To compensate counterparties for the time value of money, many contracts reference interest rate indices (reference rates). For example, a debt instrument may have a coupon that periodically resets based upon the then-current reference rate. The London Interbank Offered Rate (LIBOR) has been one of the most commonly used reference rates in the global financial markets. In July 2017, the United Kingdom’s Financial Conduct Authority announced that it would no longer persuade or compel banks to submit LIBOR as of the end of 2021. In November 2020, the ICE Benchmark Administration (the administrator of LIBOR) announced its intention to cease publication of the one-week and two-month US dollar (USD) LIBOR settings as well as all non-USD LIBOR settings immediately following the LIBOR publication on December 31, 2021. It will cease publication of the remaining USD LIBOR settings immediately following the LIBOR publication on June 30, 2023. Concerns about the sustainability of LIBOR and other interbank offered rates (IBORs) globally has led to an effort to identify alternative reference rates.
The shift away from the most widely used interest rate benchmarks to alternative reference rates is a significant change for the global financial markets. The impact of this change is not limited to financial services companies; it will impact all companies. IBOR rates are frequently used in financial instruments, such as debt agreements, investments, and derivatives, but may also be present in leases, compensation arrangements, and contracts with customers. Preparing for the impact of IBOR reform is likely to be a significant effort and will require a multidisciplinary team to identity where IBOR is used and negotiate changes to arrangements. Many institutions are already working to insert provisions frequently referred to as “fallback language” into new or existing agreements. These provisions specify how a replacement rate will be identified (and other terms, such as how the spread above the reference rate will be changed) once a trigger event (such as LIBOR no longer being quoted) occurs. Industry working groups continue to develop standard fallback terms for a number of financial instruments that they are recommending entities adopt.
From an accounting perspective, IBOR reform has the potential to create challenges when accounting for contract modifications and hedging relationships. For example, there may be a significant volume of contracts that will need to be modified and then assessed to determine whether the modification results in the establishment of a new contract or a continuation of the existing contract for accounting purposes. In addition, modifications related to reference rate reform to derivatives or hedged items involved in hedging relationships could result in de-designations of otherwise highly effective hedges. As a result, both the FASB and the IASB have issued accounting relief from the effects of reference rate reform.
On March 12, 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting (the “ASU”). This ASU provides relief that, if elected, will require less accounting analysis and less accounting recognition for modifications related to reference rate reform. The ASU provides specific guidance relating to instruments subject to ASC 310, Receivables, ASC 470, Debt, ASC 840 and ASC 842, Leases, and ASC 815, Derivatives and Hedging. It also includes a principle that provides relief from contract modification requirements in other guidance not explicitly addressed.
In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope, to clarify that the scope of ASC 848 includes derivatives that are affected by a change in the interest rate used for margining, discounting, or contract price alignment that do not also reference LIBOR or another reference rate that is expected to be discontinued as a result of reference rate reform.
The IASB pursued a two-phase project. Phase 1 led to amendments to IFRS 9, IAS 39, and IFRS 7 in September 2019. Similar to the relief offered by the FASB under US GAAP, these amendments provide temporary relief from applying specific hedge accounting requirements to hedging relationships directly affected by IBOR reform. The amendments have the effect that hedge accounting will generally not need to be discontinued due to the uncertainties created by interest rate benchmark reform. However, any hedge ineffectiveness should continue to be recorded in the income statement under both IAS 39 and IFRS 9. Furthermore, the amendments establish triggers for when the relief will end, which includes when the uncertainty arising from interest rate benchmark reform no longer exists.
The Phase 2 amendments, issued in August 2020, primarily address issues that arise as benchmark reform is implemented (e.g., the actual replacement of one benchmark rate with an alternative one). Phase 2 amendments (1) provide specific relief when there is a change in the basis for determining contractual cash flows of financial assets or financial liabilities (including lease liabilities) as a result of IBOR reform and (2) enabling the continuation of hedge accounting when changes are made to hedging relationships as a result of the transition to alternative benchmark rates.
This chapter compares the IASB Phase 1 and Phase 2 IBOR reform amendments to the FASB reference rate reform standard (ASC 848).
For more detailed guidance on ASC 848, see PwC’s Reference rate reform guide. For more detailed guidance on the IASB’s amendments, see PwC’s In depth, Practical Guide to Phase 2 amendments IFRS 9, IAS 39, IFRS 7, IFRS 4, and IFRS 16 for interest rate benchmark (IBOR) reform.
Technical references
IFRS 9, IAS 39, IFRS 7, IFRS 4, IFRS 16
The following discussion captures the differences between ASC 848 and the IASB IBOR reform amendments that we consider to be the most significant or pervasive. It should be read in combination with the authoritative literature and a thorough analysis of all the facts and circumstances.
Entities that had adopted IFRS 9 had a choice to continue to apply existing IAS 39 hedge accounting guidance or to apply the revised hedging guidance included in IFRS 9. The following discussion assumes that an entity has adopted the amended IFRS 9 hedge accounting requirements.
Certain insurance entities elected to temporarily defer the adoption of IFRS 9 in its entirety based on an optional election provided by the IASB. The impact of differences for those entities is not addressed in this publication.
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