CFM50430 - Derivative contracts: relevant contracts: other contracts with embedded derivatives
CTA09/S586
Derivatives embedded in other types of host contract
A company may account separately for a derivative (or derivatives) that are embedded in a host contract that is neither a loan relationship nor a derivative - for example, a sale and purchase contract, or a lease.
Where a company,
- is party to a contract that is not a loan relationship or a hybrid derivative, and
- in accordance with GAAP treats the contract as split between one or more embedded derivatives and a host contract,
S586 treats the company as party to one or more relevant contracts whose rights and liabilities are those of the embedded derivative or derivatives. As with derivatives embedded in a loan relationship, the relevant contracts are options, futures or contracts for differences, according to how they would be treated were they stand-alone contracts.
S586 will only apply where, in accordance with GAAP, the company has actually adopted accounting policies that require it to bifurcate such contracts.
The effect of S586 is to remove uncertainty about whether such embedded derivatives are relevant contracts for CTA09/PT7 purposes on first principles: initially, at least, they are all brought within the regime.
Where S586(2) (or S584(2)) applies, CTA09/S616 provides that S573 and S574 - which bring into account trading and non-trading credits or debits on derivative contracts - do not apply to fair value changes in embedded derivatives that are brought into PT7. An exception is where regulation 9 of the Loan Relationships and Derivative Contracts (Disregard and Bringing into Account of Profits and Losses) Regulations 2004 (SI 2004/3256) (‘the Disregard Regulations’) applies.
A company may, under CTA09/S617, elect out of S616, unless the embedded derivative in question is a commodity derivative. More detailed guidance on S616 is at CFM52530+.