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ASC 848 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 6.4.5.1), 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 are met:
  • 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)
ASC 848 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 through 25-105, 815-20-25-107 through 25-109 and 815-20-25-111 through 25-117, 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 through 25-7:
  1. 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
  2. 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.
Examples REF 3-1 and REF 3-2 illustrate how to apply the various optional expedients within ASC 848 for a fair value hedging relationship throughout the relief period.
EXAMPLE REF 3-1
Fair value hedge applying the ASC 848 relief
On January 1, 20X1, Company A issues a five-year fixed rate debt instrument with quarterly interest payments at a rate of 5%. Company A is exposed to changes in the fair value of the debt instrument due to changes in interest rates and wants to hedge the changes in fair value due to changes in the benchmark interest rate. Company A enters into a fixed-to-float interest rate swap with a maturity of five years where Company A will pay USD LIBOR plus 200 bps and receive a fixed rate of 5%. The interest rate swap also pays quarterly interest. Company A designates this swap as a hedging instrument to hedge the changes in fair value of the hedged item due to changes in the benchmark interest rate which is designated as USD LIBOR. Company A assesses effectiveness using a quantitative long-haul method.
In December 20X2, Company A modifies its interest rate swap to change the floating leg of the swap to overnight SOFR.
Should Company A dedesignate its hedge relationship or could it adopt provisions of ASC 848 to continue its hedge relationship?
Analysis
Certain provisions of ASC 848 are available to Company A to allow it to continue its hedge relationship.
Company A has changed the critical terms of the hedge relationship by changing the contractual terms of the hedging instrument (the interest rate swap). Under ASC 815, a change in the critical terms of a hedge relationship would require the hedge relationship to be dedesignated. However, ASC 848-30-25-3 provides an optional expedient that allows a reporting entity to change the critical terms of a hedge relationship and not dedesignate the hedge relationship if the only change in critical terms is due to reference rate reform. Since Company A changed the critical terms of the hedging instrument only to switch the floating leg of the interest rate swap from LIBOR to SOFR, the modification is eligible for the relief under ASC 848. Company A would not be required to dedesignate the hedge relationship if it adopts the optional expedient in ASC 848-30-25-3. In accordance with ASC 848-30-25-4, Company A would need to update its hedge documentation for the change in critical terms by the time it performs its next assessment of effectiveness. Assuming Company A performs its effectiveness assessment at quarter end, it would need to update its hedge documentation for the change by December 31, 20X2.
Company A may also wish to change the designated benchmark interest rate within the hedge relationship from LIBOR to SOFR. Similar to the change to the hedging instrument, this would normally be considered a change in critical terms of the hedging relationship that would require dedesignation. However, the relief in ASC 848-40-25-2 (if elected) would allow Company A to update the designated benchmark interest rate in the hedge relationship if (1) the designated benchmark interest rate being changed is LIBOR, (2) the replacement designated benchmark interest rate is an eligible rate in accordance with ASC 815-20-25-6A, and (3) the hedge relationship is expected to be highly effective prospectively. ASC 815-20-25-6A lists the Secured Overnight Financing Rate (SOFR) swap rate as a benchmark interest rate. Therefore, Company A designates the Overnight SOFR swap rate as the new benchmark interest rate being hedged which is consistent with the rate on the interest rate swap.
Once the optional expedient within ASC 848-40-25-2 has been elected, Company A would be 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. The update to the designated benchmark interest rate would change the calculation of the cumulative basis adjustment. ASC 848-40-25-5 provides two alternatives for how to account for the change to the calculation of the cumulative basis adjustment. A reporting entity may either calculate a new cumulative basis adjustment based on the updated discount rate used to discount the hedged item cash flows and record the change in the basis adjustment through earnings, or apply a spread adjustment to the calculation (such as by applying a spread to the discount rate used to discount the hedged item cash flows or adjusting the hedged item’s cash flows) that would result in no change to the cumulative basis adjustment. If a spread adjustment is applied, this spread adjustment must be consistently applied for the remainder life of the hedge relationship. Company A should apply the method selected to similar hedges and must justify using a different methodology for similar hedges.
Once the hedge documentation has been updated, the hedge relationship no longer qualifies for the ASC 848 relief since the relationship no longer references a rate expected to be discontinued (though as noted, if Company A elected to apply a spread adjustment when updating the benchmark interest rate, this adjustment must be consistently applied for the entire life of the hedge relationship). Company A must now apply the requirements in ASC 815 to assess hedge effectiveness.
EXAMPLE REF 3-2
Fair value hedge applying the ASC 848 relief
Assume the same facts as Example REF 3-1 except that rather than modifying the interest rate swap directly, Company A enters into a basis swap that has the effect of swapping its USD LIBOR payments to SOFR payments.
Could Company A elect to jointly designate the original USD LIBOR-based interest rate swap and the newly entered into basis swap as the hedging instrument without dedesignating the hedge relationship?
Analysis
Yes. ASC 848-30-25-9(b) notes that reporting entities can update the designated hedging instrument to combine two or more derivative instruments to jointly designate these derivatives as the hedging instrument. This would be considered a change in the critical terms of the hedge relationship; however, ASC 848-30-25-3 provides an optional expedient to allow a reporting entity to change the critical terms of a hedge relationship and not dedesignate the hedge relationship if the change in critical terms was solely due to reference rate reform. Therefore, Company A could jointly designate the USD LIBOR-based interest rate swap and the USD LIBOR to SOFR basis swap as the hedging instrument and continue to apply hedge accounting.
3.2.3 Adjusting the basis adjustment under shortcut method
ASC 848-30-25-11B 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.
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