Federal Home Loan Bank System Boards of Directors and Executive Management

SUPPLEMENTARY INFORMATION:

I. Comments

FHFA invites comments on all aspects of the proposed rule and will take all comments into consideration before issuing a final rule. Comments will be posted to the electronic rulemaking docket on the FHFA public website at https://www.fhfa.gov, except as described below. Commenters should submit only information the commenter wishes to make available publicly. FHFA may post only a single representative example of identical or substantially identical comments, and in such cases will generally identify the number of identical or substantially identical comments represented by the posted example. FHFA may, in its discretion, redact or refrain from posting all or any portion of any comment that contains content that is obscene, vulgar, profane, or threatens harm. All comments, including those that are redacted or not posted, will be retained in their original form in FHFA's internal rulemaking file and considered as required by all applicable laws. Commenters that would like FHFA to consider any portion of their comment exempt from disclosure on the basis that it contains trade secrets, or financial, confidential or proprietary data or information, should follow the procedures in section IV.D. of FHFA's Policy on Communications with Outside Parties in Connection with FHFA Rulemakings, see https://www.fhfa.gov/sites/default/files/documents/Ex-Parte-Communications-Public-Policy_3-5-19.pdf. FHFA cannot guarantee that such data or information, or the identity of the commenter, will remain confidential if disclosure is sought pursuant to an applicable statute or regulation. See12 CFR 1202.8 and 1214.2 and the FHFA FOIA Reference Guide at https://www.fhfa.gov/about/foia-reference-guide for additional information.

II. Background

A. Statutory Requirements on Bank System Governance

The Bank System consists of eleven district Banks and the OF. The Banks are wholesale, cooperatively owned financial institutions, the debt of which is the joint and several obligation of all eleven Banks. They are organized under authority of the Federal Home Loan Bank Act (Bank Act) to serve the public interest by enhancing the availability of residential housing finance and community lending credit through their member institutions and, to a very limited extent, through certain eligible nonmembers. In general, only members may obtain advances (low-cost secured loans) and access other products and services provided by a Bank.

The Bank Act vests the management of each Bank in its board of directors. As required by statute, each Bank's board comprises two types of directors: (1) member directors, who are drawn from the officers and directors of member institutions located in the Bank's district and who are elected to represent members in each respective state in that district; and (2) independent directors, who are unaffiliated with any of the Bank's member institutions or borrowing housing associates, but who reside in the Bank's district and are elected on an at-large basis. The Bank Act specifies that a majority of seats on each Bank's board of directors must be member directorships, while not less than 40 percent must be independent directorships. Both types of directors serve four-year terms, which must be staggered so that approximately one-quarter of a Bank's total directorships are up for election every year. The Bank Act establishes the eligibility requirements for both types of Bank directors, including the professional qualifications required for independent directors, and sets forth requirements for their nomination and election. The statute requires the FHFA Director to annually designate the size and composition of each Bank's board of directors for the following calendar year, including by establishing the number of member and independent directorships and allocating member directorships among the states of the Bank district.

The Bank Act requires that at least two of a Bank's independent directors qualify as “public interest” independent directors, each of which must “have more than 4 years of experience in representing consumer or community interests on banking services, credit needs, housing, or financial consumer protections.” Each independent director that is not a public interest independent director (referred to in this proposed rule as a “regular independent director”) must “have demonstrated knowledge of, or experience in, financial management, auditing and accounting, risk management practices, derivatives, project development, or organizational management, or such other knowledge or expertise as the [FHFA] Director may provide by regulation.” By regulation, FHFA has added “the law” to that list of qualifying knowledge and experience.

B. Existing Regulations on Corporate Governance of Banks and OF

Part 1261 of FHFA's regulations, entitled “Federal Home Loan Bank Directors,” implements the statutory provisions and otherwise establishes requirements and processes relating to the composition and operations of Bank boards of directors. With respect to the former, sections in subpart B of the regulation (§§ 1261.2 through 1261.15) cover the annual designation of Bank directorships by the FHFA Director, director eligibility, the nomination and election processes, reporting and record retention requirements, handling conflicts of interest, and the filling of vacancies. Sections in subpart C (§§ 1261.20 through 1261.24) address director compensation and expenses and the conduct of board and committee meetings.

