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3.1 Hedge accounting relief
Publication date: 31 Dec 2022
us Reference rate reform guide
ASC 848 provides several optional expedients designed to allow hedging relationships to continue, without dedesignation, when one or more critical terms of the hedging relationship change, or are expected to change, due to reference rate reform. The type of relief that is available to reporting entities depends on a number of factors including the nature of the hedging relationship and the method in which effectiveness is assessed. Reporting entities should carefully evaluate whether their specific fact pattern enables them to qualify for relief in ASC 848 and the specific relief provisions that they are eligible to apply. Not all hedge relationships will qualify for the same relief provisions.
3.1.1 Scope of ASC 848: Hedging relationships
Optional expedients under ASC 848 may be applied if the hedging instrument, the hedged item, or the hedged forecasted transaction in a hedging relationship:
- references LIBOR or a reference rate expected to be discontinued (see ASC 848-10-15-3), and
- includes only modifications that are made or expected to be made related to the replacement of LIBOR or a reference rate expected to be discontinued (see ASC 848-20-15-2 through ASC 848-20-15-3).
- This criterion is not required to elect the cash flow hedge optional expedient for assessing the probability of the hedged forecasted transaction (ASC 848-50-25-2), assessing a group of individual forecasted transactions (ASC 848-50-25-13 through ASC 848-50-25-14), assessing the initial assessment of hedge effectiveness performed using a quantitative method (ASC 848-50-25-11) and changing the method designated for assessing hedge effectiveness (ASC 848-30-25-8).
The guidance in this Topic, if elected by an entity, shall apply to contracts or other transactions that reference the London Interbank Offered Rate (LIBOR) or a reference rate that is expected to be discontinued as a result of reference rate reform.
Certain provisions of the guidance in this Topic, if elected by an entity, shall apply to derivative instruments that do not meet the scope of paragraph 848-10-15-3 that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform (see paragraph 848-10-55-1).
The guidance in this Subtopic, if elected, shall apply to contracts that meet the scope of paragraph 848-10-15-3 if either or both of the following occur:
- The terms that are modified directly replace, or have the potential to replace, a reference rate within the scope of paragraph 848-10-15-3 with another interest rate index. If other terms are contemporaneously modified in a manner that changes, or has the potential to change, the amount or timing of contractual cash flows, the guidance in this Subtopic shall apply only if those modifications are related to the replacement of a reference rate. For example, the addition of contractual fallback terms or the amendment of existing contractual fallback terms related to the replacement of a reference rate that are contingent on one or more events occurring has the potential to change the amount or timing of contractual cash flows and the entity potentially would be eligible to apply the guidance in this Subtopic.
- The interest rate used for margining, discounting, or contract price alignment is modified as a result of reference rate reform.
Certain optional expedients in this Subtopic, if elected, shall apply to derivative instruments that meet the scope of paragraph 848-10-15-3A (see paragraph 848-10-55-1).
Other than a modification of the interest rate used for margining, discounting, or contract price alignment in accordance with paragraph 848-20-15-2(b), for contracts that meet the scope of paragraph 848-10-15-3, the guidance in this Subtopic shall not apply if a contract modification is made to a term that changes, or has the potential to change, the amount or timing of contractual cash flows and is unrelated to the replacement of a reference rate. That is, this Subtopic shall not apply if contract modifications are made contemporaneously to terms that are unrelated to the replacement of a reference rate.
Certain expedients may be applied for derivatives designated as hedging instruments that are modified to change an interest rate used for margining, discounting, or contract price alignment (see ASC 848-10-15-3A). ASC 848-10-55-1 lists out the specific optional expedients that can be applied to derivatives that meet the scope of ASC 848-10-15-3A. This includes:
- for all hedges:
- the option to not dedesignate a hedge relationship due to a change in the critical terms of the hedging relationship because of an election of an optional expedient (see REF 3.1.3),
- the option to change the contractual terms of a hedging instrument, including by entering into fully offsetting derivative and contemporaneously entering into a new derivative with revised terms without dedesignating the hedge relationship (see REF 3.1.3), and
- the option to change the systematic and rational amortization method for excluded components (see REF 3.1.5).
