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Novation of derivatives (IASB only)

Date recorded:

The IASB previously discussed an issue that has been raised from the Committee regarding whether hedge accounting should be discontinued in a circumstance in which an over-the-counter (OTC) derivative, which has been designated as a hedging instrument, is novated from one counterparty to a central counterparty (CCP) following the introduction of new regulations.

At that meeting, the Board tentatively decided to propose a limited-scope amendment to IFRS 9 Financial Instruments and IAS 39 Financial Instruments: Recognition and Measurement requiring the continuation of the existing hedging relationship in circumstances in which a novation is required as a result of legislation, regulation or similar statutory requirements; all parties to the original OTC derivative contract are affected in the same way by the novation; and there are no changes to the terms of the original OTC derivative contract other than the change of counterparty to a CCP. The IASB also tentatively decided on a 30 day comment period for the Exposure Draft (which was subsequently confirmed as acceptable by the Due Process Oversight Committee).

At this meeting, the staff noted that constituent feedback had been received following the Board’s previous tentative decision which suggested a limited-scope amendment to IFRS 9 and IAS 39 would not be helpful to constituents if the scope was limited to circumstances in which no changes to the terms of the original OTC derivative contract are evident other than the change of counterparty to a CCP. Specifically, constituents noted that, in practice, the introduction of new legislation is expected to yield changes beyond parties to the contract, such as changes in collateral margins. Therefore, the staff recommended an amendment to the previous tentative decisions of the Board to specify that changes in the contract directly attributable to the novation would not negate the ability of the party to the OTC derivative contract from applying the proposed amendment.

Board members generally agreed that an amendment to their previous tentative decision was required to respond to constituent concerns. However, some Board members expressed concern with broadening the proposals too significantly. They believed the amendment should be specific as to changes in contract terms which would be within the scope of the proposed amendment. The staff noted the recommended wording was intended to capture changes to contractual terms that are a necessary consequence of the novation. Board members generally agreed with this principle and asked that the wording of the ballot draft capture this principle. With little additional debate, the Board tentatively supported amending previous tentative decisions to capture consequential contract changes of the novation within the scope of the amendment.