In May 2019, the IASB published an Exposure Draft (‘ED’) entitled ‘Interest Rate Benchmark Reform: Proposed amendments to IFRS 9 and IAS 39’. The ED aims to provide relief on specific aspects of hedge accounting in order to prevent certain hedge relationships being discontinued as a result of the uncertainties arising from Interest Rate Benchmark Reform (IBOR Reform).
What is IBOR Reform?
IBORs are interest reference rates, such as LIBOR and EURIBOR. They represent the cost of obtaining unsecured funding, in a particular combination of currency and maturity, and in a particular interbank term lending market. Since the financial crisis, the long-term viability of IBORs has been called into question and, following a fundamental review by the Financial Stability Board, numerous jurisdictions have developed plans to replace IBOR rates with Alternative Interest Rates, ie risk free interest rates that are based, to a greater extent, on transaction data.
What are the financial reporting implications of IBOR Reform?
Given the prevalence of IBOR-based products such as LIBOR or EURIBOR linked loans, bonds and interest rate swaps across various industry sectors and jurisdictions, IBOR Reform brings about several potentially significant implications for entities reporting under IFRS. These implications can be categorised as follows:
- Pre-replacement issues: these are issues arising during the period of uncertainty prior to any reforms taking place, such as implications for specific hedge accounting requirements (under both IAS 39 and IFRS 9) which require forward-looking assessment.
- Replacement issues: these are issues arising at the time the reforms take place, ie at the point at which IBOR is replaced with an Alternative Interest Rate. For example, whether a modification of the contractual terms of a financial instrument to reflect the new rate should result in that financial instrument being derecognised, and the implications of this on any hedge relationships.
What does the ED propose?
The recently published ED considers only some ‘pre-replacement’ issues although the IASB has stated its intention to monitor developments and will also consider ‘replacement’ issues in due course. The proposed amendments aim to provide relief on specific aspects of hedge accounting in order to prevent certain hedge relationships being discontinued as a result of the uncertainties regarding the amount and timing of cash flows that arise as a result of IBOR Reform. The key proposed reliefs are summarised below:
|Highly Probable Requirement
||When assessing the likelihood that a forecast transaction will occur, an entity would assume that IBOR-based contractual terms are not altered as a result of IBOR Reform
|Prospective Assessment Requirement
||When assessing for prospective effectiveness, an entity would assume that the IBOR-based contractual cash flows from the hedging instrument and the hedged item are not altered as a result of IBOR Reform
||As long as a non-contractually specified IBOR risk component meets the separately identifiable requirement at inception of the hedge relationship, hedge accounting should be continued
As a result of these reliefs, entities will effectively be able to disregard the uncertainties arising as a result of IBOR Reform when considering the specific aspects of hedge accounting mentioned above.
The ED proposes that these reliefs should be mandatory and should apply to both existing and new hedges until the earlier of the date the hedge relationship is discontinued or the date the uncertainty regarding the amount and timing of cash flows arising from IBOR Reform ceases.
What are the next steps?
Those entities who have designated IBOR-linked hedging instruments or hedged items in hedge accounting relationships under IAS 39 or IFRS 9 should study these proposed amendments, given the impact that they will have on their financial statements. The comment period for the ED ends on 17 June 2019, with the IASB aiming to finalise the amendments by the end of 2019. At present it is proposed that the amendments would be effective for accounting periods beginning on or after 1 January 2020 with earlier application permitted.
Read the ED: Interest Rate Benchmark Reform: Proposed amendments to IFRS 9 and IAS 39.
For help and advice on financial instruments related matters please get in touch with your usual BDO contact or Mark Spencer.
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