NASCUS Comments: Regulatory Review (2019)

June 1, 2019

Office of the General Counsel 
National Credit Union Administration 
1775 Duke Street 
Alexandria, Virginia 22314

            Re: Regulatory Review (2019)

Via e-mail to ogcmail@ncua.gov

To Office of the General Counsel,

The National Association of State Credit Union Supervisors (NASCUS)1 submits the following comments in response to the National Credit Union Administration's (NCUA's) request for comments on the 2019 Regulatory Review. We commend NCUA for reinstituting its rolling one-third annual review of its regulations pursuant to Interpretive Ruling and Policy Statements (IRPS)87-2, 03-2, 13-1, and 15-1.

The 2019 Regulatory Review covers NCUA’s Rules and Regulations Parts 700 through 710. These rules include 17 provisions applicable to federally insured state credit unions (FISCUs) by way of incorporation by reference in NCUA’s Part 741.

Consolidation of NCUA Title II Insurance Rules

The organization of NCUA Rules and Regulations creates unnecessary compliance burdens for FISCUs by failing to clearly convey what regulatory requirements apply to FISCUs. NCUA should reorganize its rules to consolidate all National Credit Union Share Insurance Fund (NCUSIF) rules for FISCUs in one section and all rules related to the federal charter in another. Reorganizing the rules in this manner would provide significant regulatory relief to credit unions without increasing risk to the NCUSIF.

NCUA’s notice for the 2019 Regulatory Review is one example of how NCUA’s current organization of its rules overly burdens not only FISCUs but all system stakeholders. Not all the provisions subject to comment in this year’s review apply to FISCUs. Therefore, a reader reviewing the notice on behalf of FISCUs has to spend an inordinate amount of time determining which provisions applied to FISCUs by researching every provision within Part 741 to identify any cross references to the rules subject to this year’s review.

To further complicate matters, in some cases the wording in Part 741 instructs FISCUs to comply with “applicable” provisions found elsewhere in NCUA’s rules.  Unless the adjective “applicable” is mere surplusage, this adjective distinguishes some provisions from others, by indicating that some provisions apply to FISCUs whereas other provisions do not apply to FISCUs.  Without any guidance in the form of a clear designation of the “applicable provisions,” however, the reader can only speculate how many applicable provisions there are, and what they might be.

For example, §741.202 reads, in part:2

  • The supervisory committee of each credit union insured pursuant to title II of the Act shall make or cause to be made an audit of the credit union at least once every calendar year covering the period elapsed since the last audit. The audit must fully meet the applicable requirements set forth in part 715 of this chapter or applicable state law, whichever requirement is more stringent. (12 CFR 741.202)

The difficulty arises because Part 715 does not clearly indicate which provisions are applicable to FISCUs. One reasonable reading is that only the specific audit provisions of Part 715 apply and not the provisions speaking to the supervisory committee in general. The point is that the compliance obligations are unclear.

Another way in which the current organization of NCUA’s rules burdens stakeholders is when a cross reference in Part 741 references a discreet sub-part of a provision within a federal credit union rule comprised of numerous provisions. For example, the various sub-provisions of Part 701 applicable to FISCUs are scattered among different provisions in Part 741. Part 741.8 references §701.23(b)(i) and (b)(iii) but not (b)(ii). In addition, §741.8(b)(4) directs FISCUs to the loan participation definitions in §701.22 and refers to “meeting the requirements of §701.22” without any limitation to “applicable” requirements.  The implication of Paragraph 741.8(b)(4) might seem to be that all the requirements of §701.22 apply, but this implication is contradicted by §741.225, which definitely states that FISCUs “are exempt from the requirement in §701.22(b)(4).”  Thus, in a section far removed from §741.8(b)(4), the meaning of the phrase “meeting the requirements of §701.22” is, in at least one way, clarified. 

Distinct provisions of Part 701 are also referenced elsewhere in Part 741.  For example, under §741.205, only “the requirements stated in §701.14(c) of this chapter concerning the prior notice and NCUA review” currently apply to any FISCU chartered for less than 2 years, or “defined to be in troubled condition as set forth in §701.14(b)(3).”  Under §741.221, “the requirements in §701.20” apply to a FISCU that undertakes “with its principal to pay or perform an obligation to a third person,” or “agrees to satisfy the obligation of the principal only if the principal fails to pay or perform.”  All of these subjects could be covered more coherently, comprehensively, and conveniently for the FISCUs if the provision were restated in Part 741. 

To further complicate matters, the loan participation rule is also separately referenced in §741.225. In fact, distinct provisions of Part 701 are also referenced in §741.205, §741.221, §741.203, and §741.204.

That the organizational structure of such regulations currently is confusing and burdensome should be obvious.  Accordingly, NCUA should resolve the confusion and reduce regulatory burden by consolidating FISCU rules in their entirety in Part 741. 

§701.21 Loans to Members and Lines of Credit to Members

NCUA’s regulations concerning loans applies to FISCUs, in part, by way of reference in §741.203. Part 701.21 provides another example of the confusion presented by NCUA’s practice of incorporation by reference. While the rule itself is extensive, only three sub-provisions apply to FISCUs.  However, on their face, those provisions themselves only refer to federal credit unions, once again creating confusion to the FISCU reader. To clarify the rule, we recommend Part 701.21(c)(8) be incorporated into Part 741 in its entirety.  At a minimum, NCUA should change the references within the sub-section (c) to include FISCUs.3

In addition, while §741.203 provides an exemption to the requirements of §701.21(c)(8) and (d)(5) if a state has adopted a substantially similar rule, the requirement for FISCUs to comply with §701(h) is contained in §741.203(c), which includes no provision allowing states to adopt substantially similar rules.  NCUA should extend the exemption provision for substantially similar state rules to include the third-party servicing provisions of §721(h).

Part 702 Capital Adequacy

With its risk-based capital rule scheduled to take effect on January 1, 2020, NCUA should work with stakeholders to publish a proposed supplemental capital rule for complex and low-income designated credit unions. In designing a supplemental capital framework for the risk-based capital rule, NCUA should focus on allowing subordinated debt instruments and design the framework in anticipation of eventual statutory changes to credit union capital requirements.

Allowing supplemental capital for credit union capital requirements would provide several tangible benefits to the credit union system:

1) It would allow for measured expansion of products and services without the dilution of regulatory capital. This could be especially beneficial to credit unions seeking to modernize and enhance member services to maintain competitiveness with other financial service providers.

2) It would empower a credit union’s members by allowing those members to recapitalize, or augment the capitalization of, their credit union. NCUA has often sought ways to “empower” members.4 Providing for members’ ability to directly recapitalize their credit union would be consistent with NCUA’s approach in that regard.

3) It would enable credit unions to attract additional capital that serves as a buffer for the share insurance fund, absorbing credit union losses in a first loss position and protecting the share insurance fund. To the extent that the goal of NCUA’s risk-based capital rulemaking is to increase the capital buffer protecting the share insurance fund, supplemental capital is wholly consistent with that rulemaking.

We note that NCUA has assured stakeholders that supplemental capital rulemaking would accompany final implementation of risk-based capital. In its preamble to the 2015 final RBC rule, NCUA wrote:

“[t]he Board plans to address comments supporting additional forms of supplemental capital in a separate proposed rule, with the intent to finalize a new supplemental capital rule before the effective date of this risk-based capital final rule.” 5

In a November 2015 report to Congress, NCUA assured Congress that “[a]s part of modernizing NCUA’s risk-based capital rule, the NCUA Board was unanimous in its commitment to move forward with a separate rulemaking to allow supplemental capital to be counted toward the risk-based capital ratio. The effective date of this proposed change would coincide with implementation of NCUA’s modernized risk-based capital rule scheduled for January 1, 2019.” 6

In addition to risk-based capital, NCUA has also communicated its intention to re-visit the regulatory framework related to secondary capital for low-income designated credit unions. NASCUS commends NCUA for this initiative and recommends that secondary capital rules incorporate concepts related to subordinated debt and supplementary capital.

Part 704 Corporate Credit Unions

NCUA’s corporate credit union rule applies in its entirety to state-chartered corporate credit unions by way of reference in §741.206. 7 After the recession and subsequent failure of several corporate credit unions exposed shortcomings in corporate credit union regulation and supervision, NCUA promulgated a comprehensive overhaul of §704, drastically limiting corporate credit union powers, homogenizing corporate credit union regulation, and imposing a new corporate credit union capital regime. 8 As a result, the corporate credit union system today is far smaller than it was in 2008. 9

In the years since the recession, the corporate credit union system has consolidated and stabilized. While giving due consideration to the lessons learned from the recession, NCUA should work with state regulators to perform a comprehensive review of Part 704 to identify rule changes that could help sustain the healthy growth of the overall credit union system. At the same time, the joint NCUA/State review could identify governance and other areas where NCUA preemption of state rules for corporate credit unions might be rolled back to provide an opportunity for regulatory diversity, and corporate credit union innovation, to strengthen the corporate system itself.

