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LIBOR Transition: Regulatory Guidance for Hedge Accountants

As the London Inter-bank Offered Rate (LIBOR) begins to phase out, many corporate treasurers have been flooded by a wave of uncertainty. Our advice has been to proactively start planning alternatives by looking out for the guidance and term structures released by accounting regulatory bodies.

There isn’t a lot to do just yet, but some companies aren’t waiting around. They’re taking the initiative and educating their teams on the situation, checking fallback provisions on LIBOR-based contracts and considering not only derivatives and loans, but also leases, account receivables, transfer pricing and other places with a LIBOR trace.

On the other end of the spectrum, however, there exists a large number of companies that are still in the dark, unsure as to how the situation will impact their operations. This speaks volumes. Companies need to be educated and prepared for what’s to come – so when action must be taken, they know what to do and how to do it. 

So where should corporates look?

The International Accounting Standards Board (IASB)

Who is IASB? 

The International Accounting Standards Board (IASB) is an independent, accounting standard-setting body that belongs to the International Financial Reporting Standards (IFRS) Foundation. IASB is the FASB equivalent for many countries across the works and specifically for the European Union.

As a global accounting standard setter, IASB will greatly influence the guidance of transitioning away from the global interest rate, LIBOR.

What does IASB have to say about LIBOR?

An existing IASB rule states that in order to accomplish hedge accounting, future interest rates must be probable. This is where it gets tricky. After 2021, it’s agreed that LIBOR will not be probable. That means any organization with a LIBOR-based swap contract that goes past 2021 should theoretically stop their hedge accounting as soon as possible.

This widespread hedge accounting issue has left corporates across the world fearing their risk management efforts will be ineffective come 2021.

That’s where IASB has stepped in to say, “not so fast.” The accounting body has proposed temporary relief to ease uncertainty, saying that organizations don’t have to rush out of their hedge accounting to meet the original rule.

The existing IASB rule would require an assessment of future cash flows from contracts. For companies with LIBOR-based contracts, this kind of calculation would prove impossible due to the lack of clarity on what interest rate will be referenced post-LIBOR, rendering many contracts invalid and disrupting operations.

Even though the LIBOR-based interest rates will not be probable after 2021, IASB is saying that it’s safe to operate as usual under the assumption that the rates are probable – until the world agrees on a new standard under which they can re-work contracts.

The Financial Accounting Standards Board (FASB)

Who is FASB?

The Financial Accounting Standards Board (FASB), the standard-setting body in the U.S. for organizations that follow Generally Accepted Accounting Principles (GAAP). Domestic (U.S.) public companies must use U.S. GAAP (and thus, refer to FASB guidance).

What does FASB have to say about LIBOR?

Like the IASB, FASB has offered some relief for hedge accountants.

In June, FASB provided some relief on the LIBOR transition from the difficult accounting processes that would normally be required for any contract modification.

This accounting requirement states that if a corporate were to modify a loan or lease contract, it would have to assess whether the modification qualifies as an extinguishment or a troubled debt restructuring (TDR), and thus whether the derivative accounting may be continued.

LIBOR is referenced in thousands and thousands of contracts. Naturally, some proactive organizations have been looking to modify their loan or lease contracts with new interest rates, only to stop and wonder – would they have to de-designate every contract for derivative accounting under this rule?

FASB has stepped in to say “no.” Due to the magnitude of contract restructuring, FASB decided to eliminate those requirements for related contract modifications. If a corporate were to modify a contract for any other reason, they’d still have to follow that rule. But, because it’s an industry-wide migration, organizations can rest easy and move on to the next step of transition.

In July, the Board met again and made a number of tentative decisions that will be issued for comment in coming days. Organizations may be permitted to:

  1. Continue hedging relationships without de-designation upon a change in the critical terms of the hedging instrument due to reference rate reform
  2. Change the benchmark interest rate designated as the hedge risk in a fair value hedging relationship without de-designation, so long as that benchmark interest rate is impacted by the LIBOR reference rate reform. If an organization elects to follow this guidance, it would:
    1. Adjust the fair value hedge basis adjustment due to the change in the designated hedge risk
    2. Make an accounting policy election to recognize the adjustment either immediately in current earnings or in earnings in the same manner as other components of the carrying amount of the hedge asset or liability
  3. Apply certain practical expedients for the initial and subsequent assessments of hedge effectiveness for a cash flow hedging relationship affected by reference rate reform
  4. Apply the elections in items 1 through 3 on a hedge-by-hedge basis

If an organization chooses to use this guidance in their hedge programs, it would:

  1. Apply the guidance prospectively
  2. Disclose the nature of and reason for electing the guidance in each interim financial statement of the fiscal year of change and the annual financial statement of the period of the change in accordance with Topic 250, Accounting Changes and Error Corrections
  3. Cease applying the guidance as of January 1, 2023

Next Steps for Hedge Accountants

Despite jurisdictional and post-implementation differences, both key regulatory bodies seem to be heading in the same direction when it comes to guidance on the LIBOR transition.

Please note, these actions by the IASB and FASB are tentative proposals, but full draft guidance is on the horizon for the coming months of 2019.

Hedge accountants are starting to get answers to their LIBOR transition questions. The same can be said of the hiccups and regulatory roadblocks that treasurers have run into. The path is a little clearer, which means companies can actually take care of the economic LIBOR transition next steps and rest easy with respect to their hedge accounting activities. We are as happy to hear that news as you are!

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Contact us today if you need help protecting your margins with a better hedge program.


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