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IFRS amendments to IAS 39

IFRS amendments to IAS 39

IFRS amendments to IAS 39 : Recognition and Measurement and IFRS 9 Financial Instruments: Novation of derivatives and continuation of hedge accounting

The objective is to provide an exception to the requirement for the discontinuation of hedge accounting in IAS 39 and IFRS 9 in circumstances when a hedging instrument is required to be novated to a central counterparty as a result of laws or regulations.

IFRS amendments to IAS 39

IFRS amendments to IAS 39

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.

IFRS amendments to IAS 39

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.

IFRS amendments to 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.

IFRS amendments to IAS 39: 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.

In its May 2013 meeting, the IASB discussed an analysis of comment letters received on the Exposure Draft ED/2013/2 Novation of Derivatives and Continuation of Hedge Accounting (Proposed Amendments to IAS 39 and IFRS 9) that was published in February 2013.

The IASB published Novation of Derivatives and Continuation of Hedge Accounting (Amendments to IAS 39) in June 2013. These amendments allow hedge accounting to continue when derivatives are novated to effect clearing with a central counterparty as a result of laws or regulations, if specific conditions are met.

The amendments are to be applied retrospectively for annual periods beginning on or after 1 January 2014.

IFRS amendments to IAS 39- Benifits:

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, intravenous notations 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 counterpart.
    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.

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