- for fair value hedges:
- the option to change the designated benchmark interest rate (see REF 3.2.1),
- the option to adjust the basis adjustment for a fair value hedge applying the shortcut method by the payment or receipt of a cash settlement (or equivalent) intended to compensate for the change in interest rate (see REF 3.2.3), and
- the option to apply the subsequent effectiveness assessment expedients when the shortcut method was used prior to the modification of the interest rate used for margining, discounting, or contract price alignment (see REF 3.2.2).
- for cash flow hedges:
- the option to adjust the amount in accumulated other comprehensive income for a cash flow hedge by the payment or receipt of a cash settlement (or equivalent) intended to compensate for the change in interest rate (see REF 3.3.7), and
- the option to continue applying a perfectly effective assessment methodology for a cash flow hedge using the subsequent effectiveness optional expedients in ASC 848 provided a perfectly effective assessment methodology was used prior to the modification of the interest rate used for margining, discounting, of contract price alignment or the option to switch to using a quantitative method (see REF 3.3.5).
Unlike the guidance for contract modifications under ASC 848-20, a reporting entity can apply the optional expedients to hedge accounting relationships designated under ASC 815 on an individual hedging relationship basis. That is, an optional expedient can be elected for some hedging relationships but not elected for other similar hedging relationships. In addition, a reporting entity may elect to apply multiple optional expedients to the same individual hedging relationship and may elect those optional expedients in different reporting periods. For example, a reporting entity may elect to apply the optional expedient to change the critical terms of a hedging relationship in one period and then elect to apply the optional expedient to change the method used for assessing hedge effectiveness in a different reporting period. There is no requirement when electing optional expedients under ASC 848 to assess effectiveness for similar hedges in a similar manner.
3.1.2 Updating hedge documentation
ASC 848 requires a reporting entity to update its hedge documentation upon changing the critical terms of a hedging relationship due to the election of an optional expedient for a fair value, cash flow, or net investment hedging relationship (including the reporting entity changing its method of assessing hedge effectiveness for the hedging relationship). The hedge documentation needs to be updated, pursuant to ASC 848-30-25-4, no later than when the reporting entity is required to perform its first assessment of hedge effectiveness after electing the optional expedient.
If an entity elects the optional expedient in paragraph 848-30-25-3, the entity shall update its hedge documentation (as applicable) noting the changes made no later than when the entity performs its first assessment of effectiveness after the change was identified in accordance with paragraphs 815-20-25-3(b)(2)(iv)(02) and 815-20-25-3A.
3.1.3 Changing critical terms
For a hedging instrument, hedged item, or forecasted transaction designated in a fair value, cash flow, or net investment hedge, a reporting entity may elect an optional expedient to change the contractual terms of the hedging instrument or hedged item. If the modification (a) directly replaces or has the potential to replace a reference rate within the scope of ASC 848-10-15-3 with a different interest rate index and (b) does not modify a term that changes, or has the potential to change, the amount and timing of cash flows unrelated to the replacement of a reference rate (ASC 848-20-15-2 through ASC 848-20-15-3), a reporting entity may elect an optional expedient such that the modification would not trigger an automatic de-designation of the hedging relationship when the contractual terms are modified. ASC 848-30-25-7 specifies that a change to the interest rate used for margining, discounting, or contract price alignment for a derivative used as hedging instrument is not considered a change to the critical terms of the hedging relationship that requires dedesignation.
ASC 848 clarifies that this optional expedient applies to modifications to derivatives designated as hedging instruments, including changes that are effectuated by (1) entering into a fully offsetting derivative contract to effectively cancel the original derivative contract, and (2) contemporaneously entering into a new derivative contract with the revised terms. In these situations, even though a reporting entity entered into a new derivative contract, the reporting entity may still view the series of transactions as a modification of the original derivative contract that would not require an automatic de-designation of the hedging relationship (see ASC 848-30-25-5 through ASC 848-30-25-7).
