Novation in OTC Derivatives
Background
Novation has existed in Indian over the counter ("OTC") derivative markets for years, but as derivative volumes and market maker turnover grew, the absence of a comprehensive framework spanning asset classes became a genuine gap. In July 2025, the Reserve Bank of India ("RBI") released a draft titled "Reserve Bank of India (Novation of OTC Derivative Contracts) Directions, 2025", seeking to close this gap through a unified set of directions. After consultation with various stakeholders, RBI finalised the framework on 22 September 2026, but abandoned the standalone Directions format. What makes this notification noteworthy is not merely its content, but its architecture: RBI chose to insert nearly identical novation provisions into four pre-existing Master Directions (defined hereinafter) governing foreign exchange derivatives, rupee interest rate derivatives, government securities forwards, and credit derivatives.
The four Master Directions are: Master Direction – Risk Management and Inter-Bank Dealings, Master Direction – Reserve Bank of India (Rupee Interest Rate Derivatives) Directions, 2025, Reserve Bank of India (Forward Contracts in Government Securities) Directions, 2025 and Master Direction – Reserve Bank of India (Credit Derivatives) Directions, 2026, all collectively referred as "Master Directions".
Key Questions
Three questions confront practitioners. First, what did RBI substantively change between the draft and the final rule, particularly regarding who may qualify as a "remaining party" and whether inter-user novation is permitted. Second, what are the practical compliance consequences of RBI's decision to embed novation mechanics within each asset class's own rulebook rather than issue one unified regulation. Third, how does this new mechanism interact with adjacent regulatory obligations, namely margining, cross-border eligibility, enforcement, and the role of the Clearing Corporation of India Limited ("CCIL") as both central counterparty and trade repository, that a novated contract will continue to carry.
The Regulatory Framework
Each amended Master Direction defines "Novation" as the replacement of a market maker or Authorised Dealer with another of the same kind, where the transferor steps out and the transferee steps in to face the remaining party. This carries express carve outs for novation undertaken by a central counterparty for settlement purposes, and for novation pursuant to a merger, demerger, or amalgamation, which continues to be governed by the circular issued in 2013. The central counterparty carve-out is principally aimed at preserving CCIL's own longstanding open-offer clearing model, under which CCIL routinely interposes itself between buyer and seller and becomes "seller to the buyer and buyer to the seller" through its own novation mechanism. Each Direction also defines "Remaining Party" as the user, market maker or central counterparty that continues to be a counterparty in the new contract post novation.
The mechanism is uniform across the Master Directions. Novation requires the prior consent of the remaining party, must be executed at prevailing market rates, and requires that the mark to market value to be exchanged upfront between the transferor and the transferee. The parties must enter into a tripartite agreement under which the original contract is extinguished and replaced by an identical new contract, save for the change in counterparty. Any fee agreed between transferor and transferee for the transfer must be kept strictly outside the novation agreement. Foreign Exchange Dealers’ Association of India ("FEDAI") for foreign exchange derivatives, and Fixed Income Money Market and Derivatives Association of India ("FIMMDA"), for the remaining three asset classes, are responsible for devising standard form novation agreements, with a standard master agreement available as a fallback; these standard forms do not appear to have been published as of the date of this notification, so this remains a pending compliance dependency. The Master Direction on Risk Management and Inter-Bank Dealings additionally mandates reporting of novation details for foreign exchange and foreign currency interest rate derivative contracts to CCIL trade repository, and this is not an isolated obligation: the Credit Derivatives Directions separately and independently require market makers to report all novation events to CCIL's trade repository.
What Changed, and Why It Matters
The most consequential change between draft and final direction lies in the definition of "Remaining Party". The draft confined this term to the user alone. Market participants pointed out that on centrally cleared or anonymous trading platforms, such as CCIL's ASTROID, the central counterparty itself, or another market maker, may in fact be the party that remains in the contract post novation. RBI accepted this and expanded the definition to include market makers, authorised dealers, and central counterparties, further clarifying that where a central counterparty is the remaining party, novation must follow that counterparty's own prescribed procedure. In practice, this defers the operative mechanics of any such novation to CCIL's own byelaws, rules, and regulations rather than to the Master Directions themselves. For centrally cleared contracts, the Master Directions therefore function more as a jurisdictional marker than as an operative rulebook, with CCIL's own membership regulations doing the substantive work and displacing the generic tripartite agreement, consent, and upfront mark-to-market requirements described above.
On inter-user novation, RBI drew a firm line. Requests to permit novation where both transferor and transferee are users, for instance, a corporate transferring its position to its own group treasury entity, were expressly rejected. At least one party to any novated contract must continue to be a regulated market maker, Authorised Dealer, or central counterparty authorised by RBI. This reinforces RBI's longstanding preference for intermediated OTC derivative markets and limits intra-group risk-transfer structures.
The Master Directions apply prospectively only to novations executed on or after 22 September 2026, regardless of whether the underlying contract predates that date. Existing novation agreements need not be re-papered, offering meaningful relief from a transition cost perspective.
On architecture, RBI's decision to fold these provisions into existing Master Directions, rather than issue a fifth standalone rulebook, reflects a deliberate regulatory preference for integration over proliferation. It must be built into the primary compliance checklist for each derivative product line, with careful attention paid to asset class specific terminology, namely authorised dealer for foreign exchange transactions and market maker for the remaining three classes, as well as the differing documentation bodies of FEDAI and FIMMDA.
Connected Compliance Considerations
Because a novated contract does not exist in isolation from the rest of the regulatory framework, three connected considerations arise. First, where a non-centrally cleared derivative is novated, firms should confirm whether variation and initial margin already posted under the Master Direction – Reserve Bank of India (Margining for Non-Centrally Cleared OTC Derivatives) Directions, 2024 continue to apply to the replacement contract, or must be re-assessed, since the upfront mark-to-market exchange mandated on novation is a distinct obligation from ongoing margin exchange. Second, because non-resident transactions must conform to FEMA, a novation that substitutes or removes a non-resident counterparty may trigger a fresh FEMA eligibility check. Third, because the Credit Derivatives Directions, 2026, is itself a newly issued instrument, novation activity in that asset class is likely to remain limited in the near term, and its interaction with these new novation mechanics, including its own CCIL reporting obligation, merits separate monitoring as that market develops.
Conclusion
RBI's final novation framework changes little in substance from its July 2025 draft but sharpens it materially on the two fronts that market participants had flagged: it now recognises market makers and central counterparties, not merely users, as eligible remaining parties, while firmly closing the door on unintermediated, user-to-user novation. Combined with its prospective only application, its deliberate dispersal across four existing Master Directions rather than one new rulebook, its continuing intersection with margining, cross-border, and enforcement obligations, and its reliance on CCIL's own clearing and trade repository infrastructure for centrally cleared contracts, this is less a new law than a structural recalibration of an existing one.
Market makers, authorised dealers, and corporate treasury desks should promptly map which standing novation practices fall outside the new compliance framework, update documentation templates to align with forthcoming FEDAI and FIMMDA standard agreements once published, build upfront mark-to-market settlement into operational workflows, reconcile this against existing margin arrangements, and confirm trade repository reporting readiness, particularly for foreign exchange desks. As with most RBI consolidations, the real compliance burden lies in the operational detail, and on novation, that detail is now live.