The Reserve Bank of India (RBI) has for the novation of over-the-counter (OTC) derivative contracts, which would govern how a market participant can exit and a new party can take their place.
A novation involves the replacement of a market maker with another party in an OTC derivative contract between two counterparties (the transferor stepping out of the existing deal and remaining party) to a transaction with a new contract between the remaining party and a third party (the transferee). The transferee becomes the new counterparty to the remaining party. Guidelines on undertaking a novation:
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- Prior consent of the remaining party in the contract is mandatory before novation can occur.
- Prevailing market rates on the date of the transfer shall apply between the transferor and the transferee.
- A tripartite agreement replaces the old contract with a new contract carrying identical terms, except for the change in counterparty for the remaining party.
- This agreement ensures the transfer of the counterparty credit and market risk arising from the OTC derivative contract from the transferor to the transferee.
- The tripartite agreement also ensures that the remaining party and the transferor are released from their obligations under the old contract.
- The transferor and the transferee can agree on any charges or fees between them for the transfer, which will not form part of the novation.
- Relevant documents shall be transferred from the transferor to the transferee.
- Standard agreements for novation shall be devised by the Fixed Income Money Market and Derivatives Association of India and the Foreign Exchange Dealers’ Association of India, in consultation with market participants, and based on international best practices.
- The novation must be reported to the Trade Repository of Clearing Corporation of India.
Currently, the governs OTC derivative contracts, providing comprehensive operational guidelines on their novation.
