Are you ready for interest rate benchmark reform? With clear end dates for when LIBOR will be phased out, companies that are impacted need to be working to complete their transition plan.
The UK Financial Conduct Authority confirmed in March 2021 the dates for which LIBOR settings will stop being published. LIBOR settings will cease following the LIBOR publication on December 31, 2021, for:
- GBP LIBOR - all settings (overnight, 1 week, 1, 2, 3, 6 and 12 months)
- EUR LIBOR - all settings (overnight, 1 week, 1, 2, 3, 6 and 12 months)
- CHF LIBOR - all settings (spot next, 1 week, 1, 2, 3, 6 and 12 months)
- JPY LIBOR - all settings (spot next, 1 week, 1, 2, 3, 6 and 12 months)
- USD LIBOR - 1 week and 2 months settings
The remaining USD LIBOR settings (overnight, 1, 3, 6 and 12 month) will cease following the LIBOR publication on June 30, 2023.
Transitioning from IBORs to alternative risk-free rates has widespread impacts. The IASB addressed specific accounting and reporting issues in their Interest Rate Benchmark Reform project.
IASB’s Interest Rate Benchmark Reform Project
The work to assess the accounting impacts and to complete a transition from interbank-offered rates to alternative risk-free rates could be substantial so I urge you not to delay.
Interbank-offered rates (IBORs) are widely used in the global financial system as benchmarks for financial products and contracts. With the shift away from IBORs to alternative risk-free rates, you can imagine the uncertainty that arose regarding the impacts to financial accounting and reporting. You can refresh your memory on the background on issues with interbank-offered rates underpinning why there is a need for interest rate reform on Vicky’s blog post, IBOR Reform is Coming! What are the Standard Setters Doing?
To address the uncertainty of interest rate reform on financial reporting, the IASB identified two groups of issues, breaking up their Interest Rate Benchmark Reform project into two phases:
- Phase 1 addressed pre-replacement issues which are issues affecting financial reporting in the period before the reform. Phase 1 was completed in September 2019 with amendments made to IFRS 9 Financial Instruments, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures. Phase 1 amendments were effective for annual reporting periods beginning on or after January 1, 2020.
- Phase 2 addressed replacement issues or issues that might affect financial reporting when an interest rate benchmark is either reformed or replaced. Phase 2 was competed in August 2020, with amendments made to IFRS 9 Financial Instruments, IAS 39 Financial Instruments: Recognition and Measurement, IFRS 7 Financial Instruments: Disclosures, IFRS 4 Insurance Contracts and IFRS 16 Leases. Phase 2 amendments are effective for annual reporting periods beginning on or after January 1, 2021.
Phase 1 – Pre-replacement Issues
The IASB’s phase 1 amendments focused on hedge accounting issues. IBOR reform could impact hedge accounting requirements which could result in hedge accounting discontinuation. The IASB did not believe discontinuation solely due to IBOR reform provided useful information to financial statement users and therefore issued the Phase 1 amendments addressing these hedge accounting requirements. A summary of the amendments are as follows:
The objective of the Phase 1 amendments was to provide temporary exceptions from applying specific hedge accounting requirements during the period of uncertainty arising from the reform. As such, these exceptions are temporary and end once the uncertainty of IBOR reform is resolved.
Phase 2 – Replacement Issues
In Phase 2, the IASB focused on issues that arise when a rate is actually replaced with a new one. The amendments impact accounting for modifications to financial instruments, lease liabilities, and insurance contracts as well as hedge accounting. Additionally, there are new disclosure requirements.
A summary of the amendments:
- Modification of financial instruments under IFRS 9 can be complex and could result in recognition of an immediate gain of loss in the income statement. The IASB amended IFRS 9, adding a practical expedient whereby a company will NOT be required to derecognize or adjust the carrying amount of financial instruments for modifications required as a direct result of IBOR reform made on an “economically equivalent basis”. These modifications will be accounted for by updating the effective interest rate.
- IFRS 4 and IFRS 16 were also amended to apply a similar practical expedient to insurance contracts and leases.
- An amendment to hedge accounting was made to require changes to documentation of the hedging relationship for changes due to IBOR reform and to specify that these required changes do not constitute a discontinuation of the hedge relationship. Additional hedge accounting amendments were made related to accounting for amounts accumulated in the cash flow hedge reserve, accounting for groups of items, and to the separately identifiable requirements.
- New disclosure requirements to help users of the financial statements to understand the nature and extent of risks arising from IBOR reform are also included in the Phase 2 amendments.
Interest rate benchmark reform has deep impacts as IBORs are embedded in a large volume and wide range of financial products and contracts. The amendments provided by the FASB touch areas where the FASB determined targeted relief was necessary. There are other implications to accounting and reporting that will also need to be considered where existing IFRS provides adequate guidance to determine the accounting, such as derecognition accounting and the effect on the accounting for embedded derivatives. The work to assess the accounting impacts and to complete a transition from interbank-offered rates to alternative risk-free rates could be substantial so I urge you not to delay.
Some additional resources that may be useful to you are as follows:
- ICE Benchmark Administration
- ISDA’s Benchmark Reform and Transition from LIBOR InfoHub
- ISDA 2020 IBOR Fallbacks Protocol
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