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On 5 March 2021, the FCA announced that it would permanently discontinue a number of LIBOR settings (for example, all seven EUR and Swiss franc LIBOR tenors, etc.) immediately after 31 December 2021. In response to this, ISDA has announced:

„Today’s announcement constitutes an index cessation event under the IBOR Fallbacks Supplement and the ISDA 2020 IBOR Fallbacks Protocol for all 35 LIBOR settings. As a result, the fallback spread adjustment published by Bloomberg is fixed as of the date of the announcement for all euro, sterling, Swiss franc, US dollar and yen LIBOR settings.”

This will have immediate ramifications for entities that have designated LIBOR interest rate hedges for hedge accounting under IFRS. For the purpose of applying hedge accounting, as of 5 March 2021, companies must now determine whether or not there any uncertainties remain with regard to the timing and amount of LIBOR-based derivatives. Answering this question is essential in view of phases 1 and 2 of the IASB LIBOR reform.

Phase 1 of the IASB reform was created as a bridging measure until there is no longer any uncertainty regarding the timing and amount of LIBOR-based derivatives used in hedge accounting. If a company now determines that there is no longer any uncertainty regarding the timing and amount of LIBOR-based derivatives since 5 March 2021, then the application of phase 1 of the IASB reform ends and phase 2 becomes effective. 

This in turn has the following implication: 

IFRS 9.6.9.1 As and when the requirements in para. 6.8.4–6.8.8(*) cease to apply to a hedging relationship, an entity shall amend the formal designation of that hedging relationship …

IFRS 9.6.9.4   An entity shall amend a hedging relationship as required in paragraph 6.9.1 by the end of the reporting period during which a change required by interest rate benchmark reform is made to the hedged risk, hedged item or hedging instrument. …

The challenge here is that the standard setter writes "formal designation" rather than "hedge documentation". Initially, the difference may not seem to be really crucial, but it has direct consequences for assessing the hedge effectiveness and measuring the hedge ineffectiveness. 

If one decides that "designation" and "documentation" are two different and separate issues, then the designation will immediately change as of 5 March 2021, but not the documentation of the hedging relationship. Any adjustment to the hedge documentation must be completed by the end of the reporting period. For a risk originally designated under LIBOR, this causes the following effects on the assessment of the effectiveness of the underlying:

End of IBOR

Source: KPMG AG

Obviously, there will be hedge ineffectiveness between 5 March and 31 December 2021.

If, however, one decides that "designation" and "documentation" are one and the same, the underlying of the hedging instrument will change but not the hedge documentation. For a risk originally designated under LIBOR, this causes the following effects on the assessment of the effectiveness of the underlying:

End of IBOR

Source: KPMG AG

Obviously, there will be hedge ineffectiveness from 31 December 2021. For long-term interest rate hedges, the ineffectiveness shown in example 2 may have a significantly greater impact than in example 1.

If, however, a company determines that, despite the announcement of 5 March 2021, uncertainties remain regarding the timing and amount of LIBOR-based derivatives, the continued application of phase 1 of the IASB LIBOR reform is possible until 31 December 2021. Naturally, such an assessment must be appropriately justified and documented.

Our accounting and valuation experts will be happy to answer your questions regarding the end of IBOR.

Source: KPMG Corporate Treasury News, Edition 111, May 2021