We recommend NCUA modernize § 704 in the following manner:

  • Take steps to de-homogenize the corporate credit union system by providing for state regulatory diversification of corporate credit union rules.

NCUA could strengthen the corporate credit union system by allowing states to introduce variations on NCUA’s rules, thereby diversifying the regulatory framework of the corporate credit union system. Providing an opportunity for diversity of regulation between state and federal charters, within prudent safe and sound parameters, yields benefits to both charters, and contributes to a more vibrant credit union system. There comes a time when the very homogenous nature of the corporate credit union system, bereft of the cooperative competition of dual chartering, may itself pose a threat to the health of the system.

  • Clarify that state-chartered corporate credit unions satisfy the compensation disclosure requirements by filing the IRS 990.

All state-chartered credit unions, including state-chartered corporate credit unions, are required to annually file an Internal Revenue Service Return of Organization Exempt from Income Tax (Form 990).10 The Form 990 is a publicly available document. NCUA should clarify that state-chartered corporate credit unions satisfy the requirements of this provision so long as the corporate’s Form 990 filing contains the information required by the provision, and access to the Form 990s is made available to the members. We note that with corporate credit unions the “members” in question are primarily institutional members (natural person credit unions) who themselves file, and understand, the Form 990 and the information it provides. Clarifying the ability of a corporate credit union to satisfy Part 704.19 with the filing of a Form 990 reduces regulatory burden, vindicates the spirit of the rule, and raises no safety and soundness implications.

  • Provide corporate credit unions greater flexibility to serve as a liquidity source for natural person credit unions

Although a substantially smaller sector of the credit union movement than in the past, corporate credit unions still are an integral part of the system with 5,000 natural person credit union members. NCUA should work with state regulators to evaluate the risks and benefits of regulatory changes that would better position corporates to provide liquidity and other services to natural person credit unions. For example, modestly extending the term of the weighted average life requirements in §704.8(f) could allow corporates to provide longer funding options for natural person credit unions during times of stressed liquidity in the natural person credit union system. Consideration could also be given to extending the permissible term of corporate credit union secured borrowing.

NCUA should also consider regulatory and (and supporting statutory changes) to the process by which natural person credit unions may access the Central Liquidity Facility (CLF) to allow corporate credit unions to provide the access on behalf of their natural person credit union members.11 Part 704 should be amended to include rules for corporate credit unions to once again act as agents and become a direct members of the CLF. So doing would enable far more natural person credit unions to obtain meaningful access to CLF liquidity.

  • Exempt state corporate credit unions from Part 704.14(a)(2) board representation

Part 704.14(a)(2) provides “[o]nly an individual who currently holds the position of chief executive officer, chief financial officer, chief operating officer, or treasurer/manager at a member credit union, and will hold that position at the time he or she is seated on the corporate credit union board if elected, may seek election or re-election to the corporate credit union board;”. When this provision was proposed in 2010, NASCUS wrote:

NASCUS also questions the utility of the proposed regulations. There is no evidence that mandating a director be a CEO, CFO or COO will result in enhanced board competence or function. Further, many highly talented potential directors from member entities may not hold the prescribed titles. For example, an economist or an attorney employed by a member entity could enhance the leadership of a particular corporate. While an individual corporate may decide to establish such criteria for its directors, that is a business decision for the individual corporate which should be guided by the institution’s own corporate governance framework.

  • NASCUS comments on Proposed Rulemaking for Part 704 (March 5, 2010)12

We remain skeptical of this provision for the reasons stated in our March 2010 comment letter. This provision should be rescinded. At a minimum, state corporate credit unions should be exempted from this, and other, governance provisions in Part 704.

  • NCUA should provide greater flexibility for corporate credit unions to invest in CUSOs and other fintech opportunities

Financial institutions around the world are investing heavily in financial technology to improve efficiencies, enhance member/customer experience, and compete against increasingly aggressive non-depository financial services technology companies. Corporate credit unions are not immune to these market-place pressures.

Part 704.11 should be revised to provide greater flexibility for corporate credit unions to engage in fintech development by reducing regulatory burden for non-material investments and enabling greater cooperation with natural person credit union CUSOs. One prevailing method by which companies gain an understanding of emerging fintech innovation is by making modest investments in the startup, thereby gaining visibility on its technological development.

