Why are we doing this project?
The IFRS Interpretations Committee (the Interpretations Committee) received a request to clarify whether hedge accounting should be discontinued in a circumstance in which a derivative, which has been designated as a hedging instrument, is novated from one counterparty to a central counterparty (CCP) as a consequence of laws or regulations.
This issue was discussed by the Interpretations Committee and subsequently by the IASB. The IASB noted that the novation of a derivative contract to a CCP would meet the derecognition requirements both for financial assets and financial liabilities in IAS 39. Consequently, an entity whose hedging instrument is novated would be required to discontinue the hedge accounting for such a hedging instrument. The new derivative, with a counterparty being the CCP, would be recognised at the time of the novation.
The IASB, however, was concerned about the financial reporting effects that would arise from the novation as a result of new laws or regulations. The IASB noted that the requirement to discontinue hedge accounting meant that although an entity could designate the new derivative as the hedging instrument in a new hedging relationship, this would result in more hedge ineffectiveness, especially for cash flow hedges, compared to a continuing hedging relationship. This is because the derivative that would be newly designated as the hedging instrument would be on terms that would be different from a new derivative, ie it would not be ‘at-market’ (for example, the derivative would have a non-zero fair value if it is a non-option derivative, such as swap or forward) at the time of the novation. The IASB also noted that there would be an increased risk that the hedging relationship would fail to meet the 80 per cent – 125 per cent hedge effectiveness range required by IAS 39.
The IASB, taking note of these financial reporting effects, was convinced that accounting for the hedging relationship that existed before the novation as a continuing hedging relationship in this specific situation would provide more useful information to users of financial statements.
The IASB considered the fact that the legislative changes that would require such novation of derivatives would be widespread across jurisdictions. These legislative changes were prompted by a G20 commitment to improve transparency and regulatory oversight of over-the-counter derivatives in an internationally consistent and non-discriminatory way.
What are we doing?
In its January 2013 meeting, the IASB decided to propose in an Exposure Draft a narrow-scope amendment to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments that would require a continuation of the existing hedging relationship in a circumstance where the hedging instrument is novated from one counterparty to a CCP as a consequence of laws or regulations, if specific conditions are met. An Exposure Draft was published in February 2013.