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Should Derivative Contract Novation Mean Hedge Accounting Dedesignation?

A new exposure draft issued yesterday by the FASB clarifies that a novation of a derivative from one counterparty to another is NOT necessarily an automatic dedesignation. This is great news for Corporates that have been faced with counterparties withdrawing from the marketplace or monetizing their current positions.

The FASB is asking several questions during the comment period, which lasts through Oct. 5, 2015.

Why should I write a comment letter?

If you have experienced a novation where no other terms in the derivative have changed and you want to be able to go back to your original designation (shortcut or long-haul), you need to address FASB Question No. 3. A brief summary of all of the questions follows. For a complete reading of the questions, please go to the FASB website at http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176166248164.

  1. Do you agree that a change in the counterparty to a derivative instrument should not, in and of itself, require dedesignation?
  2. Do you agree that this amendment should be applied on a prospective basis to existing AND new relationships that have a change in counterparty after the amendment date?
  3. For those entities that had been applying an abbreviated qualitative method of hedge accounting before a dedesignation resulting from a past novation, should the Task Force permit, but not require a retrospective transition.
  4. Should there be a difference in the amendment for private companies?
  5. Should the implementation period differ for public versus private entities? Should it be effective upon issuance?
  6. Should the reporting entity be required to provide transition disclosures including the nature of and reason for the change in accounting principle and an explanation of why the newly adopted accounting principle is preferable? If so, should these disclosures be required for both interim and annual periods.

The FASB is asking for comments both from those that disagree AND those that agree with the proposal. We believe that adoption of this proposal will provide welcome relief for corporate hedgers faced with novations.

When commenting, we recommend that you include clarification surrounding Question No. 3 if you have a previously novated derivative that originally used the long-haul effectiveness testing approach. As written, it is NOT CLEAR if an entity will be able to retrospectively apply the guidance unless the original designation was made under shortcut or one of the other qualitative options like matched terms. The retrospective application would potentially eliminate the ineffectiveness that can ping in and out of the P&L from off-market designations. We believe that it’s important to revise the wording to clearly indicate that retrospective transition is allowed for ALL previous designations.