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ASC 848 provides a number of optional expedients for cash flow hedging relationships affected by reference rate reform, as well as guidance on assessing probability when the forecasted transaction will be affected by reference rate reform.
3.3.1 Probability of the forecasted transaction
In order to apply cash flow hedging, entities are required to document the forecasted transaction in a cash flow hedge and to support that the documented forecasted transaction remains probable of occurring throughout the life of the hedge relationship (see DH 6.3.3.4). Additionally, a change in the probability of a forecasted transaction may require that a reporting entity discontinue hedge accounting and may affect the timing of recognizing amounts deferred in accumulated other comprehensive income in earnings. To alleviate stakeholder concerns over how meeting these requirements might be affected by reference rate reform, ASC 848 provides an optional expedient on how to evaluate probability when the forecasted transaction references LIBOR or another reference rate expected to be discontinued.
When the designated hedged risk in a cash flow hedge of a forecasted transaction is LIBOR, or another reference rate expected to be discontinued, ASC 848-50-25-2 allows a reporting entity to assert that the hedged forecasted transaction remains probable of occurring regardless of a modification or expected modification 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 (see ASC 848-20-15-2 through ASC 848-20-15-3).
That is, when a reporting entity modifies, or expects to modify, contractual terms that are related to the replacement of a reference rate in accordance with ASC 848, a reporting entity may continue to assert that the forecasted transaction (documented as the reference rate that will be replaced) continues to be probable of occurring (i.e., the hedge is not discontinued). The ability to continue to assess the forecasted transaction as probable of occurring applies when the change in contractual terms is expected to replace the reference rate (i.e., the rate designated in the cash flow hedge) with another reference rate. It would not, however, apply in circumstances when the underlying transaction (e.g., the forecasted interest payments) was probable of not occurring (e.g., a reporting entity expects to pay off its debt).
3.3.2 Change in the designated hedged risk
ASC 815-30-35-37A indicates that the designated hedged risk for a cash flow hedge of a forecasted transaction may change during a hedging relationship and a reporting entity may continue to apply hedge accounting if the hedge remains highly effective. ASC 848 expands how a reporting entity can evaluate whether a cash flow hedge relationship affected by reference rate reform remains highly effective. Specifically, upon a change in the designated hedge risk on a hedge impacted by reference rate reform (e.g., replacing LIBOR with SOFR), ASC 848 provides that an existing cash flow hedge relationship may continue hedge accounting subject to the hedging relationship remaining highly effective (ASC 848-50-25-3) based upon a reporting entity:
  • assessing hedge effectiveness in accordance with ASC 815-20 and ASC 815-30, or
  • electing an optional expedient method to assess hedge effectiveness in accordance with ASC 848-50.
3.3.2.1 Benchmark rate of a forecasted debt issuance or purchase
When hedging the forecasted issuance or purchase of fixed-rate debt, ASC 815-20-25-19A(a) and ASC 815-20-25-19B require that the reporting entity must designate the variability in cash flows attributable to changes in the benchmark interest rate as the hedged risk. ASC 848-50-25-3 states that if the hedging instrument references LIBOR or another rate expected to be discontinued due to reference rate reform (see ASC 848-10-15-3) and the referenced interest rate index changes (or a reporting entity changes the designated hedging instrument by combining two or more derivatives) in a hedge of a forecasted issuance or purchase of fixed rate debt, a reporting entity may change the benchmark interest rate being hedged as long as:
  • the replacement designated benchmark interest rate is an eligible benchmark rate in accordance with ASC 815-20-25-6A, and
  • the hedging relationship remains highly effective in accordance with ASC 815-20 or ASC 815-30.

If the reporting entity does not know at the inception of the hedging relationship whether the debt instrument that will be issued or purchased will be fixed rate or variable rate, this guidance also applies.
3.3.3 Hedging a group of forecasted transactions
When hedging a group of forecasted transactions, ASC 815-20-25-15(a)(2) requires that the individual transactions in the group share the same risk exposure. However, if the group of forecasted transactions references LIBOR or another reference rate expected to be discontinued due to reference rate reform, a reporting entity may elect to disregard that guidance based on the guidance in ASC 848-50-25-13 through ASC 848-50-25-14. However, the requirement prohibiting a forecasted purchase and a forecasted sale from both being included in a group continues to apply. As a result, forecasted interest receipts and forecasted interest payments are not permitted to be included in the same group, even if a reporting entity elects this optional relief.
3.3.4 Changing the designated method of assessing effectiveness
A reporting entity may elect to change the method designated for use in assessing hedge effectiveness in a cash flow hedge (ASC 848-50-35-1 through ASC 848-50-35-3) if both of the following criteria in ASC 848-30-25-8 are met:
  • Either the hedging instrument or the hedged forecasted transaction (but not both) references LIBOR or a reference rate expected to be discontinued due to reference rate reform.
  • The new designated method of assessing hedge effectiveness is an optional expedient specified in ASC 848-50 (see REF 3.3.5).

