Reference Rate Reform
The final ASU will provide optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedge accounting relationships affected by reference rate reform, facilitating a smoother transition to new reference rates.
On September 5, 2019, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) to provide temporary optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.
On July 17, the Board wrapped up its decisions and agreed to move forward with proposing optional accounting relief to reduce cost and complexity associated with accounting for contracts and hedging relationships affected by reference rate reform.
The proposal would simplify the accounting evaluation of a contract modification and allow for that modification to be considered a continuation of the contract for accounting purposes. This accounting relief could be applied to loans, debts, leases, or any other type of contracts affected by reference rate reform.
With respect to specialized hedge accounting, the proposal would also simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. This relief is intended to minimize the disruption of reference rate reform on financial reporting and provide users with more decision-useful information. Application of this relief would be optional on a hedge-by-hedge basis.
The proposed accounting relief could be applied up until January 1, 2023, a year after the expected discontinuation of LIBOR.
Next Step:Stakeholders are encouraged to review and provide comments on the proposed ASU by October 7, 2019.
Practice Fellow David Challen discusses the context behind the FASB’s Reference Rate Reform proposal. Please take a look and share your feedback with the Board by October 7.
What is reference rate reform?
Currently, LIBOR is the most commonly used reference rate in the global financial market. However, concerns about the sustainability of LIBOR and other IBORs globally has led to an effort to identify alternative reference rates prior to late 2021 when LIBOR may no longer be used as an international benchmark.
In the United States, the Alternative Reference Rates Committee convened by the Federal Reserve has identified the Secured Overnight Financing Rate as its preferred alternative reference rate to U.S. dollar LIBOR.
Because the long-standing use of LIBOR as an international benchmark will likely cease in late 2021, the FASB has taken proactive steps to stay ahead of the migration away from LIBOR to an alternate benchmark.
As an initial step, in October 2018, the Board issued Accounting Standards Update No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes.
Why did the FASB add this project to the agenda?There are trillions of dollars in loans, derivatives and other financial contracts that reference LIBOR. Consequently, the related cash flows are tied to that rate.
The Board recognized early on that this will be a major undertaking for not just the banks, but for anyone with loans or debt on their books and added a project to its agenda to look at all areas of accounting that are impacted by reference rate reform.
Concurrent with the issuance of Update 2018-16, the Board decided to add this project to its agenda to broadly consider changes to generally accepted accounting principles (GAAP) necessitated by reference rate reform, which includes (but is not limited to) the modification of existing hedging relationships and of debt and other financial instruments.
What is the objective of the project?The objective of this project is to facilitate the effects on financial reporting of the market-wide migration from interbank offered rates (IBORs) to alternative reference rates.
Reference Rate Reform is a top priority for the FASB and the Board is working to do everything it can to help ensure a smooth transition from an accounting perspective during the lead up to the migration away from the LIBOR.