Source: https://www.federalregister.gov/documents/2012/11/05/2012-26806/funding-and-fiscal-affairs-loan-policies-and-operations-and-funding-operations-investment-management
Timestamp: 2017-10-19 15:29:23
Document Index: 717951488

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Federal Register :: Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Investment Management
A Rule by the Farm Credit Administration on 11/05/2012
FCA-2012-0024
Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations: Investment Management
https://www.federalregister.gov/d/2012-26806 https://www.federalregister.gov/d/2012-26806
Ensure that Farm Credit banks [1] hold sufficient high-quality, readily marketable investments to provide sufficient liquidity to continue operations and pay maturing obligations in the event of market disruption;
Congress created the System as a Government-sponsored enterprise (GSE) to provide a permanent, stable, and reliable source of credit and related services to American agricultural and aquatic producers. Farm Credit banks obtain funds that they and System associations use to provide credit and related services primarily through the issuance of Systemwide debt securities.[2] If access to the debt market becomes temporarily impeded, Farm Credit banks must have enough readily available funds to continue operations and pay maturing obligations. Subpart E of part 615 imposes comprehensive requirements regarding the investments of System institutions in order to ensure continuity of operations.
In 2010, we issued FCA Bookletter BL-064, which provided clarification and guidance regarding our regulations and expectations with respect to the key elements of a robust investment asset management framework that institutions should establish to prudently manage their investments in changing markets.[3] The issuance of this bookletter was an interim measure towards strengthening our investment regulations.
On August 18, 2011, we published a proposed rule to amend FCA's regulations governing System investments.[4] Our intention was to strengthen and enhance board governance and controls and clarify our expectations over investment management practices, while reducing regulatory burden in several areas. After considering the comments we received on the proposed rule, we now plan to finalize the proposed provisions contained in the proposed rule in installments.
§ 615.5131—Definitions;
§ 615.5132—Investment Purposes;
§ 615.5133—Investment Management;
§ 615.5136—Emergencies Impeding Normal Access of Farm Credit Banks to Capital Markets;
§ 615.5143—Management of Ineligible Investments and Reservation of Authority to Require Divestiture;
§ 615.5174—Farmer Mac Securities;
§ 615.5180—Bank Interest Rate Risk Management Program; and
In addition, we are making minor technical conforming revisions to § 615.5140 and to § 615.5201, which is the Definitions section in our capital adequacy regulations.
§ 615.5135—Management of Interest Rate Risk (we are incorporating its provisions, as amended, into § 615.5180);
§ 615.5141—Stress Tests for Mortgage Securities (we are incorporating its provisions, as amended, into §§ 615.5133(f)(1)(iii) and 615.5133(f)(4)); and
§ 615.5181—Bank Interest Rate Risk Management Program (we are incorporating its provisions, as amended, into § 615.5180).
§ 615.5140—Eligible Investments (except for minor technical changes); and
§ 615.5142—Association Investments.
Because we are not at this time finalizing revisions to § 615.5142, governing association investments, the guidance on association investments in BL-064, which clarifies existing § 615.5142, will continue to be relevant. In addition, institutions should be mindful of our Informational Memorandum on Association Investments dated May 16, 2012, which reminds banks and associations of their obligations under § 615.5142.
FCA received comment letters from two Farm Credit banks—CoBank, ACB and the Farm Credit Bank of Texas. FCA also received comment letters from four Farm Credit associations—Colonial Farm Credit, ACA, FCS Financial, ACA, Farm Credit Services of Mid-America, ACA, and AgStar Financial Services, ACA. In addition, the Farm Credit Council (Council) submitted comments that were developed with input from a workgroup that includes financial officers from several associations, all Farm Credit banks, and the Federal Farm Credit Banks Funding Corporation (Funding Corporation). Finally, we also considered a comment letter the Council submitted to FCA on a similar proposed rule governing the Federal Agricultural Mortgage Corporation (Farmer Mac) [5] that generally encouraged us to make the requirements of the two rules more similar. Although the two final rules continue to differ where appropriate, changes were made to both this rule and the Farmer Mac rule to make the requirements more similar.[6]
We proposed to amend § 615.5131 to add definitions for the terms Government agency and Government-sponsored agency. The Council noted that FCA had already defined these terms in our capital adequacy regulation at § 615.5201. The Council stated that FCA and the other banking regulators “essentially define these terms identically” for capital purposes, and it asked us to conform the definitions.
