A novation indicates an event where the original parties to a derivative agree that one or more clearing counterparties replace their original counterparty to become the new counterparty to each of the parties. In order to benefit from the amended guidance, novation to a central counterparty (CCP) must happen as a consequence of laws or regulations or the introduction of laws or regulations.

The IASB saw an urgent need for the amendment, as the G20 had committed themselves to improve transparency and regulatory oversight of over-the-counter (OTC) derivatives in an internationally consistent and non-discriminatory way. Consequently, all OTC derivatives should be cleared centrally going forward. This includes OTC derivatives that are within the scope of the European Market Infrastructure Regulation (EMIR), or the Dodd-Frank Act in the USA, respectively. The objective of the amendments is to avoid any impact on an entity’s hedge accounting from derecognising the derivative, following its novation. Specifically, the IASB was concerned that the effectiveness for cash flow hedges might not be sufficient to maintain the designation or to designate the novated derivative as a hedging instrument.

In order to benefit from the changes to IAS 39 an entity must meet all of the following criteria:

1. Novation to a central counterparty (CCP) must happen as a consequence of laws or regulations or the introduction of laws or regulations.
   This constitutes a significant change to the requirements proposed in the Exposure Draft, as the novation need not be required by law or regulation: A novation might equally occur because of existing or newly introduced laws or regulations. However, the mere possibility of laws or regulations being introduced would not be sufficient.
   
   
2. Following the novation, a central counterparty would become the new counterparty to each of the original parties to the derivative.
   In this context, it would also be possible to introduce a party that is acting as a counterparty in order to effect the clearing with a CCP. This could be a clearing member or a clearing organisation that is contracted because the party does not have direct access to a CCP. In some jurisdictions, a novation will be effected with clients of clearing members of a CCP (so-called indirect clearing). The IASB reasoned that such novations should also be in the scope of the amendments because they are consistent with the objective of the proposed amendments. Further, intragroup novations would also be in the scope if these were in order to access a CCP. In cases in which a novation is not effected directly with the CCP, an entity must ensure that each of the parties to the hedging instrument effects clearing with the same CCP.
   
   
3. Any changes to the hedging instrument are limited to those that are necessary to effect such a replacement of the counterparty.
   Such changes include changes in the collateral requirements, rights to offset receivables and payables balances, and charges levied. However, this does not include changes to the maturity, the payment dates, or the contractual cash flows or their basis of their calculation.

The amendments to IAS 39 are effective for annual periods beginning on or after 1 January 2014. Earlier application is permitted but requires corresponding disclosures. In accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, the amendments are to be applied retrospectively.

In addition to amending IAS 39, the IASB decided to make equivalent amendments to forthcoming chapter 6 on hedge accounting in IFRS 9 Financial Instruments, which is expected to be issued during the third quarter of 2013.

Click for:

• IASB press release (link to IASB website)
• IFRS in Focus newsletter explaining the amendments
• Our project page outlining the history of this project.