RBI issues draft directions for novation of OTC derivative contracts

Draft norms enable position transfer in OTC derivatives with consent and fair pricing; RBI mandates tripartite structure to ensure risk shift and regulatory adherence

The Reserve Bank of India (RBI) on Wednesday issued draft directions for the novation of Over-the-Counter (OTC) derivative contracts, aimed at outlining the process by which a market participant can exit an existing OTC derivative contract and transfer their position to another party.

 

Comments on the draft directions are invited from banks, market participants and other stakeholders by August 1, 2025.

 

Novation refers to the replacement of a market maker with another market maker in an OTC derivative contract between two counterparties, resulting in a new contract between the remaining party and a third party (transferee).

 

Under the directions, novation will require the prior consent of the remaining party and must be carried out at prevailing market rates. The RBI has also mandated that all parties adhere to existing regulatory frameworks, with the original contract being replaced by a new one with identical terms, except for the change in counterparty.

 

“Eligible market participants may undertake novation of an OTC derivative contract, subject to the following: the novation of an OTC derivative contract shall be done with the prior consent of the remaining party; the transaction shall be undertaken at prevailing market rates,” the draft norms said.

 

“The amount corresponding to the mark-to-market value of the OTC derivative contract at the prevailing market rate on the novation date shall be exchanged between the transferor and the transferee; and the parties to the novation shall adhere to the provisions of the Governing Directions and the new contract post-novation shall be in compliance with the provisions of the Governing Directions,” it said. 

 

Additionally, as part of the novation process, all parties must enter into a tripartite agreement under which the transferee replaces the transferor as the counterparty to the remaining party. The original OTC derivative contract is extinguished and replaced with a new contract that mirrors the original in all terms and parameters, except for the change in counterparty. This ensures that counterparty credit risk and market risk are fully transferred from the transferor to the transferee, and that both the transferor and the remaining party are released from their mutual obligations and rights under the original contract, which are reinstated in the new agreement between the remaining party and the transferee.

 

While the transferor and transferee may mutually agree on a fee for the transfer, such terms will not form part of the novation agreement. Additionally, all relevant documents pertaining to the original contract and its underlying exposure must be handed over by the transferor to the transferee.