provides guidance on specific optional expedients for fair value hedging relationships affected by reference rate reform. Entities can elect the different optional expedients on an individual hedging relationship basis.
3.2.1 Changing the designated benchmark interest rate
When the designated hedged risk is changes in fair value attributable to a benchmark interest rate (see DH 18.104.22.168
), changing the designated benchmark interest rate may be desirable if (1) the referenced interest rate index of the hedging instrument changes or (2) a reporting entity rebalances an existing fair value hedge relationship by combining two or more hedging instruments that are jointly designated as the hedging instrument (e.g., adding a new interest rate basis swap to an existing interest rate swap). For example, if a LIBOR swap was designated as the hedging instrument in a fair value hedge and a reporting entity selected the LIBOR swap rate as its designated hedged interest rate risk, the change in fair value of the swap and the change in fair value of the hedged item based on a LIBOR swap rate would differ if the swap’s variable rate changes to SOFR. As a result, a reporting entity may need to change the designated benchmark interest rate from LIBOR to SOFR. If one of those two changes in the hedging instruments occur, a reporting entity may elect to change the designated benchmark interest rate and the component of cash flows related to the benchmark interest rate and continue hedge accounting without de-designation if all the following criteria in ASC 848-40-25-2
- The designated benchmark interest rate being changed is LIBOR or a reference rate expected to be discontinued (see ASC 848-10-15-3) or a derivative in the scope of ASC 848-10-15-3A.
- The replacement designated benchmark interest rate is an eligible benchmark interest rate in accordance with ASC 815-20-25-6A.
- The hedging instrument is expected to be prospectively highly effective at achieving offsetting changes in fair value attributable to the revised hedged risk on the basis of the amended terms of the hedging relationship.
Upon electing this optional expedient, a reporting entity is required to revise the rate used to discount the cash flows associated with the hedged item to reflect the change in the designated benchmark interest rate. A reporting entity may include a spread adjustment to the revised benchmark interest rate used to discount the cash flows associated with the hedged item. In addition, a reporting entity is permitted to adjust the cash flows for the designated term of the hedged item. If the hedging relationship extends beyond December 31, 2022 (i.e., the ASC 848
sunset date), ASC 848-40-25-6
requires a reporting entity to continue to use the revised discount rate (including the spread adjustment, if applicable) and any remaining revised cash flows over the life of the designated hedging relationship.
Changing the designated benchmark interest rate in a fair value hedge will, absent other changes to the calculation, change the cumulative basis adjustment to the hedged item. ASC 848
addresses this by providing two approaches in ASC 848-40-25-5
- Apply an approach that adjusts the cumulative basis of the hedged item attributable to changing from the originally designated benchmark interest rate to the replacement designated benchmark interest rate.
Under this approach, a reporting entity would be required to recognize the change to the hedged item’s basis adjustment immediately in earnings within the same income statement line used to present the earnings effect of the hedged item.
- Apply an approach that results in no basis adjustment to the hedged item (i.e., maintain the same cumulative basis adjustment that existed prior to electing the optional expedient).
To accomplish this, one approach may include solving for a spread to include as an adjustment to the discount rate (the newly designated benchmark interest rate) such that, at the date the designated interest rate is changed, the present value of cash flows equals the carrying amount including the cumulative basis adjustment that existed prior to electing the optional expedient. If a reporting entity includes a spread adjustment, the spread adjustment would remain constant throughout the life of the hedge (even if the hedge continues beyond December 31, 2022).
The guidance does not prescribe a specific method for applying the measurement approaches above. A reporting entity is required to use a method that is reasonable. However, a reporting entity is required by ASC 848-40-25-5
to use a similar method for similar hedges and to justify the use of different methods for similar hedges. Therefore, while a reporting entity can elect to change the benchmark interest rate designated on an individual hedging relationship basis, once this optional expedient is elected, the approach to recognize the cumulative effect of the change in the designated benchmark interest rate must be applied in a similar manner to similar hedges. For instance, a reporting entity cannot elect the optional expedient in one hedge relationship and apply an approach that results in an immediate adjustment to earnings, while electing the optional expedient on another similar hedge and apply an approach that results in no basis adjustment (or no immediate earnings impact).
3.2.2 Applying the shortcut method (fair value hedge)
provides an optional expedient that can be elected to disregard certain criteria when determining whether a fair value hedging relationship continues to qualify for the shortcut method (see DH 9.4
). The shortcut method provides criteria that, when met, allows for an assumption of perfect effectiveness in a fair value hedge relationship with an interest rate swap. The optional expedient may be elected upon a change in the contractual term of the hedging instrument that:
- 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 (ASC 848-20-15-2 through ASC 848-20-15-3).
When a reporting entity changes an interest rate swap’s contractual terms, it may elect to disregard the criteria in ASC 848-40-25-8
when determining whether its fair value hedging relationship can continue to apply the shortcut method.
Excerpt from ASC 848-40-25-8
For fair value hedges for which the shortcut method is applied in accordance with paragraphs 815-20-25-102
, the following conditions from paragraph 815-20-25-104
that apply to fair value hedges may be disregarded in determining whether the hedging relationship continues to qualify for the shortcut method upon a change in the contractual terms of the hedging instrument in accordance with paragraphs 848-30-25-5
- the formula for computing net settlements under the interest rate swap is the same for each net settlement in accordance with paragraph 815-20-25-104(d), and
- the terms are typical of those instruments, and the terms do not invalidate the assumption of perfect effectiveness in accordance with paragraph 815-20-25-104(g).
This optional expedient survives throughout the life of the fair value hedging relationship, which may extend beyond December 31, 2022 (the ASC 848
sunset date) unless a reporting entity elects the practical expedient in accordance with ASC 848-30-25-10
to combine two or more derivatives as the hedging instrument in a hedging relationship and continues to apply the shortcut method. In this instance, the reporting entity must cease applying the shortcut method after December 31, 2022, and must revert to assessing hedge effectiveness using a method prescribed in ASC 815-20
and ASC 815-25
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 shortcut method was used to assess effectiveness prior to the modification of the interest rate.
3.2.3 Adjusting the basis adjustment under shortcut method
provides an optional expedient for a fair value hedge using the shortcut method to allow a reporting entity to adjust the fair value hedge basis adjustment for the amount of cash compensation paid or received related to the change in the interest rate used for margining, discounting, or contract price alignment using a reasonable approach. A reporting entity should use a similar method for similar hedges. If different approaches for similar hedges are used, the reporting entity must justify its rationale.
For discussion on adjusting the basis adjustment for a fair value hedge under the shortcut method due to changes to the designated benchmark interest rate, refer to REF 3.2.1