§708a Bank Conversions and Mergers & §708b Mergers of Federally Insured Credit Unions; Voluntary Termination or Conversion of Insured Status

Recognizing that the Federal Credit Union Act grants NCUA the authority to promulgate rules for the merger of federally insured credit unions as well as conversion to non-credit union status, we continue to urge NCUA to read its statutory mandate with prudent regulatory restraint. With respect to FISCUs, NCUA should focus on safety and soundness, not on governance issues that are more appropriately subject to state chartering rules and regulations.

Accordingly, NCUA should limit application of both §708a and §708b to FISCUs to questions of safety and soundness and risk to the NCUSIF.13 For FISCUs, the manner and content of the notice to members, the means by which elections are conducted, vote thresholds, and other governance issues are matters for state law.

Historically, NCUA has failed to articulate a convincing safety and soundness rationale for applying many of the §708a and b governance provisions to FISCUs.14 The strength of the dual chartering system is that the different chartering authorities may hold different views of various issues. NCUA may not agree with a state’s view on mergers or charter conversion, but as the share insurer its only concern should be material risk to the NCUSIF.

NCUA’s implementation of its merger and conversion rules has also been problematic. Since the effective date of the 2018 merger rule, NASCUS has received comments from numerous state regulators who are frustrated with the rule’s implementation. Those frustrations include inconsistent messages from NCUA regarding the rule and unnecessary delays of common-sense mergers. Other administrative issues have plagued NCUA’s 2018 rulemaking. NCUA, by its own admission, only studied federal credit union mergers in preparing the rulemaking, despite the fact NCUA ultimately applied the rule to FISCUs. NCUA’s call for comments reflected this lack of attention to FISCUs, as it was worded for federal credit unions with only the question of applicability to FISCUs included almost as an afterthought. We believe the nature of NCUA’s comment call may have affected the volume of comments submitted with respect to submissions on behalf of FISCUs.

We urge NCUA to revisit its rulemaking with respect to FISCU conversions and mergers. NCUA should issue an Advance Notice of Proposed Rulemaking (ANPR) on the question of NCUSIF merger and conversion rules for FISCUs and engage in a meaningful discussion of the safety and soundness issues with stakeholders.

We thank NCUA for the opportunity to submit recommendations for improving its Rules and Regulations. NCUA is to be commended for continuing the rule review process. We would be happy to discuss all of our comments in detail at NCUA’s convenience.

Sincerely,

- signature redacted for electronic publication -

Brian Knight
Executive Vice President & General Counsel

1. NASCUS is the professional association of the nation’s 45 state credit union regulatory agencies that charter and supervise over 2,100 credit unions.

2. While Part 715 is not subject to the 2019 Regulatory Review, it is emblematic of the problems with NCUA’s current organization of its rules.

3. Part 701.21(c)(8) is currently subject to a separate noticed of proposed rulemaking. NASCUS will provide additional recommendations pursuant to that request for comments. See 84 Fed. Reg. 78 (April 23, 2019) p. 16796.

4. See NCUA final Voluntary Merger Rule, 83 Fed. Reg. 30301 (June 28, 2018).

5. 80 Fed. Reg. 66665 (October 29, 2015).

6. NCUA, Report to the House Financial Services Committee on the Final Risk-Based Capital Rule, November 2015. Available at https://www.ncua.gov/regulation-supervision/Documents/RBC/final-risk-based-capital-rulereport.pdf. (accessed August 27, 2018). See also NCUA’s Frequently Asked Questions about NCUA’s Risk-Based Capital Final Rule, October 2015. Available at https://www.ncua.gov/Legal/Documents/RBC/RBC-Final-RuleFAQs.pdf (accessed August 27, 2018).

7. Corporate credit unions are also separately referenced in Part 741.3(b)(3) which cross references Part 741.206, which incorporates by reference Part 704.

8. 75 Fed. Reg. 200 (October 20, 2010), p. 64786.

9. In 2008, there were 27 corporate credit unions with aggregate assets of over $85 billion. In 2019, there are 11 corporate credit unions with aggregate assets of just over $20 billion in assets.

10. IRM §6033.

11. Although 12 CFR Part 725 is not directly subject to this notice and comment, as with NCUA’s incorporation by reference for FISCUs, it is implicated by considering changes to Part 704. Therefore, NASCUS submits these recommendations as part of corresponding changes to Part 704.

13. NCUA’s rules regarding mergers and conversions apply to FISCUs by way of reference in §741.208.

14. Most recently, NCUA cited the possibility of a disgruntled member ceasing to do business with the credit union as a safety and soundness risk to the NCUSIF. (See Bylaws and Voluntary Mergers of Federally Insured Credit Unions, 83 Fed. Reg. 125 (June 28, 2018) p. 303031.