For a cash flow hedge with a hedging instrument that meets the scope of ASC 848-10-15-3A, a reporting entity that was previously using a subsequent effectiveness method that assumed perfect effectiveness at the time of the election of the optional expedient may (1) apply the corresponding available optional expedients for the subsequent assessment method for assuming perfect effectiveness in accordance with ASC 848-50-35-4 through ASC 848-50-35-9, or (2) switch to using a quantitative measure of assessing effectiveness in accordance with ASC 815-20 and ASC 815-30 after the election.
If a reporting entity applies this optional expedient and changes its method of assessing effectiveness, the replacement method is not required to be assessed to determine whether it is an improved method or if it is considered a preferable method.
Upon electing an optional expedient method, reporting entities are required to assess effectiveness using the newly designated method prospectively from the date in which the optional expedient method is elected to determine whether hedge accounting may continue to be applied. After the date on which the optional expedient is first applied (assuming the hedging relationship was highly effective), both retrospective and prospective hedge effectiveness need to be assessed using the optional expedient method.
3.3.5 Optional expedients—initial and subsequent hedge effectiveness
A reporting entity may perform its initial and subsequent hedge effectiveness assessment in a manner that adjusts how it applies certain guidance in ASC 815-20 and ASC 815-30 for cash flow hedges in which the hedged forecasted transaction or hedging instrument references LIBOR or a reference rate expected to be discontinued due to reference rate reform.
See REF 3.3.5.1 through REF 3.3.5.8 for the optional expedients for assessing initial and subsequent hedge effectiveness under ASC 848.
3.3.5.1 Applying the shortcut method (cash flow hedge)
ASC 815 provides a list of criteria that must be met in order to assume perfect hedge effectiveness in a cash flow hedge with an interest rate swap, which is referred to as the shortcut method (see DH 9.4). Under ASC 848, a reporting entity may elect to disregard the items in ASC 848-50-25-6 (and repeated in ASC 848-50-35-5 for subsequent assessments) when assessing whether the shortcut method can be applied.

Excerpt from ASC 848-50-25-6 and ASC 848-50-35-5

  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).
  2. the terms are typical of those derivative instruments and do not invalidate the assumption of perfect effectiveness in accordance with paragraph 815-20-25-104(g).
  3. the repricing dates of the variable-rate asset or variable-rate liability and the hedging instrument must occur on the same dates and be calculated the same way in accordance with paragraph 815-20-25-106(d).
  4. the index on which the variable leg of the interest rate swap is based matches the contractually specified interest rate designated as the interest rate being hedged for that hedging relationship in accordance with paragraph 815-20-25-106(g).

3.3.5.2 Option’s terminal value (assuming perfect effectiveness)
When hedge effectiveness is based on an option’s terminal value, ASC 848 permits a reporting entity to disregard the criteria in ASC 848-50-25-7 (repeated in ASC 848-50-35-6 for subsequent assessments) when determining whether a hedging relationship is considered perfectly effective under ASC 815-20-25-126 through ASC 815-20-25-129A.

Excerpt from ASC 848-50-25-7 and ASC 848-50-35-6

  1. The underlying of the hedging instrument needs to match the underlying of the hedged forecasted transaction in accordance with paragraph 815-20-25-129(a).
  2. The strike price (or prices) of the hedging option (or combination of options) matches the specified level (or levels) beyond (or within) which the entity’s exposure is being hedged in accordance with paragraph 815-20-25-129(b).
  3. The hedging instrument’s inflows (outflows) at its maturity date due to the underlying reference rate and strike price (or prices) of the hedging option (or combination of options) completely offset the change in the hedged transaction’s cash flows for the risk being hedged in accordance with paragraph 815-20-25-129(c).

