RBI Issues Draft Guidelines on Novation of OTC Derivative Contracts

Context

On July 10, 2025, the Reserve Bank of India (RBI) released draft guidelines proposing a structured mechanism for novation of over-the-counter (OTC) derivative contracts. This move aims to enhance transparency, fairness, and legal certainty in OTC derivatives markets.

What is Novation?

Novation is a legal process that replaces an existing contract with a new one by substituting one counterparty while maintaining identical contractual terms (except the party change).

• Parties Involved in Novation:
  • Transferor: Original party who exits the contract.
  • Transferee: New party entering the contract.
  • Remaining Party: The party that remains unchanged and continues in the new contract.

Key Features of the RBI Draft Guidelines

1. Consent Requirement
   • Novation can occur only with the explicit consent of the remaining party.
2. Tripartite Agreement
   • A formal tripartite agreement among the transferor, transferee, and remaining party is necessary.
3. Fair Valuation and Market Rates
   • Novation must occur at prevailing market rates.
   • The mark-to-market value must be exchanged between transferor and transferee to reflect financial fairness.
4. Standardised Documentation
   • RBI has asked FIMMDA (Fixed Income Money Market and Derivatives Association of India) and FEDAI (Foreign Exchange Dealers’ Association of India) to:
     • Develop standard documentation based on international best practices.
   • Alternatively, participants can use a standard master agreement.
5. Regulatory Reporting
   • All novated transactions must be reported to the Trade Repository of CCIL (Clearing Corporation of India Ltd) in compliance with existing norms.

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