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IASB proposes urgent amendments to hedge accounting to respond to G20 OTC initiatives

28 Feb 2013

The International Accounting Standards Board (IASB) has issued ED/2013/2 'Novation of Derivatives and Continuation of Hedge Accounting'. The exposure draft proposes changes to IAS 39 and the forthcoming hedge accounting chapter of IFRS 9 to permit the continuation of hedge accounting where hedging instruments are novated to a central counterparty in accordance with laws or regulations introduced by jurisdictions to implement the G20's agreed reforms around over the counter (OTC) derivatives. As a number of jurisdictions are currently considering implementing these laws, the IASB is proposing an urgent amendment and has set a 30 day comment period.


Background

This project arose out of a request to the IFRS Interpretations Committee in respect of a European Regulation on OTC derivatives, central counterparties and trade repositories (the so-called European Market Infrastructure Regulation - EMIR) which implemented central clearing for certain classes of OTC derivatives.

The legislation in Europe giving rise to the Committee request arose out of a commitment from the G20, in response to the global financial crisis, to implement new requirements for  centralised clearing for standardised OTC derivative contracts.  Specifically, in September 2009, the G20 leaders agreed that:

All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the FSB [Financial Stability Board] and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.

The original request to the Committee concerned the impact on hedge accounting from when an OTC derivative is novated to a central counterparty (CCP) in accordance with EMIR. Specifically, the Committee considered whether the novation of OTC derivatives in these circumstances would result in the discontinuing of hedge accounting and recommended a limited scope amendment to provide relief so that hedge accounting could be continued.

The IASB considered the issue and agreed to add this project to its active agenda at its January 2013 meeting, determining that without an amendment, the novation of an existing OTC derivatives in these circumstances would lead to its derecognition and lead to the discontinuation of hedge accounting.


Overview of the proposed amendments

ED/2013/2 proposes that the novation of a hedging instrument should not be considered an expiration or termination giving rise to the prospective discontinuation of hedge accounting if all of the following (summarised) criteria are met:

  • the novation is required by laws or regulations
  • the novation results in a central counterparty becoming the new counterparty to each of the parties to the novated derivative
  • the changes in terms of the novated derivative are limited to those necessary to effect the terms of the novated derivative.

As such, the amendment is narrowly focused on the specific fact pattern introduced by the G20's OTC derivative reforms.  The IASB's view is that accounting for the  hedging relationship that existed before the novation as a continuing hedging relationship in these circumstances provides more useful information to financial statement users. However, given its limited scope the amendment would not grandfather continuation of hedge accounting for any voluntarily novated derivative that the two original parties to the contract agreed to (e.g., if the entities agreed to novation as a preemptive measure knowing that the change in legislation was coming). This represents a difference to U.S. GAAP where similar requirements to the EMIR Regulation are included in the Dodd-Frank Act. In the U.S. the SEC has opined that hedging relationships where the hedging derivative was novated to a central counterparty would be continued even if the exchange of counterparties took place before the effective date of the Act.

The exposure draft notes that since the forthcoming hedge accounting chapter of IFRS 9 Financial Instruments will require the discontinuation of hedge accounting where novation occurs, the exposure draft proposes amendments to be incorporated into IFRS 9 in addition to IAS 39 Financial Instruments: Recognition and Measurement.

Given that many jurisdictions are in the process of finalising legislation to introduce the G20's OTC reforms, the proposed amendments are being expedited and the exposure draft is open for a short comment period of only 30 days, which closes on 2 April 2013.

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The ED will be discussed in the upcoming Dbriefs webcast — IFRS: Important developments on 27 March.