IFRS Interpretations Committee issues (IASB only)
The IASB discussed one issue recently discussed by the IFRS Interpretations Committee (‘the Committee’) – a request to clarify whether an entity is required to discontinue hedge accounting in a circumstance in which the hedging instrument is novated from one counterparty to another following the introduction of new regulations.
Novation of derivatives and consequences for hedge accounting
At its January 2013 meeting, the Committee considered a request to clarify whether an entity is required to discontinue hedge accounting in a circumstance where the hedging instrument is novated from one counterparty to another following the introduction of new regulations. The Committee noted that IAS 39 requires that an entity discontinue hedge accounting when an over-the-counter (OTC) derivative, which is designated as a hedging instrument, is novated to a central counterparty (CCP) under new legislation because the existing novated derivative is to be derecognised and new derivative contracts, with a counterparty being the CCP, are to be recognised at the time of the novation. The Committee expressed some concerns about the consequence of current IAS 39 guidance in this area; believing that continuing to account for the original hedging relationship (pre-novation) would provide more useful information to users.
The Committee identified a possible response to these concerns, but this would require an amendment to the hedge accounting requirements of IAS 39. Furthermore, because the legislative change would come into force within a short time, any amendment would need to be completed quickly. Consequently, the Committee decided to recommend a limited-scope amendment to IAS 39 to the IASB.
The Committee recommended that the hedge accounting requirements of IAS 39 (and IFRS 9 Financial Instruments) should be amended to allow the continuation of hedge accounting for an OTC derivative designated as a hedging instrument in the event of novation of that hedging instrument, but only if the following conditions are met and not under any other circumstances:
- the OTC derivative is novated to a CCP as a consequence of the requirement of a legislative or regulatory change; and
- as a result of the novation, all parties to the original contract are affected in the same way (i.e., each of the parties to the original derivative contract will be subject to the same terms and conditions as in the original contract after the novation, except that each of the parties has a CCP as counterparty).
The staff also noted there should be no changes to the terms of the derivative contract other than the change of counterparty.
Board members expressed general support with the Committee’s recommendation to amend IAS 39 and IFRS 9; however, a number of questions were outlined in relation to the proposals. Those questions included:
- One Board member, noting that the staff was recommending an amendment to IFRS 9 (because the proposals in the Review Draft would lead to the same issue arising under IAS 39), asked how the amendment would be applied. Specifically, as the proposed amendment would apply to the hedge accounting chapter of IFRS 9 – which is still being drafted – he asked how the staff intended to incorporate these amendments (e.g., incorporate in one document or issue the hedge accounting chapter of IFRS 9 with a subsequent amendment for these proposals). The staff intend to consider this point at a later date closer to the finalisation of both sets of proposals.
- One Board member noted that the staff proposals would ‘allow’ continuation of the existing hedging relationship. He believed the proposals should require consideration on the basis that this accounting was seen as preferable in the eyes of the Board. The staff noted that IAS 39 allows for voluntarily de-designation of hedging relationships, and thus, the staff’s proposal to allow continuation was consistent with other elective options in IAS 39.
- One Board member noted the proposals included no disclosure requirements. He believed disclosure should be required. However, others did not support any disclosure as they did not see it as useful, particularly since hedge relationships can be de-designated voluntarily for other relationship types.
- The appropriateness of the recommended comment period for the proposed amendments was discussed. The staff recommended a comment period of 90 days. However, many Board members believed a more expedited comment period was necessary to aid constituents. Given that the proposed amendment would be short, was expected to be broadly supported and the topic is exceptionally urgent following the introduction of new regulations in certain jurisdictions, one Board member recommended the minimum exposure period of 30 days. This was universally supported by others.
When put to a vote, the Board supported the recommendation of the Committee that a narrow scope amendment should be made to IAS 39 and IFRS 9 to allow a novation of an OTC derivative that is designated as a hedging instrument, where that novation is required by legislation/regulation of an otherwise unchanged hedging instrument, to be deemed to be a continuation of the existing hedging relationship. The comment period for the proposals will be 30 days.