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Many companies use benchmark interest rates – e.g. in their loan instruments, lease contracts and in hedge accounting. The replacement of some of these rates with alternative benchmark rates is expected to be mostly complete by the end of 2021. To ensure that financial statements best reflect the economic effects of IBOR reform, the International Accounting Standards Board (the Board) has issued amendments[1] that focus on the accounting once a new benchmark rate is in place.

Despite the COVID-19 pandemic, the Board has completed its project on the financial reporting impacts arising from global reform of benchmark interest rates. These amendments aim to reduce the accounting ‘noise’ surrounding the change to an alternative benchmark rate. Allowing companies to account for this change as a continuation of a hedging relationship, for example, will not only provide welcome practical relief but also better reflect the economic effects of the reform.

Chris Spall
KPMG global IFRS financial instruments leader

The story so far...

IBOR reform refers to the global reform of interest rate benchmarks, which includes the replacement of some interbank offered rates (IBOR) with alternative benchmark rates. The Board identified two groups of accounting issues arising from IBOR reform that could affect financial reporting and divided its project, IBOR Reform and its Effects on Financial Reporting, into two phases:

  • pre-IBOR reform: where uncertainty could arise in the run-up to transition (Phase 1 amendments); and
  • post-IBOR reform: when that uncertainty goes away but companies update the rates in their contracts and the details of their hedging relationships (Phase 2 amendments).

Phase 1: modifications

Amendments to IFRS 9, IAS 39 and IFRS 7[2] have now been issued to address uncertainties related to the ongoing reform of interbank offered rates (IBOR).

The amendments provide targeted relief for financial instruments qualifying for hedge accounting in the lead up to IBOR reform. 

The amendments address issues affecting financial reporting in the period leading up to IBOR reform, are mandatory and apply to all hedging relationships directly affected by uncertainties related to IBOR reform. Below is a summary of the amendments:

Issue covered

All companies with hedges affected by IBOR reform are required to…

The ‘highly probable’ requirement

… assume that the interest rate benchmark on which hedged cash flows are based is not altered as a result of IBOR reform when assessing whether the future cash flows are highly probable. Also, for discontinued hedging relationships, the same assumption is applied for determining whether the hedged future cash flows are expected to occur. 

Prospective assessments

… assess whether the economic relationship between the hedged item and the hedging instrument exists based on the assumptions that the interest rate benchmark on which the hedged item and the hedging instrument are based is not altered as a result of IBOR reform.

Retrospective assessments (for IAS 39)

… not discontinue a hedging relationship during the period of uncertainty arising from IBOR reform solely because the actual results of the hedge are outside the range of 80-125 per cent.

Eligibility of certain risk components (for a hedge of a non-contractually specified benchmark component of interest rate risk)

… apply the separately identifiable requirement only at the inception of the hedging relationship. A similar exception is also provided for redesignation of hedged items in hedges where designation and redesignation take place frequently – e.g. macro hedges.

End of application

… prospectively cease applying the exceptions at the earlier of:

(a)   when the uncertainty regarding the timing and the amount of interest rate benchmark based cash flows is no longer present; and

(b)   the discontinuation of the hedging relationship (or reclassification of all amounts from the cash flow hedge reserve).

The assessment of uncertainty should be performed on an item-by-item basis for hedges involving groups of items.

Disclosure (for hedging relationships directly affected by IBOR reform)

… disclose:

  • the significant interest rate benchmarks to which hedging relationships are exposed;
  • the extent of risk exposure that is affected by IBOR reform; 
  • how the transition to alternative benchmark interest rates is being managed;
  • a description of significant assumptions or judgements made in applying the amendments; and
  • the nominal amount of the hedging instruments in those hedging relationships.

Companies with hedges affected by IBOR reform may need to take steps to apply the amendments, which are mandatory and effective from 1 January 2020. Early application is permitted.

The Phase 2 amendments principally address the following issues.

Phase 2: Practical expedient for modifications

Under the detailed rules of IFRS 9 Financial Instruments, modifying a financial contract can require recognition of a significant gain or loss in the income statement. However, the amendments introduce a practical expedient if a change results directly from IBOR reform and occurs on an ‘economically equivalent’ basis. In these cases, changes will be accounted for by updating the effective interest rate.

A similar practical expedient will apply under IFRS 16 Leases for lessees when accounting for lease modifications required by IBOR reform.

Phase 2: Specific relief from discontinuing hedging relationships

The amendments also allow a series of exemptions from the regular, strict rules around hedge accounting. See our summary of the amendments (PDF 53 KB) for details. For example, a company will not need to discontinue existing hedging relationships because of changes to hedge documentation required solely by IBOR reform. Therefore, when a hedged risk changes due to benchmark reform, a company may update the hedge documentation to reflect the new benchmark rate and the hedge may be able to continue without interruption.

However, similar to the Phase 1 amendments, there is no exception from the measurement requirements that apply for the hedged items and hedging instruments under IFRS 9 or IAS 39 Financial Instruments: Recognition and Measurement. Once the new benchmark rate is in place, the hedged items and hedging instruments are remeasured based on the new rate and any hedge ineffectiveness will be recognized in profit or loss.

Phase 2: New disclosures will apply

So that users of financial statements can understand the effect of the reform on a company’s financial instruments and risk management strategy, a company will need to provide additional information about:

  • the nature and extent of risks to which the company is exposed arising from financial instruments subject to IBOR reform and how it manages those risks; and
  • the company’s progress in completing its transition to alternative benchmark rates and how it is managing that transition.

Phase 2: Amendments apply retrospectively from 1 January 2021

The amendments apply retrospectively with earlier application permitted. Hedging relationships previously discontinued solely because of changes resulting from the reform will be reinstated if certain conditions are met.

  1. Interest Rate Benchmark Reform—Phase 2: Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16
  2. IFRS® 9 Financial Instruments, IAS® 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures.

 

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