US GAAP generally requires that if a "critical term" of a hedging relationship is modified, either through modification of the hedging instrument or changing the documented hedged item, the hedging relationship must be terminated (de-designated) and a new hedging relationship created (re-designated) to apply hedge accounting.
Market protocols for derivatives may be changing in the near future. Financial reform legislation could make novations (in this case, substitution of counterparties to a contract) more common as over-the-counter (OTC) transactions are migrated to central exchanges. In anticipation of these changes, the International Swaps and Derivative Association (ISDA) asked the SEC’s Office of the Chief Accountant if the novation of a bilateral OTC derivative contract to a central counterparty "on the same financial terms" would require the designation of a new hedging relationship. The SEC staff responded that it does not object, under certain limited circumstances, to a conclusion that, for accounting purposes, the original contract has not been terminated and replaced with a new derivative contract, nor would the staff object to the continuation of the existing hedging relationship, provided that the other terms of the contract have not been changed.
This Dataline discusses the SEC staff's response and looks at the implications to hedge accounting of changes to derivative counterparties or hedging relationships.