priority security interest in the collateral by 
taking physical possession or control of the collateral, or is recorded 
as owner of the collateral through the Federal Reserve Book Entry 
Securities Transfer System; and the Federal credit union, or its agent, 
receives a daily assessment of the market value of the collateral, 
including accrued interest, and maintains adequate margin that reflects 
a risk assessment of the collateral and the term of the loan;
    (3) Any cash the Federal credit union receives is subject to the 
borrowing limit specified in Section 107(9) of the Act, and any 
investments the Federal credit union purchases with that cash are 
permissible for Federal credit unions and mature no later than the 
maturity of the transaction; and
    (4) The Federal credit union has executed a written loan and 
security agreement with the borrower.
    (f)(1) Trading securities. A Federal credit union may trade 
securities, including engaging in when-issued trading and pair-off 
transactions, so long as the Federal credit union can show that it has 
sufficient resources, knowledge, systems, and procedures to handle the 
risks.
    (2) A Federal credit union must record any security it purchases or 
sells for trading purposes at fair value on the trade date. The trade 
date is the date the Federal credit union commits, orally or in 
writing, to purchase or sell a security.
    (3) At least monthly, the Federal credit union must give its board 
of directors or investment-related committee a written report listing 
all purchase and sale transactions of trading securities and the 
resulting gain or loss on an individual basis.


Sec.  703.14  Permissible investments.

    (a) Variable rate investment. A Federal credit union may invest in 
a variable rate investment, as long as the index is tied to domestic 
interest rates and not, for example, to foreign currencies, foreign 
interest rates, or domestic or foreign commodity prices, equity prices, 
or inflation rates. For purposes of this part, the U.S. dollar-
denominated London Interbank Offered Rate (LIBOR) is a domestic 
interest rate.
    (b) Corporate credit union shares or deposits. A Federal credit 
union may purchase shares or deposits in a corporate credit union, 
except where the NCUA Board has notified it that the corporate credit 
union is not operating in compliance with part 704 of this chapter. A 
Federal credit union's aggregate amount of paid-in capital and 
membership capital, as defined in part 704 of this chapter, in one 
corporate credit union is limited to two percent of its assets measured 
at the time of investment or adjustment. A Federal credit union's 
aggregate amount of paid-in capital and membership capital in all 
corporate credit unions is limited to four percent of its assets 
measured at the time of investment or adjustment.
    (c) Registered investment company. A Federal credit union may 
invest in a registered investment company or collective investment 
fund, as long as the prospectus of the company or fund restricts the 
investment portfolio to investments and investment transactions that 
are permissible for Federal credit unions.
    (d) Collateralized mortgage obligation/real estate mortgage 
investment conduit. A Federal credit union may invest in a fixed or 
variable rate collateralized mortgage obligation/real estate mortgage 
investment conduit.
    (e) Municipal security. A Federal credit union may purchase and 
hold a municipal security, as defined in Section 107(7)(K) of the Act, 
only if a nationally-recognized statistical rating organization has 
rated it in one of the four highest rating categories.
    (f) Instruments issued by institutions described in Section 107(8) 
of the Act. A Federal credit union may invest in the following 
instruments issued by an institution described in Section 107(8) of the 
Act:
    (1) Yankee dollar deposits;
    (2) Eurodollar deposits;
    (3) Banker's acceptances;
    (4) Deposit notes; and
    (5) Bank notes with original weighted average maturities of less 
than 5 years.
    (g) European financial options contract. A Federal credit union may 
purchase a European financial options contract or a series of European 
financial options contracts only to fund the payment of dividends on 
member share certificates where the dividend rate is tied to an equity 
index provided:
    (1) The option and dividend rate are based on a domestic equity 
index;
    (2) Proceeds from the options are used only to fund dividends on 
the equity-linked share certificates;
    (3) Dividends on the share certificates are derived solely from the 
change in the domestic equity index over a specified period;
    (4) The options' expiration dates coincide with the maturity date 
of the share certificate;
    (5) The certificate may be redeemed prior to the maturity date only 
upon the member's death or termination of the corresponding option;
    (6) The total costs associated with the purchase of the option is 
known by the Federal credit union prior to effecting the transaction;
    (7) The options are purchased at the same time the certificate is 
issued to the member.
    (8) The counterparty to the transaction is a domestic counterparty 
and has been approved by the Federal credit union's board of directors;
    (9) The counterparty to the transaction:
    (i) Has a long-term, senior, unsecured debt rating from a 
nationally-recognized statistical rating organization of AA- (or 
equivalent) or better at the time of the transaction, and the contract 
between the counterparty and the Federal credit union specifies that if 
the long-term, senior, unsecured debt rating declines below AA- (or 
equivalent) then the counterparty agrees to post collateral with an 
independent party in an amount fully securing the value of the option; 
or
    (ii) Posts collateral with an independent party in an amount fully 
securing the value of the option if the counterparty does not have a 
long-term, senior unsecured debt rating from a nationally-recognized 
statistical rating organization.
    (10) Any collateral posted by the counterparty is a permissible 
investment for Federal credit unions and is valued daily by an 
independent