This guidance may also be applied to derivatives that meet the scope of ASC 848-10-15-3A (derivatives that do not meet the scope of ASC 848-10-15-3 but that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform) when a change in critical terms occurs.
3.1.4 Rebalancing of hedging relationships
Transitioning away from a discontinued reference rate to a replacement rate may result in certain hedging relationships needing to be adjusted because of changes in the terms of hedging instruments and hedged items. This may be the case, for example, when a reporting entity needs to rebalance the hedge ratio for duration-weighted fair value hedges that transition to another eligible benchmark interest rate. Additionally, a reporting entity may need to change the designated hedging instrument, for example, by adding a new interest rate basis swap to an existing interest rate swap designated as the hedging instrument in a cash flow hedge.
ASC 848-30-25-9 provides an optional expedient that can be elected to rebalance a hedging relationship without triggering an automatic de-designation. This optional expedient can be elected if the hedging instrument, the hedged forecasted transaction, or the designated benchmark interest rate in a fair value hedge references LIBOR, or a reference rate expected to be discontinued, and the hedging relationship is expected to be impacted by reference rate reform. This expedient also allows a reporting entity to subsequently remove one or more derivatives added under ASC 848-30-25-9 without dedesignating the hedge relationship. Depending on how a reporting entity chooses to rebalance a hedge relationship under ASC 848-30-25-9, there may be different expedients allowed for how to subsequently assess effectiveness.
3.1.4.1 Fair value hedge rebalancing
For fair value hedge relationships, ASC 848-30-25-9(a) permits rebalancing of the hedging relationship by any of the following means (including any combination):
- Increasing or decreasing the designated notional amount of the hedging instrument
- Increasing or decreasing the designated portion of the hedged item.
If a reporting entity elects to change the designated portion of the hedged item, the cumulative effect on the basis adjustment of the hedged item should be recognized in earnings in the same income statement line item as the earnings effect of the hedged item.
A reporting entity can also change its designated hedging instrument to combine two or more derivative instruments, or proportions of those instruments, to be jointly designated as the hedging instrument in a fair value hedging relationship (see ASC 848-30-25-9(b)). If a reporting entity elects this alternative, it is required to assess hedge effectiveness of the amended relationship using an existing method outlined in ASC 815-20 and ASC 815-25. However, the method selected to assess hedge effectiveness does not need to be the original method designated for use at hedge inception; a reporting entity can elect to select another method under ASC 815-20 and ASC 815-25. As described in ASC 848-30-25-10, a reporting entity may elect to apply the optional expedient for the shortcut method in ASC 848-40 if the reporting entity is applying the shortcut method in ASC 815-20 at the time of the rebalancing of the hedging relationship, including combining two or more derivatives. However, as discussed in ASC 848-40-25-8, a reporting entity using two or more derivatives as a hedging instrument that elected the optional expedient to continue to apply the shortcut method is not permitted to continue to use the shortcut method beyond the sunset date of ASC 848. In this situation, the reporting entity can elect to apply an alternative hedge effectiveness methodology under ASC 815 as of the sunset date without having to dedesignate the hedge relationship. Refer to REF 3.2.2 for the optional expedients available when applying the shortcut method.
3.1.4.2 Cash flow hedge rebalancing
Similar to fair value hedges, for cash flow hedge relationships, a reporting entity can change the designated hedging instrument by combining two or more derivatives, or proportions of those instruments, to be jointly designated as the hedging instrument (see ASC 848-30-25-11 through ASC 848-30-25-11A).