We note that the definitions of these terms in the capital regulations of FCA and of other banking regulators such as the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) contain technical differences from one another.[7] In an effort to bring additional clarity to these definitions, the definitions we proposed in this rulemaking also differed in technical ways from any of these other definitions. In the absence of definitive common definitions, we believe our technical differences from the other regulators are warranted. We agree, however, that FCA's definitions should be consistent among themselves. Accordingly, we are finalizing the § 615.5131 definitions as proposed with minor technical changes and, as discussed below, we are revising the definitions in § 615.5201 to conform.
Section 615.5132 permits each Farm Credit bank to hold eligible investments, for specified purposes,[8] in an amount not to exceed 35 percent of its total outstanding loans. We remind banks that generating earnings is not an authorized investment purpose, although it is permissible if the earnings are incidental to one or more of the specified investment purposes.[9]
In § 615.5132(b)(1), we adopt as final our proposal to permit Farm Credit banks to exclude investments pledged to meet margin requirements for derivative transactions (collateral) when calculating the 35-percent investment limit under paragraph (a). We note that investments that are pledged as collateral do not count toward a Farm Credit bank's compliance with its liquidity requirements.[10] We make this change because derivatives are used as a hedging tool against interest rate risk and liquidity risk. Farm Credit banks use derivative products as an integral part of their interest rate risk management activities and as a supplement to the issuance of debt securities in the capital markets. We recognize that banks are required to post collateral to counterparties resulting from entering into derivative transactions, and we believe banks should not be discouraged from implementing appropriate risk management practices. We received positive comments on this proposal from the Council and a bank.
Finally, the Council requested that investment securities pledged in secured borrowing relationships be excluded from the 35-percent limit. The Council cited State Ag-Linked lending programs and repurchase agreements as examples of these secured borrowing relationships. Under both arrangements, according to the Council, the pledging of securities acts as an alternative that provides cash for operations without the issuance of new Federal Farm Credit Banks debt obligations. Under § 615.5134(b), these investments may not be counted in the liquidity reserve because they are not unencumbered. The Council asserts that excluding pledged securities from the 35-percent limit would be consistent with use of the securities as an alternative method to secure financing and their treatment under the FCA regulatory liquidity measurement.
We decline to exclude these investments from the investment limit on a blanket basis. We view these types of transactions as part of a Farm Credit bank's normal cash management operations. Thus, under normal conditions, we expect each Farm Credit bank to manage the level of its investments within FCA's portfolio size limits to ensure regulatory compliance. As discussed below, however, we are providing additional flexibility to each bank in the management of its investment portfolio by revising the regulation to allow compliance with the limit on a 30-day average daily balance (ADB) basis rather than on a daily basis; this change will enable a bank to exceed the investment limit temporarily, as long as its 30-day ADB is below the limit. Moreover, final § 615.5132(b)(2) permits the exclusion from the investment limit of other investments as FCA determines is appropriate.
The numerator (investments) will be calculated as a 30-day ADB of investments measured at amortized cost, excluding interest and net of all collateral pledged for derivative purposes and any other investments for which FCA has approved exclusions. The calculation of the denominator (total outstanding loans) remains unchanged, although the regulation makes explicit our existing interpretation that total loans include accrued interest and do not include allowance for loan loss.[11] Compliance will only be measured at month end.
Effective investment management requires financial institutions to establish policies that include risk limits, approved mechanisms for identifying, measuring, and reporting exposures, and strong corporate governance. The recent crisis and its lingering effects have re-emphasized the importance of sound investment management, and we believe that strengthened regulation would further ensure the safe and sound management of investments. Accordingly, we are making significant changes to § 615.5133, which governs investment management.
Revised § 615.5133(b), which we discuss in greater detail below, requires investment policies to be sufficiently detailed, consistent with, and appropriate for the amounts, types, and risk characteristics of an institution's investments.[12] As we stated in 1999 and have repeated since that time, bank oversight does not absolve an association's board and managers of their fiduciary responsibilities to manage investments in a safe and sound manner. The fiduciary responsibilities of association boards obligate them to develop appropriate investment management policies and practices to manage the risks associated with investment activities. Moreover, each association's investment managers must fully understand the risks of its investments and make independent and objective evaluations of investments prior to purchase. An association must comply with all the requirements in § 615.5133 if the level or type of its investments could expose its capital to material loss.
We also move to this section and clarify a documentation requirement that we had proposed in § 615.5133(b). We had proposed to require institutions to document in their records or board minutes any analyses used in formulating their policies or amendments to the policies. The Council stated that suggesting board minutes as a place to document this analysis is burdensome and does not enhance the investment management process. We do not agree that suggesting board minutes as an optional location for documentation is burdensome. Nevertheless, we revise the last sentence of § 615.5133(a) to require that any changes to the policies must be documented, without specifying a location.
The Council commented that the revisions in this proposed paragraph appeared reasonable overall. We move from § 615.5133(f)(1) a sentence requiring investment policies to fully address the extent of pre-purchase analysis that management must perform for various classes of investments. Otherwise, except for several minor non-substantive technical changes, the revisions in this paragraph are unchanged from the proposed rule.
We received comment on the clarity of the proposed language in this provision. Accordingly, we are clarifying the requirements in final § 615.5133(c) to require that investment policies must include concentration limits to ensure prudent diversification of credit, market, and liquidity risk in the investment portfolio.
Existing § 615.5133(c)(1)(ii) requires an institution's board to review annually the investment policy criteria for selecting securities firms and to determine whether to continue the institution's existing relationships with them. To reduce regulatory burden, we proposed to permit a designated committee of the board to review the criteria and to determine whether to continue existing relationships, but the board would have had to approve any changes to the criteria or to the existing relationships.
Existing § 615.5133(c)(1)(iii) requires investment policies to establish collateral margin requirements on repurchase agreements. We proposed to require institutions to regularly mark the collateral to market and ensure appropriate controls are maintained over collateral held. We received positive comments on this provision and adopt it as proposed.
Existing § 615.5133(c)(2) requires an institution's board to establish market risk limits in accordance with our regulations and other policies. In our proposed rule, we specifically identified these other regulations as those governing stress testing and interest rate risk.
In response to these comments, the final regulation, like the existing regulation, requires investment policies to set market risk limits for specific types of investments and for the investment portfolio.[13] We believe this requirement is sufficient and the reference to our “regulations and * * * other policies” is not needed.
Existing § 615.5133(e)(2) requires System institutions to establish and maintain a separation of duties and supervision between personnel who execute investment transactions and personnel who approve, revaluate, and oversee investments. Proposed § 615.5133(e)(2) would have added to the list of personnel whose duties and supervision would have had to be separated from personnel who execute investment transactions. These additional personnel would have been those who post accounting entries, reconcile trade confirmations, and report compliance with investment policy.
Both the Council and a bank objected to this proposed revision as overly prescriptive. In response, rather than itemizing all of the possible personnel functions, final § 615.5133(e)(2) provides that System institutions must establish and maintain a separation of duties between personnel who supervise or execute investment transactions and personnel who supervise or engage in all other investment-related functions. These other investment-related functions include those itemized in the list in the proposed rule, as well as any other functions that are investment-related. Examples of those items in the proposed rule include but are not limited to posting accounting entries and reconciling trade confirmations. This regulation does not prohibit one person from performing or supervising more than one investment-related function, except that the same person cannot supervise or execute investment transactions and at the same time supervise or engage in any other investment-related function. Each institution must maintain appropriate controls as warranted by the complexity and risk of its investment operations.
Proposed § 615.5133(e)(4) would have added a new requirement that System institutions must implement effective internal audit programs to review, at least annually, their investment controls, processes, and compliance with FCA regulations and other regulatory guidance. Internal audit programs would have had to specifically include a review of the process for ensuring all investments, at the time of purchase, were eligible and suitable for purchase under the boards' investment policies.