[[Page 32966]]

third party along with the value of the option;
    (11) The aggregate amount of equity-linked member share 
certificates does not exceed the credit union's net worth;
    (12) The terms of the share certificate include a guarantee that 
there can be no loss of principal to the member regardless of changes 
in the value of the option unless the certificate is redeemed prior to 
maturity; and
    (13) The Federal credit union provides it board of directors with a 
monthly report detailing at a minimum:
    (i) The dollar amount of outstanding equity-linked share 
certificates;
    (ii) Their maturities; and
    (iii) The fair value of the options as determined by an independent 
third party.


Sec.  703.15  Prohibited investment activities.

    Adjusted trading or short sales. A Federal credit union may not 
engage in adjusted trading or short sales.


Sec.  703.16  Prohibited investments.

    (a) Derivatives. A Federal credit union may not purchase or sell 
financial derivatives, such as futures, options, interest rate swaps, 
or forward rate agreements, except as permitted under Sec. Sec.  
701.21(i) and 703.14(g) of this chapter;
    (b) Zero coupon investments. A Federal credit union may not 
purchase a zero coupon investment with a maturity date that is more 
than 10 years from the settlement date;
    (c) Mortgage servicing rights. A Federal credit union may not 
purchase mortgage servicing rights as an investment but may perform 
mortgage servicing functions as a financial service for a member as 
long as the mortgage loan is owned by a member;
    (d) A Federal credit union may not purchase a commercial mortgage 
related security that is not otherwise permitted by Section 107(7)(E) 
of the Act; and
    (e) Other prohibited investments. A Federal credit union may not 
purchase stripped mortgage-backed securities, residual interests in 
collateralized mortgage obligations/real estate mortgage investment 
conduits, or small business related securities.


Sec.  703.17  Conflicts of interest.

    (a) A Federal credit union's officials and senior management 
employees, and their immediate family members, may not receive anything 
of value in connection with its investment transactions. This 
prohibition also applies to any other employee, such as an investment 
officer, if the employee is directly involved in investments, unless 
the Federal credit union's board of directors determines that the 
employee's involvement does not present a conflict of interest. This 
prohibition does not include compensation for employees.
    (b) A Federal credit union's officials and employees must conduct 
all transactions with business associates or family members that are 
not specifically prohibited by paragraph (a) of this section at arm's 
length and in the Federal credit union's best interest.


Sec.  703.18  Grandfathered investments.

    (a) Subject to safety and soundness considerations, a Federal 
credit union may hold a CMO/REMIC residual, stripped mortgage-backed 
securities, or zero coupon security with a maturity greater than 10 
years, if it purchased the investment:
    (1) Before December 2, 1991; or
    (2) On or after December 2, 1991, but before January 1, 1998, if 
for the purpose of reducing interest rate risk and if the Federal 
credit union meets the following:
    (i) The Federal credit union has a monitoring and reporting system 
in place that provides the documentation necessary to evaluate the 
expected and actual performance of the investment under different 
interest rate scenarios;
    (ii) The Federal credit union uses the monitoring and reporting 
system to conduct and document an analysis that shows, before purchase, 
that the proposed investment will reduce its interest rate risk;
    (iii) After purchase, the Federal credit union evaluates the 
investment at least quarterly to determine whether or not it actually 
has reduced the interest rate risk; and
    (iv) The Federal credit union accounts for the investment 
consistent with generally accepted accounting principles.
    (b) All grandfathered investments are subject to the valuation and 
monitoring requirements of Sec. Sec.  703.10, 703.11, and 703.12 of 
this part.


