With trillions of dollars in loans, derivatives, and other contracts expected to move away from LIBOR and other benchmarks toward alternative reference rates, the Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update (ASU) that would provide temporary optional guidance to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting.
“The FASB is committed to providing stakeholders with the guidance they need to ease the process of migrating away from LIBOR and other interbank offered rates to new reference rates,” said FASB Chairman Russell G. Golden. “The Board’s proposal will address operational challenges they have raised and ultimately help simplify the process while reducing related costs.”
Migration from LIBOR. Responding to concerns about structural risks of LIBOR and other interbank offered rates, regulators around the world have been working on reform initiatives to identify alternative reference rates that are more observable or transaction-based and less susceptible to manipulation. In late July, IOSCO issued a statement emphasizing the need to move away from LIBOR and identifying specific topics for LIBOR users to consider, including risk-free rates (RFRs), infrastructure, conventions, fallbacks, term rates, regulatory dependencies, communication, and international engagement. The SEC and CFTC have also stressed the need to switch to alternative reference rates.
Proposed FASB guidance. Given the significant volume of contracts and other arrangements like debt agreements, lease agreements, and derivative instruments that reference LIBOR and other interbank offered rates, benchmark reform poses significant operational challenges in terms of the need to modify existing contracts. As FASB explained in a fact sheet, certain accounting issues may arise. For example, changes in a reference rate could disallow the application of certain hedge accounting guidance, and certain hedge relationships may not qualify as highly effective during the period of the market-wide transition to a replacement rate.
The proposed guidance, “Facilitation of the Effects of Reference Rate Reform on Financial Reporting,” would:
- Simplify accounting analyses under current GAAP for contract modifications if qualifying criteria are met;
- Allow hedging relationships to continue without dedesignation upon specified changes in the critical terms of an existing hedging relationship due to reference rate reform;
- Provide optional expedients for existing fair value hedging relationships for which the derivative designated as the hedging instrument is affected by reference rate reform;
- Provide temporary optional expedients for cash flow hedging relationships affected by reference rate reform.
- Applicable to all entities, subject to meeting certain qualifying criteria;
- Limited to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform;
- Elective, not required;
- Temporary; the amendments would not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022.