The guidance in ASC 848 is meant to provide temporary relief and, in many instances will require discontinuance.

ASC 848 provides a reporting entity with an optional expedient when determining if a fair value hedging relationship can be assumed to be highly effective under the shortcut method (see REF 3.2.2). This expedient may be applied throughout the life of the hedging relationship, even in instances when the life of the hedging relationship extends beyond December 31, 2024. That is, the ability to apply the shortcut method optional expedient may continue to be applied until (1) the hedging relationship ceases to exist or (2) a reporting entity voluntarily discontinues the hedging the relationship 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 continue to apply the shortcut method. In this instance, the reporting entity must cease applying the shortcut method after December 31, 2024, and must change to assessing hedge effectiveness using a method prescribed in ASC 815-20 and ASC 815-25.

ASC 848 also provides a reporting entity with the ability to change the designated benchmark interest rate hedged and component of cash flows (see REF 3.2.1) and, when doing so, requires a reporting entity to update the discount rate used and permits it to incorporate other adjustments to the calculation. If the hedging relationship extends beyond December 31, 2024, ASC 848-40-25-6 states that a reporting entity should continue to use the revised discount rate (including any spread adjustment, if applicable) and any remaining revised cash flows over the life of the designated hedging relationship.

The guidance in ASC 848 is meant to provide relief on a temporary basis for both existing and new cash flow hedges. As a result, entities should discontinue using an optional expedient for assessing hedge effectiveness if any of the following occur prior to December 31, 2024 for each hedging relationship in which an optional expedient was elected:

For hedging relationships that cease to apply ASC 848 (e.g., extend beyond December 31, 2024 or a reporting entity no longer qualifies to apply the guidance), a reporting entity should apply the guidance in ASC 815-20 and ASC 815-30 to determine if hedge accounting should continue to be applied. Any eligible method for assessing effectiveness under ASC 815-20 and ASC 815-30 may be applied without requiring dedesignation, including a method other than the one designated for use prior to the optional expedient being applied. In accordance with ASC 848-50-35-21, if a reporting entity chooses to assess hedge effectiveness using the hypothetical derivative method, or another acceptable method under ASC 815-20 and ASC 815-30, the reporting entity may create the terms of the instrument used to estimate changes in the fair value of its hedged risk based on market data as of hedge inception.

If a new method is selected, a reporting entity should update its hedge documentation noting the changes made no later than when the reporting entity performs its first assessment of effectiveness after the change was identified in accordance with ASC 848-30-25-4. ASC 848 specifically notes that a reporting entity must continue to assess whether the underlying hedged forecasted transaction is probable of occurring.

If it is determined that the hedging relationship no longer qualifies for hedge accounting, hedge accounting should be discontinued prospectively and ASC 815-30-40-2 through ASC 815-30-40-6A should be applied.

ASC 848-50-35-21 provides guidance on how to apply the hypothetical derivative method for cash flow hedges when assessing effectiveness for a hedge relationship that is exiting the relief offered by ASC 848.

Upon exiting the relief offered by ASC 848, either because the hedge relationship no longer references a rate expected to be discontinued, the sunset date of ASC 848 has occurred, or a reporting entity elects to stop applying the expedients in ASC 848, a reporting entity is required to assess the effectiveness of the hedge relationship in accordance with ASC 815. When using the hypothetical derivative method, questions may arise on how to construct the hypothetical derivative. Under the hypothetical derivative method, the assessment of hedge effectiveness is based on a comparison of (1) the change in fair value of the actual swap designated as the hedging instrument and (2) the change in fair value of a hypothetical swap. The hypothetical swap must have a fair value of zero at the inception of the hedging relationship and terms that exactly match the critical terms of the hedged item. If a reporting entity was using the hypothetical derivative method prior to entering the ASC 848 relief, the hypothetical derivative would have been created based on the rates designated as the hedged item (e.g., LIBOR). Upon existing the relief, both the hedging instrument (i.e., the interest rate swap) and the hedged item will now reference a new interest rate (e.g., SOFR). The creation of a hypothetical derivative with a fair value of zero as of the date the relationship exits the relief in ASC 848 could cause significant ineffectiveness in the hedge relationship since the actual swap will not have a fair value of zero.

We believe that there are multiple approaches a reporting entity can use to construct a hypothetical derivative for purposes of assessing hedge effectiveness upon exiting the relief and on a going-forward basis. As noted in ASC 848-50-35-21, a reporting entity may elect to create the hypothetical derivative based on market data as of the inception of the hedging relationship. If a reporting entity elects to create the hypothetical derivative using this guidance, it would use market data as of the beginning of the hedge relationship, not when the hedge relationship was modified as a result of reference rate reform or when the hedge relationship exited the relief provided by ASC 848.

We believe a reporting entity could create a hypothetical derivative under one of three approaches: