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Federal Register / Vol. 86, No. 100 / Wednesday, May 26, 2021 / Rules and Regulations prohibition is included in the current rule, where FCUs are only permitted to purchase Derivatives. In continuing this prohibition, the Board was concerned with the asymmetric return profile of written options and was also was not aware of any safe uses of written options for managing IRR. To garner more information on the use and risk of written options, the proposed rule included a specific request for comments on the possibility of the Board permitting written options in a final Derivatives rule. Specifically, the Board asked for comments on whether FCUs should be able to engage in written options to manage IRR, and specific scenarios where a written option could be used to manage IRR.6 In response, five commenters stated that the Board should not prohibit an FCU
from engaging in written options. Of these commenters, one requested clarification on the NCUAs definition of a written option, and two others provided detailed examples of transactions where a written option could be both beneficial and safe and sound.
After consideration of the comments and further analysis, the Board is removing the proposed prohibition on written options. As such, this final rule permits an FCU to enter into written options, but only if such options are used to manage IRR. As a result of removing the prohibition on written options and for increased clarity in the rule text, the Board is adding a new 703.103a1 restating a mandatory characteristic in that Derivatives can only be used for the purpose of managing IRR. The Board is adding this characteristic to reinforce the principle that all Derivatives, including written options, must only be used for the management of IRR.
As part of the Boards analysis in considering written options as a permissible Derivative for FCUs, the Board reviewed the risk profile and potential uses of written options. An option contract entitles the option purchaser the right, but not the obligation, to buy, sell, or enter into a commitment with a Counterparty including specific terms on interest rates or prices at a specified date, depending on the form of the option.
The option purchaser will pay a premium upfront for this right. The seller or writer of an option, when not offsetting an existing purchased option, is the originator of an option contract exposure who, in exchange for receiving the premium, is subject to the right 6 Id.

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afforded to the purchaser in exercising the terms of the contract.
The risk profile of an interest rate option, whether purchased or written, is asymmetric. This means the payments on the option can exceed the premium paid or received for the option. With a written option, the seller of the written option would receive a premium and would generally be obligated to make payments to the purchaser if conditions are met. For example, the seller of a written interest rate cap would be required to make payments to the purchaser if the reference rate is greater than the rate on the interest rate cap contract. With interest rate options, this payment generally behaves similar to the required payments on other interest rate Derivatives. For example, the cashflow payment profile of a sold interest rate cap can be compared to a receive-fixed, pay-floating interest rate swap with the same notional and strike/
swap rate, which is permissible transaction types for FCUs. One commenter pointed out that a sold interest rate cap, combined with a purchased interest rate floor, would behave almost identical to an interest rate swap with the same strike/swap rates and the same maturities. By permitting written options for managing IRR, FCUs could enter into an exposure similar to a receive-fixed, pay-floating swap transaction more customized to the FCUs balance sheet needs.
The Board notes that written options can also be used to reduce the costs associated with managing IRR. Such cost reduction can be achieved by, among other things, offsetting the purchase of another Derivative or reducing its exposure to such Derivative.
In summary, the Board has determined that the use of written options provides additional flexibility for FCUs for the purpose of managing IRR. However, the Board would like to emphasize that any written option by an FCU would need to be for the purpose of managing IRR. The FCU must be able to demonstrate how the written option, on its own or combined with other Derivatives, is being used to manage interest rate risk.
Related to the removal of the prohibition of written options, the Board is removing the definitions of Interest rate cap, Interest rate floor and Written options from the final rule. The Board notes the specific product definitions for options are not needed given the prohibition on written options has been removed from the final rule.

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G. Pipeline Management The Board proposed to streamline sections of current part 703 on when an FCU may enter into transactions to manage interest rate exposure in its loan pipeline. The proposed rule removed the reference to specific product types for loan pipeline management and expanded pipeline management to all loans. Both of these changes are consistent with the principals-based approach the Board implemented in this rule. In making this change in the proposal, the Board asked if loan pipeline management should be limited to mortgage loans. The Board asked this to allow stakeholders the opportunity to provide input on this expansion of the loan pipeline authority. Both commenters on this question stated NCUA should not restrict pipeline management to only mortgage loans.
These commenters stated that pipeline management has value for managing IRR
for all types of loans, not just mortgages.
The Board agrees and is retaining this portion of the rule as proposed.
H. Regional Director Authority Three commenters addressed the ability of a Regional Director to prohibit an FCU from continuing to enter into Derivatives transactions. All three commenters found the proposed authority to be overly broad. One commenter noted that under the proposed rule, a Regional Director could, for any reason, prohibit an FCU
from continuing to use Derivatives. This commenter requested that a Regional Directors authority to prohibit the use of Derivatives be directly related to Derivatives activity. Further, one commenter requested that any prohibition on the continued use of Derivatives be accompanied by a written statement to that effect and the ability to appeal such decision, under part 746
of the NCUAs regulations.7
The Board believes the level of Regional Director authority is appropriate. The Board notes, given the complexity of Derivatives, it is necessary to provide the Regional Director with broad discretion to allow him or her to evaluate an FCU and, if necessary, take remedial actions to address unsafe or unsound conditions that are caused by, related to, or could be exacerbated by the continued use of Derivatives.
The Board notes that such discretion will make this final rule more flexible than the current Derivatives rule. As discussed previously in this document, under the current rule, if an FCU falls 7 12

CFR part 746.

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