RBI’s Novation Revolution: Making Derivatives Safer, Smarter, Stronger

Image Source: Business Standard

To propel India's financial markets ahead, the Reserve Bank of India (RBI) has released draft directions on the novation of Over-the-Counter (OTC) derivative contracts. This is a historic move to simplify and streamline the regulatory framework of novation and render the process more transparent and efficient for market participants.

Key Highlights

Definition of Clear Novation: Clear novation is replacing the initial market maker under a contract of an OTC derivative with a new counterparty (transferee) under a new contract with the same terms except for the new counterparty.

Consent and Market Rates: Novation must be at market rates in existence and entails the prior consent of the surviving party to the contract.

Tripartite Agreement: All the parties must sign a tripartite agreement under which the obligations of the outgoing party are completely transferred to the new counterparty and cancellation of the original contract is done.

Standardized Documentation: Fixed Income Money Market and Derivatives Association of India (FIMMDA) and Foreign Exchange Dealers' Association of India (FEDAI) shall create standard agreements based on international best practice.

Mark-to-Market Settlement: The mark-to-market value of the contract at the time of novation must be swapped between the exiting and entering parties.

Reporting and Compliance: All novation transactions must be reported to the Clearing Corporation Trade Repository. The new contract must be harmonized with existing regulatory regimes.

Exclusions: The provision does not cover novations by central counterparties or by virtue of mergers, demergers, or reorganizations sanctioned by a court.

Public Comments: RBI invited stakeholders' feedback until August 1, 2025, to ensure that the draft meets the requirements of the market and the international standards.

This revamp is likely to increase operational transparency, minimize legal uncertainty, and enhance India's OTC derivatives market risk management.

Source: Business Standard, Times of India, NDTV Profit