The IASB has issued an exposure draft proposing a limited scope amendment to IAS 39, Financial instruments: Recognition and measurement, and to the forthcoming chapter on hedge accounting in IFRS 9, Financial instruments. The exposure draft proposes some relief from the hedge accounting requirements when a derivative is novated to a central counterparty (CCP), such as a central clearing organization, under certain circumstances.
Regulations have been introduced (based on the G20 commitments arising out of the financial crisis) that will require “over the counter” (OTC) derivatives to be transacted with a CCP to improve transparency, consistency, and regulatory oversight of OTC derivatives. This will result in the novation (that is, replacing one party of the derivative contract with a new party, in this case the CCP) of existing OTC derivative contracts.
Existing guidance requires an entity to stop hedge accounting when such a novation occurs because the original derivative no longer exists. The derivative with the CCP can be designated in a new hedging relationship. However, this may result in more hedge ineffectiveness, particularly for cash flow hedges, and increases the risk that the hedging relationship will fail to meet the threshold for being highly effective because the new derivative has a non-zero fair value.
The exposure draft proposes to allow the continuation of hedge accounting when a hedging derivative is novated to a CCP and all of the following conditions are met:
Any changes to the derivative’s fair value that arise from the novation must be reflected in its measurement and therefore, in the measurement of hedge effectiveness.
In the United States, the SEC staff provided similar relief. In a letter to the International Swaps and Derivative Association (ISDA) dated May 2012, the SEC staff agreed that it would not object to the continuation of an existing hedging relationship where there is a novation of a derivative contract under specific circumstances. However, those specific circumstances differ from those proposed by the IASB and therefore, could lead to application differences. For further details on the SEC staff views, refer to Dataline 2012-16, Implications to hedge accounting of changes to derivative counterparties or hedging relationships.
The limited scope amendments will be beneficial to entities applying hedge accounting that are subject to mandatory novation of OTC derivatives.
Although the exposure draft does not specify an effective date, the IASB hopes to complete the amendments as soon as possible because the new regulations to mandate CCP clearing of OTC derivatives will become effective shortly.
The comment period ends on April 2, 2013. Entities should consider responding to the proposals so that their views can be considered by the IASB in its finalization of the amendment.
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