If a reporting entity elects this optional expedient for a derivative that is modifying an interest rate that is LIBOR or anticipated to be discontinued, it is required to assess hedge effectiveness of the amended relationship using:
- a method in accordance with ASC 815-20 and ASC 815-30,
- an optional expedient for assuming perfect effectiveness (see ASC 848-50-35-4 through ASC 848-50-35-9),
- an optional expedient for the subsequent qualitative method after an initial assessment using a quantitative method in accordance with ASC 848-50-35-10 through ASC 848-50-35-16, or
- a quantitative method optional expedient (see ASC 848-50-35-17 and ASC 848-50-35-18).
If a reporting entity elects this optional expedient for a derivative that is modifying an interest rate that is used for margining, discounting, or contract price alignment, it is required to assess hedge effectiveness of the amended relationship using:
- the same quantitative or qualitative assessment method the reporting entity was using prior to making this election in accordance with ASC 815-20 and ASC 815-30, or
- an optional expedient method that assumes perfect effectiveness in accordance with ASC 848-50-35-4 through ASC 848-50-35-9 or a quantitative method in accordance with ASC 815-20 and ASC 815-30 if the reporting entity is applying a subsequent assessment method that assumes perfect effectiveness in accordance with ASC 815-20 at the time of the election.
3.1.5 Accounting for excluded components
ASC 815 allows for certain components of a hedging instrument to be excluded from a hedging relationship and recognized in earnings using either a mark-to-market approach or a systematic and rational method (see DH 6.3.1.2). When a hedging instrument’s contractual terms are changed to replace, for example, LIBOR with an alternative reference rate, that change may affect the value of the hedging instrument’s component excluded from hedge effectiveness.
Under ASC 848-30-25-12, a reporting entity may elect to prospectively change its systematic and rational method used to recognize excluded components in earnings for fair value, cash flow, or net investment hedges if the changes to the contractual terms of a hedging instrument:
- directly replaces or has the potential to replace a reference rate within the scope of ASC 848-10-15-3 with a different interest rate index, and
- does not modify a term that changes, or has the potential to change, the amount and timing of cash flows unrelated to the replacement of a reference rate (see ASC 848-20-15-2 through ASC 848-20-15-3).
The amended systematic and rational method may be subsequently amended for subsequent changes in the hedging instrument’s contractual terms that meet the scope of ASC 848-20-15-2 through ASC 848-20-15-3. That is, a reporting entity may elect to apply this optional expedient for each modification. If elected, the amended method must be applied for the remaining life of the hedging relationship, including periods subsequent to December 31, 2024.
If a change to the contractual term of the hedging instrument results in a change in the fair value of the excluded component, a reporting entity may elect to recognize the change in fair value currently in earnings pursuant to ASC 848-30-25-13. The recognition of the change in fair value should be reported in the same income statement line item used to present the effect of the hedged item.
ASC 848 does not, however, permit a reporting entity to change whether a component is excluded or not.
This guidance may also be applied to derivatives that meet the scope of ASC 848-10-15-3A (derivatives that do not meet the scope of ASC 848-10-15-3 but that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform) when the derivative’s contractual terms that are changed affect the value of the derivative’s component excluded from hedge effectiveness.
3.1.6 Changes to repricing intervals and dates in net investment hedges
ASC 848 provides a reporting entity with an optional expedient when a receive-variable-rate, pay-variable-rate cross-currency swap that references LIBOR or another rate expected to be discontinued as a result of reference rate reform (see ASC 848-10-15-3) is designated as a hedging instrument in a net investment hedge. ASC 815-20-25-67(a)(2) stipulates that both legs of a cross currency swap designated as a hedging instrument in a net investment hedge must have the same repricing intervals and dates. This optional expedient provides relief from that requirement if the index of either or both of the legs of the cross-currency swap references a rate that meets the scope of ASC 848-10-15-3 until such time that neither leg references LIBOR or another rate anticipated to be discontinued. If neither of the legs of a cross currency swap references a rate that meets the scope of ASC 848-10-15-3 (and thus the hedge relationship no longer qualifies for the ASC 848 relief), and the legs of the swaps do not have the same repricing intervals and dates, then hedge accounting must be discontinued.
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