See DH 9.6 for further details on the terminal value method of assessing hedge effectiveness for options.
3.3.5.3 Option’s terminal value (not considered perfectly effective)
When hedge effectiveness is based upon an option’s terminal value but is not considered perfectly effective, a reporting entity may adjust the critical terms of the perfectly hypothetical hedging instrument in ASC 848-50-25-12 (repeated in ASC 848-50-35-18 for subsequent assessments) to match the hedging instrument.

Excerpt from ASC 848-50-25-12 and ASC 848-50-35-18

  1. The underlying reference rate
  2. The strike price (or prices) of the hedging option (or combination of options)
  3. The hedging instrument’s inflows (outflows) at its maturity date due to the underlying reference rate and strike price (or prices) of the hedging option (or combination of options).

In effect, the guidance permits a reporting entity to assume that certain attributes of the forecasted transaction are different than they may be for purposes of assessing hedge effectiveness.
3.3.5.4 Change-in-variable-cash-flows (assuming perfect effectiveness)
When applying the change-in-variable-cash-flows method in ASC 815, a reporting entity may disregard the terms in ASC 848-50-25-9 (repeated in ASC 848-50-35-8 for subsequent assessments) when assessing whether the hedge is perfectly effective in accordance with ASC 815-30-35-22.

Excerpt from ASC 848-50-25-9 and ASC 848-50-35-8

  1. The variable-rate leg of the interest rate swap and the hedged variable cash flows of the asset or liability are based on the same interest rate index in accordance with paragraph 815-30-35-22(a).
  2. The interest rate reset dates applicable to the variable-rate leg of the interest rate swap and to the hedged variable cash flows of the asset or liability are the same in accordance with paragraph 815-30-35-22(b).

A reporting entity may also disregard the guidance in ASC 815-30-35-22(c), which addresses other potential basis differences (e.g., caps or floors) that would preclude a hedge from being perfectly effective, when applying ASC 848 if the basis differences are due to differences in a cap or floor between the variable-rate leg of the interest rate swap and the variable-rate asset or liability.
See REF 3.3.5.6 for the application of the change-in-variable-cash-flow method when the hedge is not considered perfectly effective.
3.3.5.5 Hypothetical derivative (assuming perfect effectiveness)
When applying the hypothetical derivative method in accordance with ASC 815-30-35-25 through ASC 815-30-35-29, a reporting entity may elect to disregard the critical terms detailed in ASC 848-50-25-10 (repeated in ASC 848-50-35-9 for subsequent assessments) when determining whether the hypothetical derivative will result in a perfectly effective hedge.

Excerpt from ASC 848-50-25-10 and ASC 848-50-35-9

  1. The same repricing dates in accordance with paragraph 815-30-35-25(b)(2)
  2. The same index in accordance with paragraph 815-30-35-25(b)(3)
  3. Mirror image caps and floors (including a cap or floor that exists in a variable-rate asset or a variable-rate liability and does not exist in a hedging instrument or vice versa) in accordance with paragraph 815-30-35-25(b)(4).

See REF 3.3.5.6 for the application of the hypothetical derivative method when the hedge is not considered perfectly effective.
3.3.5.6 Applying a quantitative assessment method of effectiveness
When assessing hedge effectiveness quantitatively, a reporting entity may elect to make certain adjustments when applying the (1) change-in-variable-cash-flows method, (2) the hypothetical derivative method, or (3) the change-in-fair-value method. In applying these methods:
  • If both the hedged forecasted transaction and the hedging instrument reference LIBOR or another reference rate expected to be discontinued due to reference rate reform (see ASC 848-10-15-3), a reporting entity may assume the reference rates will not change for the remainder of the hedging relationship. This might be applied in situations when neither the hedged item nor the hedging instrument have been amended as a result of reference rate reform.
  • In a cash flow hedge of a forecasted purchase, sale, or issuance of a fixed-rate instrument, if (1) the designated hedged interest rate risk is the benchmark interest rate and (2) the hedging instrument has a reference rate that meets the scope of ASC 848-10-15-3, a reporting entity may assume the reference rates will not change for the remainder of the hedging relationship.
  • If either the hedged forecasted transaction or the hedging instrument references LIBOR or another reference rate expected to be discontinued due to reference rate reform, the terms of the hedged forecasted transaction may be altered to match the hedging instrument for the terms detailed in ASC 848-50-25-11 (repeated in ASC 848-50-35-17).

Excerpt from ASC 848-50-25-11 and ASC 848-50-35-17

  1. The referenced interest rate index,
  2. The reset period, reset dates, day-count conventions, business-day conventions, and repricing calculation (for example, forward-looking calculation or in-arrears calculation), and
  3. A spread adjustment for the difference between the existing reference rate and the replacement reference rate.
  4. A cap or floor (including a cap or floor that exists in a variable-rate asset or a variable-rate liability and does not exist in a hedging instrument or vice versa).

This might be applied if, for example, the referenced rate of the hedging instrument has been replaced, but the referenced rate of the hedged item has not yet been modified.
3.3.5.7 Applying a qualitative assessment method of effectiveness
ASC 848 provides an optional expedient when qualitatively assessing whether a hedging relationship is highly effective in periods subsequent to initial designation (i.e., after the initial hedge effectiveness assessment is performed applying ASC 815-20, ASC 815-30, or an optional expedient under ASC 848). A reporting entity may elect to disregard the guidance in ASC 815-20-35-2A through ASC 815-20-35-2F when assessing whether a cash flow hedging relationship is highly effective on a qualitative basis.
Under the optional expedient in ASC 848-50-35-10, a reporting entity may continue to assert qualitatively that it may continue to apply hedge accounting if the following criteria in ASC 848-50-35-11 are met:
  • The hedged forecasted transaction or the hedging instrument references a rate that meets the scope of ASC 848-10-15-3 (i.e., it references LIBOR or a reference rate that is expected to be discontinued as a result of reference rate reform).
  • There have been no changes to the terms of the hedging instrument or the forecasted transaction other than those specified in ASC 848-20-15-2 through ASC 848-20-15-3 (i.e., the only modifications made are to directly replace or have the potential to replace a reference rate (see REF 1.3.1.1)).
  • A reporting entity considers the likelihood of the counterparty’s compliance with the contractual terms of the hedging derivative that require the counterparty to make payments to the reporting entity.
If a qualitative assessment of effectiveness is applied, the reporting entity should verify and document whenever financial statements (or earnings) are reported, and at least every three months, that the facts and circumstances have not changed and that these criteria continue to be met. If the facts and circumstances have not changed and these criteria continue to be met, a reporting entity may continue to qualitatively assert that the hedging relationship continues to qualify for hedge accounting.
If the facts and circumstances have changed such that these criteria are no longer met, the reporting entity can no longer assert qualitatively that the hedging relationship continues to qualify for hedge accounting, the reporting entity should perform an assessment of effectiveness on a quantitative basis in accordance with ASC 815-20, ASC 815-30, or a quantitative optional expedient within ASC 848 (if eligible). A reporting entity may apply a method other than the method designated for use and documented at hedge inception but must update its hedge documentation as discussed in ASC 848-30-25-4.
If the date of the change in facts and circumstances that led to the criteria no longer being met cannot be identified, the reporting entity may begin performing their quantitative assessment from the beginning of the current period. Once a reporting entity has performed a quantitative assessment using an optional expedient for at least one period, the reporting entity may revert to a qualitative optional expedient assessment under ASC 848-50 if they qualify to do so.
3.3.5.8 Applying simplified hedge account approach
For certain entities (e.g., private companies other than financial institutions) that are able to apply ASC 815-20-25-135, the criteria in ASC 848-50-25-8 (repeated in ASC 848-50-35-7) may be disregarded in determining whether a cash flow hedge of a variable rate borrowing with a receive-variable pay-fixed interest rate swap using the simplified hedge accounting approach (see DH 11.2) may be considered perfectly effective in accordance with ASC 815-20-25-133 through ASC 815-20-25-138. This guidance may be applied if either the hedging instrument or the hedged forecasted transaction references LIBOR or reference rate expected to be discontinued due to reference rate reform.

Excerpt from ASC 848-50-25-8 and ASC 848-50-35-7

  1. Both the variable rate on the swap and the borrowing are based on the same index and reset period in accordance with paragraph 815-20-25-137(a).
  2. The terms of the swap are typical in accordance with paragraph 815-20-25-137(b).
  3. The repricing and settlement dates for the swap and the borrowing match in accordance with paragraph 815-20-25-137(c).

3.3.6 Adjusting AOCI - the discounting transition
ASU 2021-01 provides an optional expedient for a cash flow hedge to allow a reporting entity to adjust accumulated other comprehensive income 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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