In addition to the corporate governance issues addressed in part 1261, part 1239 of FHFA's regulations, entitled “Responsibilities of Boards of Directors, Corporate Practices, and Corporate Governance,” addresses duties and responsibilities of directors, required board committees, and programs and policies each Bank must establish and maintain. Although part 1239 generally applies to all of FHFA's regulated entities, subpart E of the regulation sets forth requirements that are specific to the Banks. Part 1273 of FHFA's regulations governs the Bank System's OF, with governance issues—including composition and meetings of the OF board of directors—being addressed primarily in § 1273.8.

III. Overview of the Proposed Rule

The proposed rule would make numerous revisions to part 1261, as well as more limited revisions to parts 1239 and 1273 to address various issues related to the corporate governance of the Banks and the OF. While the greater portion of the proposed changes to existing regulatory text are intended merely to restate existing requirements more clearly, many of the proposed revisions are substantive. The latter are being proposed primarily to ensure that the Banks maintain strong corporate governance that enables them to effectively fulfill their public policy mission while maintaining safe and sound operations. New proposed requirements and authorities would help ensure the Banks have the leadership and resources to forestall avoidable difficulties and to address challenges that may arise in the years ahead. The proposed revisions reflect FHFA's view that corporate governance of the Banks is strengthened when: the public interest is adequately represented; Bank boards have the collective knowledge and expertise to guide the Bank through new and emerging risks and complex problems; independent directors represent a true independent voice; each Bank has the tools to ensure that its directors are fit to serve in a fiduciary role with the Bank; and Bank directors and management are incentivized to carry out their duties and responsibilities conscientiously.

As discussed further below, several of the proposed changes implement action items from FHFA's FHLBank System at 100: Focusing on the Future Report (FHLBank System at 100 Report or Report), published in November 2023. The proposed rule would also address issues raised in comments received in response to FHFA's April 2023 Notice of Regulatory Review, which was published pursuant to FHFA's Regulatory Review Plan. Other substantive changes are intended to increase transparency by codifying existing guidance or practices or to provide clarity on issues for which there currently exists no formal guidance, but on which FHFA has received inquiries. Finally, FHFA is also proposing many non-substantive revisions to part 1261, which are intended merely to address existing requirements, processes, and authorities pertaining to Bank boards and directors more clearly than does the existing regulation.

The FHLBank System at 100 Report provides a blueprint for innovative and prudent steps to bolster and improve the Bank System over the next several years, with the goal of ensuring that the Banks remain well positioned to meet the needs of their members and the communities they serve as they approach their 100th anniversary. The Report was informed by a year-long review of the Bank System involving significant stakeholder outreach, a historical review of the role of the Banks, and detailed analysis of both the strengths and areas for improvement in the System's current structure. As stated in the Report, FHFA's vision for the future is to have an effectively governed Bank System that efficiently provides stable and reliable funding to creditworthy members and delivers innovative products and services to support the housing and community development needs of the communities its members serve, all in a safe and sound manner. The Report noted that each Bank's “effectiveness in achieving its mission and safety and soundness goals is influenced by its governance.”

The Report laid out four regulatory actions to be taken by FHFA to strengthen Bank boards of directors and enable them to effectively address emerging risks and to oversee the safety and soundness and mission achievement of the Banks in today's financial market environment: (1) clarify required qualifications for public interest independent directors; (2) expand the list of qualifying experience for regular independent directors to reflect business developments in housing finance and new and emerging risks and complex problems; (3) encourage the Banks to evaluate potential gaps in board knowledge and pursue opportunities to address these gaps by nominating individuals with particular skills, backgrounds, and experience; and (4) facilitate the nomination of individuals with technical subject matter expertise. The proposed rule would address each of those four action items.

The proposed rule would clarify required qualifications for public interest independent directors, including by specifying criteria for a Bank to consider when determining if an individual has “represented” consumer or community interests on banking services, credit needs, housing, or financial consumer protections, as required by statute to qualify as a public interest independent director. The rule would codify existing guidance that a person must have advocated for, or otherwise acted primarily on behalf of or for the direct benefit of, consumers or the community to meet the representation requirement.