Final § 615.5133(e)(4) requires institutions to implement effective internal audit programs to review, at least annually, their investment management functions, controls, processes, and compliance with FCA regulations. The scope of the annual review must be appropriate for the size, risk, and complexity of the investment portfolio. Thus, while the final rule retains the annual audit requirement, it provides flexibility in determining the scope of the audit.
While the final rule allows for flexibility depending on the nature of an institution's investment portfolio, there is no bright line de minimis portfolio size that would permit an institution not to engage in risk assessment. As stated above, an association must comply with all the requirements in § 615.5133 if the level or type of its investments could expose its capital to material loss. Each association must have the ability to manage the investments that it holds.
In addition to the regulatory requirements in § 615.5133(e)(4), the guidance provided in BL-064 continues to be relevant for institutions in their development of internal audit processes.
As proposed, the final rule adds a new § 615.5133(f) that covers due diligence. This provision combines in one location the requirements governing securities valuation and those governing stress testing that are in existing § 615.5133(f) and § 615.5141, respectively.
Proposed § 615.5133(f)(1) would have required a System institution, before it purchased an investment, to conduct sufficient due diligence to determine whether the investment was eligible and “suitable” for purchase under its board's investment policies. The institution would have been required to document this assessment.
This proposed requirement is retained in new § 615.5133(f)(1)(i), with minor clarifications. Since we had used the term “suitable” to mean an investment complied with the board's investment policies, we simplify the regulation by eliminating that term and instead requiring that an institution determine whether an investment complies with those policies. We also clarify that an institution must determine whether an investment is for an authorized purpose.
We also added a sentence to § 615.5133(f)(1)(i) specifically authorizing an institution, with board approval, to hold investments that do not comply with its investment policies. This addition recognizes that such decisions are within the discretion of the board's business judgment.[14] This provision does not authorize the board to approve investments that do not comply with our regulatory eligibility requirements and purpose limitations.
Existing § 615.5133(f)(1) requires a System institution to verify the value of a security that it plans to purchase, other than a new issue, with a source that is independent of the broker, dealer, counterparty, or other intermediary to the transaction. We proposed no substantive changes to the requirement.
This valuation requirement and exclusion for new issues is retained in new § 615.5133(f)(1)(ii).
Like proposed § 615.5133(f)(1), new § 615.5133(f)(1)(iii) provides that an institution's assessment of each investment at the time of purchase must at a minimum include an evaluation of credit risk, liquidity risk, market risk, interest rate risk, and the underlying collateral of the investment.
Proposed § 615.5133(f)(2) had required institutions to stress test all investments at the time of purchase. Commenters stated that while a pre-purchase stress-testing requirement is appropriate for complex securities such as MBS, asset-backed securities (ABS), and other non-Government guaranteed investments, it is inappropriate to require pre-purchase stress testing on instruments with low price sensitivity, such as Government-guaranteed investments and non-amortizing, bullet-type investments maturing within 1 year. Moreover, an association requested the establishment of a de minimis limit for stress testing even of higher-risk, more complex securities.
We agree that stress testing lower risk, less complex investments, such as overnight securities and commercial paper, may not provide value and may create excessive burden. Accordingly, final § 615.5133(f)(1)(iii) requires an institution to stress test before purchase only investments that are structured or that have uncertain cash flows, including all MBS and ABS. The stress test must be commensurate with the risk and complexity of the investment and must enable the institution to determine that the investment does not expose its capital, earnings, and liquidity to risks that exceed the risks specified in its investment policies.[15] The stress testing must comply with the requirements governing quarterly stress testing, which are discussed below.
We do not establish a de minimis amount below which stress testing need not be performed, because we believe that all high-risk, complex instruments must be stress tested. We note that final § 615.5133(f)(4) requires stress tests to be comprehensive and appropriate for the risk profile of each institution. Moreover, that provision also requires that the methodology an institution uses be appropriate for the complexity, structure, and cash flow of the investments in its portfolio.
We retain the requirements of the first sentence of existing § 615.5133(f)(2), with slight wording changes.
We move the second sentence of existing § 615.5133(f)(2) to § 615.5133(f)(3), with several changes. First, we delete the existing ongoing requirement to evaluate price sensitivity to market interest rates because that is adequately addressed in final § 615.5180(c)(3). Second, rather than requiring institutions to evaluate credit quality, we are requiring institutions to establish and maintain processes to monitor and evaluate changes in credit quality. Finally, we are retaining the existing requirement that institutions must analyze credit risk on an ongoing basis, rather than monthly, as we had proposed.
Final § 615.5133(f)(4)(i) imposes requirements regarding quarterly stress testing. The technical changes we made from proposed § 615.5133(f)(2)(ii) are not material. These changes consist of clarifying the language and relocating language from proposed § 615.5133(f)(2)(iii) that is more logically located here.
We do not believe that stress testing an institution's entire portfolio as a whole is sufficient to analyze the risk of investments. It is critical to know individual results. Otherwise, risks could be offsetting each other, resulting in a portfolio-wide test that shows little risk, yet has pockets of investments that may exhibit significant risk. Accordingly, both proposed § 615.5133(f)(2)(ii) and final § 615.5133(f)(4)(i) require institutions to stress test their entire investment portfolio, including stress tests of all investments individually and stress tests of the portfolio as a whole.
Final § 615.5133(f)(4)(ii) sets forth a methodology that applies to both pre-purchase and quarterly stress testing. Except for minor technical changes, it is identical to proposed § 615.5133(f)(2)(iii).
We redesignate existing § 615.5133(f)(3) as § 615.5133(f)(5) and change the word “security” to “investment.”
We proposed revisions to § 615.5133(g), which specifies information that management must report to the board or a board committee each quarter. Proposed § 615.5133(g)(1) retained the general quarterly reporting requirements from existing § 615.5133(g) but added to and modified them to strengthen the overall reporting requirements.
With one exception that we discuss below and minor technical changes, we are finalizing all of the general quarterly reporting requirements of § 615.5133(g)(1) (redesignated as § 615.5133(g)) that we proposed. We believe this level of reporting is necessary to ensure an institution's board has the information it needs about the institution's investments. The one proposed requirement that we are not adopting in final § 615.5133(g) is that we are not requiring institutions to report on the results of their quarterly stress tests. We expect, however, that institutions will report on stress tests results that do not comply with their investment policies.
We are including in final § 615.5133(g) the reporting requirements that were contained in proposed § 615.5143(c), governing management of ineligible investments, because we believe it is more logical to have all board reporting requirements in one provision of the regulations. We make technical, but not substantive, changes to these requirements.
Proposed § 615.5133(g)(2) would have required an institution to provide immediate notification to its board of directors or to a designated board committee if its portfolio exceeded the quarterly stress-test parameters defined in its board policy. The Council expressed concern that the term “immediate” is vague, and it requested that FCA require notification to be completed “in a reasonable manner” as the board may direct.
We are relocating the requirements of existing § 615.5135 to revised § 615.5180 in part 615 subpart G of our regulations, because we had other interest rate risk requirements in subpart G and it was logical to locate all of these requirements together. We will discuss the changes made to § 615.5180, and to other provisions in subpart G, below.
Final § 615.5136, which is very similar to what we proposed, provides that an emergency shall be deemed to exist whenever a financial, economic, agricultural, or national defense, or other crisis could impede the normal access of Farm Credit banks to the capital markets. Whenever the FCA determines, after consultations with the Funding Corporation to the extent practicable, that such an emergency exists, the FCA Board may, in its sole discretion, adopt a resolution that:
Modifies the amount, qualities, and types of eligible investments that banks are authorized to hold pursuant to § 615.5132;
Modifies or waives the liquidity requirement(s) in § 615.5134; and/or
We make only minor technical changes to this provision. We delete the reference to divestiture in existing § 615.5140(a)(4), because we no longer require divestiture of investments that were eligible when purchased, and the treatment of investments that were ineligible when purchased is specified in § 615.5143(a). We also delete the references to stress testing mortgage securities in existing § 615.5140(a)(5), because new § 615.5133(f) sets forth stress-testing requirements for investments. Finally, we make a slight formatting change to § 615.5140(a) to clarify its requirements.
As proposed, we remove this stand-alone, stress-testing section from our regulations, because we have included stress-testing requirements in final § 615.5133(f)(1)(iii) and (f)(4).