Sec.  703.19  Investment pilot program.

    (a) Under the investment pilot program, NCUA will permit a limited 
number of Federal credit unions to engage in investment activities 
prohibited by this part but permitted by the Act.
    (b) Except as provided in paragraph (c) of this section, before a 
Federal credit union may engage in additional activities it must obtain 
written approval from NCUA. To obtain approval, a Federal credit union 
must submit a request to its regional director that addresses the 
following items:
    (1) Certification that the Federal credit union is ``well-
capitalized'' under part 702 of this chapter;
    (2) Board policies approving the activities and establishing limits 
on them;
    (3) A complete description of the activities, with specific 
examples of how they will benefit the Federal credit union and how they 
will be conducted;
    (4) A demonstration of how the activities will affect the Federal 
credit union's financial performance, risk profile, and asset-liability 
management strategies;
    (5) Examples of reports the Federal credit union will generate to 
monitor the activities;
    (6) Projections of the associated costs of the activities, 
including personnel, computer, audit, and so forth;
    (7) Descriptions of the internal systems that will measure, 
monitor, and report the activities;
    (8) Qualifications of the staff and officials responsible for 
implementing and overseeing the activities; and
    (9) Internal control procedures that will be implemented, including 
audit requirements.
    (c) A third-party seeking approval of an investment pilot program 
must submit a request to the Director of the Office of Examination and 
Insurance that addresses the following items:
    (1) A complete description of the activities with specific examples 
of how a credit union will conduct and account for them, and how they 
will benefit a Federal credit union;
    (2) A description of any risks to a Federal credit union from 
participating in the program; and
    (3) Contracts that must be executed by the Federal credit union.
    (d) A Federal credit union need not obtain individual written 
approval to engage in investment activities prohibited by this part but 
permitted by statute where the activities are part of a third-party 
investment program that NCUA has approved under this section.

PART 742--REGULATORY FLEXIBILITY PROGRAM

0
3. The authority citation for part 742 continues to read as follows:

    Authority: 12 U.S.C. 1756 and 1766.


0
4. Revise Sec.  742.4 to read as follows:


Sec.  742.4  From what NCUA regulations will I be exempt?

    (a) RegFlex credit unions are exempt from the provisions of the 
following NCUA regulations without restrictions or limitations: Sec.  
701.25, Sec.  701.32(b) and (c), Sec.  701.36(a), (b) and (c), Sec.  
703.5(b)(1)(ii) and (2), Sec.  703.12(c); and Sec.  703.16(b) of this 
chapter.
    (b) RegFlex credit unions are exempt from the provisions of the 
following

[[Page 32967]]

NCUA regulations with certain restrictions or limitations:
    (1) Section 703.13(d)(3) of this chapter, provided the value of the 
investments that mature later than the borrowing repurchase transaction 
does not exceed 100 percent of the Federal credit union's net worth; 
and
    (2) Section 703.16(d) of this chapter provided:
    (i) The issuer of the security is domestic;
    (ii) The security is rated in one of the two highest rating 
categories by at least one nationally-recognized statistical rating 
organization;
    (iii) The security meets the definition of mortgage related 
security as defined in 15 U.S.C. 78c(a)(41) and the definition of 
commercial mortgage related security as defined in Sec.  703.2 of this 
chapter;
    (iv) The security's underlying pool of loans contains more than 50 
loans with no one loan representing more than 10 percent of the pool; 
and
    (v) The aggregate total of commercial mortgage related securities 
purchased by the Federal credit union does not exceed 50 percent of its 
net worth.

[FR Doc. 03-13660 Filed 6-2-03; 8:45 am]
BILLING CODE 7535-01-P