The revised regulation would require each Bank to take affirmative measures to ensure that its board of directors has the knowledge and experience needed to adequately oversee the management of the Bank. Based on input received during the FHLBank System at 100 outreach, the proposed rule would add artificial intelligence, information technology and security, climate-related risk, Community Development Financial Institution (CDFI) business models, and modeling to the list of qualifying experience for regular independent directors. To ensure coverage of critical areas, each Bank's board would be required to conduct an annual assessment of the skills and experience possessed by its incumbents and those for which the board has a need. “Skills and experience” assessments are authorized, but not required, under the existing regulation.

Banks would be required to take active steps to seek independent directorship nominees—and to encourage member directorship nominees—who possess needed skills and experience. The revised regulation also would require the Banks to prioritize knowledge and experience relevant to the business, programs, and mission of the Bank and gained primarily through full time paid executive, management, or other senior positions when considering potential independent directorship nominees. To provide Banks with more flexibility to address critical needs when filling board vacancies, the proposed rule would add a provision expressly permitting Banks to fill a vacant public interest independent directorship by redesignating a qualifying incumbent regular independent director as a public interest independent director and vice versa. The Bank could then find new nominees to fill the resulting independent directorship vacancy (a practice FHFA currently permits).

At several points during the outreach phase of the FHLBank System at 100 initiative, stakeholders stressed the importance of independent voices on a Bank's board. The proposed rule includes provisions addressing director independence. It would make modest changes to increase the separation between independent directors and Bank members by extending “independence” requirements (which currently only apply to seated directors) to independent directorship nominees and prohibiting former member directors from serving as an independent director until they have been off the board for at least two years.

In response to a Notice of Regulatory Review comment, the proposed rule includes a new provision clarifying the definition of “advances” for purposes of the prohibition against an independent director serving as an officer, employee, or director of any “recipient of advances” from the Bank. This issue is of particular relevance for independent directors who lead or work for entities certified as housing associates. As proposed, the word “advances” would refer to any loan from a Bank to the recipient, regardless of form or nomenclature, except for debt securities traded in the public capital markets. This definition strikes a balance between preventing circumvention of the independence requirements and allowing Banks to tap into their housing associates' valuable expertise without having to relinquish, or decline to make, investments in their debt securities.

The proposed rule would codify requirements and authorities relating to the “fitness” of an individual to serve as a director. It would require that a Bank decline to nominate or seat as a director any individual it knows to be “unfit” to serve and authorize each Bank's board to adopt bylaws or policies under which it may remove directors “for cause” upon a two-thirds vote of the board. As proposed, “cause” for removal would include code of ethics or policy violations, violations of the law, posing a risk of material harm to the Bank, conduct or a mental condition indicating an inability to oversee the Bank, and poor performance or lack of participation. The proposed rule would also require that each Bank's board conduct an annual assessment of director performance and participation to determine whether each director is contributing positively to the board's ability to adequately oversee the operations of the Bank. The proposed rule would require that director compensation reflect performance, as determined through the annual assessment, and permit the board to remove a director where the assessment reveals that a director's continuous poor performance or lack of participation is compromising the board's ability to adequately oversee the operations of the Bank. Additionally, the proposed rule would allow the FHFA Director to establish and provide notice of an annual amount of director compensation determined to be reasonable.

As further assurance that all Bank directors are fit to serve, the proposed rule would codify as a regulatory requirement the Banks' existing practice of conducting thorough background checks on independent directorship nominees, as well as individuals under consideration to fill a vacant directorship. It would also for the first time expressly require the Banks to conduct background checks for their member directorship nominees. The revised regulation would prohibit a Bank from including any individual on the ballot without having first confirmed, based on the background check, the individual's fitness to serve in a fiduciary role with the Bank.

With respect to directorship terms and term limits, the proposed rule would expressly provide that FHFA may continue, as part of the annual designation of directorships process, to adjust downward the length of terms from time to time where required to maintain the even staggering of directorship terms on a Bank's board. The proposed rule would make clear that such truncated terms do not count as “full terms” for purposes of the statutory term limit provisions, but that full terms on either side of a truncated term must be counted as consecutive for those purposes.