Existing § 615.5143 requires an institution to dispose of an investment that is ineligible[16] within 6 months unless we approve, in writing, a plan that authorizes the institution to divest the instrument over a longer period of time.
New § 615.5143(b) no longer requires a System institution to divest of (or to receive approval of a divestiture plan for) an investment that was eligible when purchased but no longer satisfies the eligibility criteria.[17] Rather, the institution must notify the FCA within 15 calendar days of determining that the investment no longer satisfies eligibility criteria. This approach provides institutions with greater flexibility to manage their positions and mitigate losses as compared with a forced divestiture during a specified time period. Two commenters supported this change to our overall approach.
It must not use the investment to satisfy its liquidity requirement(s) under § 615.5134;
It must continue to include the investment in the § 615.5132 investment portfolio limit calculation;
It may continue to include the investment as collateral under § 615.5050 and net collateral under § 615.5301(c) at the lower of cost or market value; and
As we proposed, final § 615.5143(a) provides that an investment that does not satisfy the regulatory eligibility criteria at the time of purchase is ineligible. Under the final rule (as under the existing regulation), System institutions may not purchase ineligible investments. If a System institution does purchase an ineligible investment, it must notify the FCA within 15 calendar days after determining that the investment was ineligible and must divest of the investment no later than 60 calendar days after the determination unless we approve, in writing, a plan that authorizes divestiture over a longer period of time. In addition, in the final rule as in the proposed, until the institution divests of the investment:
It must not be used to satisfy the institution's liquidity requirement(s) under § 615.5134;
It must continue to be included in the § 615.5132 investment portfolio limit calculation; and
It must be excluded as collateral under § 615.5050 and net collateral under § 615.5301(c).
Proposed § 615.5143(c) would have required each institution to report to its board at least quarterly regarding investments that were ineligible when purchased and investments that were eligible when purchased but that no longer satisfy the eligibility criteria. As discussed above, we have moved these reporting requirements to § 615.5133(g) so that all board reporting requirements for investments are in one place.
Finally, § 615.5143(d) reserves FCA's authority to require an institution to divest of any investment at any time for failure to comply with § 615.5132(a) or § 615.5142 (as applicable) or for safety and soundness purposes. Although we did not propose failure to comply with the permissible investment purposes specified in § 615.5132(a) and § 615.5142 as a basis for requiring divestiture, this change merely makes explicit our implicit authority to require divestiture of an investment that does not comply with our investment regulations. The timeframe FCA sets would consider the expected loss on the transaction (or transactions) and the effect on a System institution's financial condition and performance. Because the final rule would not require divestiture of any investment that was eligible when purchased, FCA is making express our authority to require divestiture of investments when necessary. We received no comments on our proposed reservation of authority.
We proposed changes to § 615.5174(d), governing stress testing of Farmer Mac securities, which Farm Credit banks, associations, and service corporations are permitted to purchase and hold for the purpose of managing credit and interest rate risk and furthering their mission to finance agriculture. For the reason discussed in the preamble to the proposed rule, we proposed to remove the requirement that a System institution must subject Farmer Mac securities backed by loans that the institution originated to the stress testing applicable to investments. If a System institution purchases a Farmer Mac security from another System institution or from outside the System, however, the security would remain subject to the stress testing applicable to investments. Because we proposed to eliminate our divestiture requirement for other investments that fail a stress test, we also proposed to eliminate that divestiture requirement for those Farmer Mac securities that remain subject to stress testing.
We also added a definition of the term “you” in new § 615.5174(e), to clarify that the regulation applies to Farm Credit banks, associations, and service corporations.
We received two comments on § 615.5174, both supporting the stress-testing change, and we are finalizing § 615.5174 as proposed.
We are revising § 615.5180 by moving the requirements of existing § 615.5135 and existing § 615.5181 into this section. Since all three existing sections govern interest rate risk management of banks, it makes sense to combine them into one regulatory provision.
We believe that strong policy direction from a Farm Credit bank's board of directors is essential to an effective interest rate risk management program. Accordingly, final § 615.5180(a) retains the existing requirement, currently contained in § 615.5180, that a bank's board must develop and implement an interest rate risk management program, tailored to the needs of the institution, that establishes a risk management process that effectively identifies, measures, monitors, and controls interest rate risk. Final § 615.5180(a) also contains the requirement, currently contained in § 615.5181(a), that the bank's board of directors must be knowledgeable of the nature and level of interest rate risk taken by the institution.
Final § 615.5180(b) contains the requirement, currently in § 615.5181(b), that senior management is responsible for ensuring that interest rate risk is properly managed on both a long-range and a day-to-day basis.
Final § 615.5180(c), which requires the board of directors of each bank to adopt an interest rate risk management section of an asset/liability management policy that establishes interest rate risk exposure limits as well as the criteria to determine compliance with these limits, contains the requirements we had proposed in § 615.5135, as revised. Final § 615.5180(c) requires, in addition to the existing requirements that carry over, that the interest rate risk management section must establish policies and procedures for the bank to:
Consider the effect of investments on interest rate risk based on the results of the required stress testing; [18]
We delete several existing requirements because similar requirements are also contained in the board reporting requirements of § 615.5133(g).
We remove this section from our regulations, because we have included these requirements in final § 615.5180.
As discussed above, our capital adequacy regulation at § 615.5201 defines the terms Government agency and Government-sponsored agency. We agree with the Council's comment that FCA's definitions should be consistent among themselves. Accordingly, we are revising the definitions in § 615.5201 to conform to the new definitions in § 615.5131.
2. Section 615.5131 is amended by:
3. Section 615.5132 is revised to read as follows:
(a) Each Farm Credit bank may hold eligible investments, listed under § 615.5140, in an amount not to exceed 35 percent of its total outstanding loans, to comply with its liquidity requirements in § 615.5134, manage surplus short-term funds, and manage interest rate risk under § 615.5180. To comply with this calculation, the 30-day average daily balance of investments is divided by loans. Investments are calculated at amortized cost. Loans are calculated as defined in § 615.5131. For the purpose of this calculation, loans include accrued interest and do not include any allowance for loan loss adjustments. Compliance with the calculation is measured on the last day of every month.
(b) The following investments may be excluded when calculating the amount of eligible investments held by the Farm Credit bank pursuant to § 615.5132(a):
(1) Eligible investments listed under § 615.5140 that are pledged by a Farm Credit bank to meet margin requirements for derivative transactions; and
4. Section 615.5133 is revised to read as follows:
(c) Investment policies—risk tolerance. Your investment policies must establish risk limits for the various types, classes, and sectors of eligible investments and for the entire investment portfolio. These policies must include concentration limits to ensure prudent diversification of credit, market, and liquidity risks in the investment portfolio. Risk limits must be based on all relevant factors, including your institutional objectives, capital position, earnings, and quality and reliability of risk management systems and must take into consideration the interest rate risk management program required by § 615.5180 or § 615.5182, as applicable. Your policies must identify the types and quantity of investments that you will hold to achieve your objectives and control credit, market, liquidity, and operational risks. Each association or service corporation that holds significant investments and each bank must establish risk limits in its investment policies for these four types of risk.
(f) Due diligence—(1) Pre-purchase analysis. (i) Eligibility, purpose, and compliance with investment policies. Before you purchase an investment, you must conduct sufficient due diligence to determine whether it is eligible under § 615.5140, is for an authorized purpose under § 615.5132 or § 615.5142, as applicable, and complies with your board's investment policies. You must document your assessment and the information used in your assessment. Your board must approve your decision to hold an investment that does not comply with your investment policies.
(8) The status and performance of each investment described in § 615.5143(a) and (b) or that does not comply with your investment policies; including the expected effect of these investments on your capital, earnings, liquidity, and collateral position; and
§ 615.5135
5. Section 615.5135 is removed.
6. Section 615.5136 is revised to read as follows:
§ 615.5136
Emergencies impeding normal access of Farm Credit banks to capital markets.
(a) Modifies the amount, qualities, and types of eligible investments that Farm Credit banks are authorized to hold pursuant to § 615.5132 of this subpart;
(b) Modifies or waives the liquidity requirement(s) in § 615.5134 of this subpart; and/or
7. Section 615.5140 is amended by revising paragraph (a) to read as follows:
(8) Diversified Investment Funds Shares of an investment company registered under section 8 of the Investment Company Act of 1940. NA NA The portfolio of the investment company must consist solely of eligible investments authorized by §§ 615.5140 and 615.5174 The investment company's risk and return objectives and use of derivatives must be consistent with FCA guidance and your investment policies. None, if your shares in each investment company comprise 10% or less of your portfolio. Otherwise counts toward limit for each type of investment.
§ 615.5141
8. Section 615.5141 is removed.
9. Section 615.5143 is revised to read as follows:
(a) Investments ineligible when purchased. Investments that do not satisfy the eligibility criteria set forth in § 615.5140 at the time of purchase are ineligible. You must not purchase ineligible investments. If you determine that you have purchased an ineligible investment, you must notify us within 15 calendar days after the determination. You must divest of the investment no later than 60 calendar days after you determine that the investment is ineligible unless we approve, in writing, a plan that authorizes you to divest the investment over a longer period of time. Until you divest of the investment:
(1) It must not be used to satisfy your liquidity requirement(s) under § 615.5134;
(2) It must continue to be included in the § 615.5132 investment portfolio limit calculation; and
(3) It must be excluded as collateral under § 615.5050 and net collateral under § 615.5301(c).
(b) Investments that no longer satisfy eligibility criteria. If you determine that an investment (that satisfied the eligibility criteria set forth in § 615.5140 when purchased) no longer satisfies the eligibility criteria, you may continue to hold it, subject to the following requirements:
(2) You must not use the investment to satisfy your liquidity requirement(s) under § 615.5134;
(3) You must continue to include the investment in the § 615.5132 investment portfolio limit calculation;
(4) You may continue to include the investment as collateral under § 615.5050 and net collateral under § 615.5301(c) at the lower of cost or market value; and
10. Section 615.5174 is amended by:
Farmer Mac securities.
(d) Stress Test. You must perform stress tests, in accordance with § 615.5133(f)(1)(iii) and § 615.5133(f)(4), on mortgage securities, issued or guaranteed by Farmer Mac, that are backed by loans that you did not originate.
11. Section 615.5180 is revised to read as follows:
Bank interest rate risk management program.
(3) Measure the potential effect of these risks on projected earnings and market values by conducting interest rate shock tests and simulations of multiple economic scenarios at least on a quarterly basis and by considering the effect of investments on interest rate risk based on the results of the stress testing required under § 615.5133(f)(4);
§ 615.5181
12. Section 615.5181 is removed.
13. Section 615.5182 is revised to read as follows:
§ 615.5182
Interest rate risk management by associations and other Farm Credit System institutions other than banks.
Any association or other Farm Credit System institution other than Farm Credit banks, excluding the Federal Agricultural Mortgage Corporation, with interest rate risk that could lead to significant declines in net income or in the market value of capital must comply with the requirements of § 615.5180. The interest rate risk management program required under § 615.5180 must be commensurate with the level of interest rate risk of the institution.
14. Section 615.5201 is amended by revising the definitions for “government agency” and “government-sponsored agency” to read as follows:
9. We also remind associations that, pursuant to § 615.5142, which we are not amending today, their only authorized investment purposes are reducing interest rate risk and managing surplus short-term funds. One association commenter suggested that it holds investments to augment income. As with banks, augmenting income through investments is permissible only if such income is incidental to one or more of the authorized investment purposes. Under § 611.1135(a), service corporations may hold investments for the purposes authorized for their organizers.
10. Under § 615.5134(b), all investments that a bank holds for the purpose of meeting the liquidity reserve requirement must be free of lien.
14. This authority incorporates and broadens proposed § 615.5133(f)(2)(i), which would have permitted an institution, with board approval, to purchase an investment that exceeds the stress-test parameters defined in its board policy.
15. As part of reorganizing the final rule, we relocated this requirement from proposed § 615.5133(f)(2)(iii).
16. Under existing § 615.5140.
18. Existing § 615.5135 already requires banks to include investments in their interest rate shock analysis.