In one of only a few revisions to address corporate governance issues below the board level, the proposed rule would require each Bank to adopt and implement a conflicts of interest policy covering all Bank employees. The required policy would establish appropriate limitations, standards, and procedures on the holding of outside positions and financial interests by Bank employees and close family members and associates. Although the treatment of different types of employees under such a policy may be calibrated to the risk presented, each Bank's policy would be required to prohibit its executive officers and senior management from holding paid positions with any entity that is, or may be eligible to become, a member or housing associate of any Bank or with any affiliate of such entity.

Finally, the proposed rule would revise the regulation's existing provisions on record retention. Changes would increase the amount of time a Bank must retain materials pertaining to its directors and the director nomination and election process from two years to the longer of seven years or seven years after the director to which the information pertains leaves the board. This requirement is consistent with recognized best practices and should not be burdensome to implement in an electronic environment.

Although the proposed rule would impose new requirements (in addition to codifying some existing expectations), it would also implement new, or make permanent previously temporary, flexibilities. As requested in a Notice of Regulatory Review comment, the proposed rule would remove the requirement that Bank boards satisfy their six meeting per year minimum only through in-person meetings. The proposed revision would codify the substance of a waiver that has been in place since early in the COVID-19 pandemic by permitting Bank and OF board and committee meetings to be held by video or teleconferencing, or in a hybrid format, provided all directors have an opportunity to communicate, have access to all written documents and presentations, and all participants are within a state or U.S. Territory that is part of a Bank district.

To reduce burden in other areas, the proposed rule would also implement a number of other recommendations received as comments on the Notice of Regulatory Review. These changes include expanding the range of arms-length transactions not considered to be a prohibited “financial interest” for purposes of the Bank director conflicts-of-interest requirements, updating and expanding the authorized methods for withdrawal of OF operating funds, and allowing the OF board of directors to delegate review and approval of contracts as specified in applicable governance documents.

In addition to these substantive revisions, the proposed rule would make non-substantive revisions throughout part 1261 to improve the readability of the regulatory text and provide greater clarity on the requirements, processes, and authorities pertaining to Bank directors. In particular, provisions governing the annual designation of directorships, director eligibility, the nomination and election processes, and the filling of vacant directorships would be updated. These proposed non-substantive revisions include substitution of clearer phrasing, changes to assure consistent use of terminology, consolidation of related subject matter, replacement of statutory cross-references with either substantive text or regulatory cross-references, reorganization of sections and revision of headings, and removal of transitional material that is no longer needed.

IV. Section-by-Section Analysis of the Proposed Rule

A. Revisions to 12 CFR Part 1261

1. Definitions—§ 1261.2

Section 1261.2 of the existing regulation sets forth definitions applicable to subpart B of part 1261, which consists of the provisions governing Bank director eligibility, nominations, and elections. Existing § 1261.2 includes definitions for “independent directorship,” “member directorship,” “public interest director,” and “public interest directorship.” As described below, the proposed rule would add to and revise the regulatory terms describing the Bank directorship types and sub-types. The proposals are intended to provide clarity, and revisions to existing definitions are not intended to change the scope of the defined terms.

The existing regulation defines the terms “independent directorship” and “member directorship” by means of cross-references to the relevant provisions of the Bank Act. The proposed rule would replace these statutory references with cross-references to the regulatory provisions establishing the eligibility and designation requirements for those two types of Bank directorships. FHFA believes it is preferable to define terms with reference to the regulation itself, as opposed to requiring reference to the statute the regulation is intended to implement. Because part 1261 addresses both “directorships” (the designated seats comprising a Bank's board) and “directors” (the individuals filling those seats), those variants would be defined together for each directorship type.

While both the Bank Act and the existing regulation define “public interest directorship” (referring to an independent directorship to be filled by an individual meeting the “representing consumer or community interests” qualification requirement), both refer to an independent directorship to be filled by an individual meeting the “knowledge and experience” qualification requirement of the statute with such undefined terms as “an independent directorship, other than a public interest directorship” and “an independent director that is not a public interest director.” The proposed rule would establish a joint definition for “regular independent directorship and regular independent director” to refer to those types of independent directorships and directors, and would define the terms with a cross-reference to the new provision addressing the qualifications requirements for such directors under the proposed rule (§ 1261.5(c)(1), discussed below).

The existing regulation defines “public interest directorship” as “an independent directorship filled by an individual with more than four years of experience representing consumer or community interests in banking services, credit needs, housing or consumer financial protections.” The regulation separately defines “public interest director” to mean “an individual serving in a public interest directorship.” The proposed rule would revise the former term to “public interest independent directorship” to make clear that it refers to a sub-type of independent directorship and so the construction of the term parallels that of its counterpart, “regular independent directorship.” The proposed rule would also combine the “directorship” and “director” definitions into one paragraph and define the terms with a cross-reference to the new provision addressing the qualifications requirements for such directors under the proposed rule (§ 1261.5(c)(2), also discussed below), so that the definitions parallel those of the other directorship types.

The proposed rule would also add a definition for the term “nominee,” referring to an individual formally nominated by a Bank's members or board of directors, as appropriate, to stand for election for a Bank directorship. This change is intended to allow a clearer distinction in the regulatory text between requirements that apply to persons requesting or being considered for nomination for a directorship and requirements that apply only to those that have been duly nominated.

Existing § 1261.2 defines the term “voting State” to mean “the District of Columbia, Puerto Rico, or the State of the United States in which a member's principal place of business, as determined in accordance with 12 CFR part 1263, is located as of the record date,” and further clarifies that “[t]he voting State of a member with a principal place of business located in the U.S. Virgin Islands as of the record date is Puerto Rico, and the voting State of a member with a principal place of business located in American Samoa, Guam, or the Commonwealth of the Northern Mariana Islands as of the record date is Hawaii.” The proposed rule would amend this definition to eliminate the unnecessary references to the District of Columbia and Puerto Rico in the first clause. Section 1201.1 of FHFA's regulations, which defines terms that are used frequently throughout the regulations, already defines the term “State” to include the District of Columbia and Puerto Rico (as well as American Samoa, the Commonwealth of the Northern Mariana Islands, Guam, and the United States Virgin Islands), so there is no reason to specify their inclusion in the definition of “voting State.”

Where appropriate, the proposed rule would also revise numerous references to a “State” in existing part 1261 to refer to a “voting State.” This is especially important with respect to provisions on the allocation of member directorships and member directorship nominations and voting, as the latter term includes the concept that members in U.S. Virgin Islands nominate, vote for, and are represented by member directors for Puerto Rico, while members in American Samoa, Guam, or the Northern Mariana Islands nominate, vote for, and are represented by member directors for Hawaii.

2. General Provisions—§ 1261.3

Section 1261.3 of the existing regulation sets forth “General provisions” addressing board size and composition, length of term of directorships, annual elections, location of members for purposes of voting to fill member directorships, and the calculation of dates for purposes of determining compliance with deadlines required under the regulation. The proposed rule would remove the material on board size and composition in existing § 1261.3(a), the substance of which would be consolidated with related material on the designation of directorships in revised § 1261.4. The remaining paragraphs of § 1261.3 would be redesignated as appropriate and revised to remove or replace statutory references and streamline language for greater clarity and consistency. No change in substantive meaning is intended.

3. Annual Designation of Directorships—§ 1261.4

Section 1261.4 of the existing regulation addresses the annual “designation of directorships” process which results in the issuance of an order by the FHFA Director designating the size and composition of each Bank's board of directors for the following calendar year. The proposed rule would make various revisions to this section to consolidate provisions relating to the designation of directorships and to provide clarity regarding the methods through which FHFA determines the appropriate size and composition for each Bank's board and the requirements and procedures associated with the process. The proposed rule would also change the heading of § 1261.4 to “Annual designation of directorships” to reflect that the process is annual and that the Director designates not only member directorships, but also independent directorships for each Bank. The proposed revisions are not intended to change any current procedure or requirement.

The proposed rule would redesignate existing § 1261.4(a) as § 1261.4(b) and would add a new paragraph (a) providing that the Director will annually issue a written order designating for each Bank's board of directors for the following calendar year: (1) the total number of member directorships and their allocation among the voting States of the Bank's district; (2) the total number of independent directorships; and (3) the directorships for which an election will be held for terms beginning on January 1 of the following year, and the length of those terms. The designation of directorships has been carried out by means of a Director's order since the inception of FHFA and the new regulatory text would make this explicit and would more accurately describe the content of the designations order than existing § 1261.3(a). Consistent with current practice, the proposed rule would provide that the Director will issue the designation of directorships order by June 1 of each year.

Redesignated § 1261.4(b), requiring each Bank to submit a capital stock report to provide data for the allocation of member directorships and the determination of the number of votes each member may cast in the election, would remain substantively unchanged. For clarity, however, the sentence providing that “[i]f a Bank has issued more than one class of stock, it shall report the total shares of stock of all classes required to be held by members” would be revised to refer to “the total shares of each class of stock required to be held by the members.”

Paragraphs (b) and (c) of existing § 1261.4—entitled “Designation of member directorships” and “Allocation of directorships,” respectively—would be replaced by a new § 1261.4(c), which is intended to describe the process through which FHFA sets the total number of member directorships for each Bank and allocates them among the respective States of the Bank district.

Proposed paragraph (c)(1) would describe the first part of the statutorily required process, whereby member directorships are allocated among the States of each district based on the relative amount of Bank stock the members in each respective state were required to hold as of December 31 of the preceding year. As described in the proposed regulatory text, FHFA begins by choosing for each Bank a “base” number of member directorships to allocate among the states of the district. For practical reasons, the base number is typically eight, but may differ where there is a legal or policy reason for selecting a different number. For example, where the number of states comprising a Bank district exceeds eight, FHFA must begin with a higher base number for that Bank because the Bank Act requires that each state have a minimum of one member directorship. In other cases, for example where application of the statutory “grandfather provision” (discussed below) would otherwise result in an excessively large board size, FHFA may start with a base number lower than eight.

Proposed § 1261.4(c)(1)(i) provides that FHFA will then use the “method of equal proportions” to allocate those member directorships among the voting States of the Bank district, based on the ratio of the number of shares of Bank stock required to be held by the members in each State to the number of shares required to be held by all members of the Bank. As required by statute, proposed § 1261.4(c)(1)(ii) makes clear that each State must be allocated at least one, but no more than six, member directorships. As does the existing regulation, proposed § 1261.4(c)(1)(iii) provides that, for those Banks that have issued more than one class of stock, member directorships will be allocated based on the combined number of shares required to be held by members. Proposed § 1261.4(c)(1)(iv) would make clear that the required stock amounts on which the allocations are based shall be the amounts as of the record date (December 31 of the preceding calendar year, as defined in § 1261.2) shown in the capital stock report required to be submitted by the Banks under redesignated § 1261.4(b).

In practice, when allocating member directorships for a Bank, FHFA first allocates one member directorship to each State in the Bank district to fulfill the minimum statutory requirement. Any remaining seats are then allocated using the “method of equal proportions,” which is the method that has been used to apportion seats in the United States House of Representatives since 1941. The use of the method of equal proportions is intended to result in the stock-based allocation of member directorships having the closest possible correlation with the relative amounts of stock required to be held by Bank members in each respective state of the district.

Under the method of equal proportions, after each state has been allocated one seat, a priority value is calculated for each potential subsequent seat a state could be allocated—out to the maximum of six member directorships that may be allocated to each State—based on the following formula:

• V represents a priority value.
• P represents the total shares of Bank stock required to be held by members in a particular State.
• n represents the number of member directorships the state would have if it gained a seat.

The remaining seats are then allocated sequentially among the states of the district based on those priority values.

For example, if FHFA were to allocate eight member directorships among the states of a Bank district including three states having required member stock holdings of 20 million, 12.5 million, and 5 million shares, respectively, the priority values for potential seats #2 through #6 for each state would be as follows: