Latest Details on the LIBOR Transition and Interest Rate Reform

As LIBOR is phased out, reference rate reform will identify new and alternative reference index rates for financial instruments, including the Secured Overnight Financing Rate (SOFR).

The end of 2019 saw plenty of activity and movement in regulatory guidance.

• September 5, 2019: FASB proposed a new Accounting Standard Update (ASU) to lighten the burden of accounting for financial instruments referenced to “IBOR” interest rates which will cease to exist as a reference rate source in early 2021.
• October 7, 2019: Review and comments on the proposed ASU by all stakeholders due.
• November 13, 2019: FASB approved the ASU, which is expected to be issued in early 2020, to provide temporary (and optional) guidance that relieves the accounting burden related to reference rate reform.

Given the shared concerns about how special hedge accounting will be affected by interest rate reform, stakeholders should be pleased with this guidance. To help, we’ve unpacked what this means and outlined what your company should look for and consider when approaching the transition.

How You Might Be Affected

Foreign currency derivatives, forward points, discount rates and CDS spreads will no longer be LIBOR-based. Therefore, companies that account for their own foreign currency derivatives will need to be mindful of input changes for valuations and effectiveness testing.

The impact of the transition to interest rate derivatives, debt and credit facilities will be even greater, given their valuations and accounting rely materially on the LIBOR reference rate.

One big concern is that the alternative reference rates for derivatives hedging LIBOR-based debt may be very different. This could jeopardize hedge accounting results and the economics of the hedge relationship if companies are not proactive in the transition process with their counterparties.

Next Steps: What You Can Do Today

To help you manage the interest rate transition process, we have provided a checklist of questions that you should start asking within your organization. Below is an abridged checklist:

• • Have you established a Transition Management Protocol?
    • Educate yourself and communicate with management
  • Have you identified and validated your company wide LIBOR exposure across asset classes?
    • Check Fallback Provisions on: Credit Facilities, Leases, Derivatives, and More
  • Have you assessed contractual remediation and fall back provisions?
    • What rates do your contracts use if LIBOR goes away?
  • Evaluate impact on hedge accounting and reporting
    • Hedges and debt may end up with different reference index rates which could lead to a loss of special hedge accounting.
  • Have you contacted your counterparties?
    • Expect to negotiate changes in critical contract terms
  • Look for less obvious impacts to LIBOR changes
    • Derivative contracts that are fair valued: discount rates, credit rates and effectiveness testing calculations

For even more detailed information and support, read more here.

Accounting Standard Update: The Details

The goal of the new ASU (which was approved in November) is to relieve operational challenges, simplify accounting and reduce costs associated with the transition.

The FASB realized that contract modifications due to revised reference rates will have a significant impact on special hedge accounting qualifications. Therefore, the new ASU provides accounting exceptions and practical expedients to reduce challenges associated with the reform.

For example, contracts that meet certain criteria will be allowed to continue even with updates to their reference rates without the need for de-designating and re-designating a new hedge relationship. The FASB specifically acknowledged the ability for companies to preserve hedge accounting when hedge strategies are updated to account for new reference rates. However, this exception only applies to LIBOR-based or other “IBOR”-based reference rates that are expected to be eliminated.

The ASU will remain active until December 31, 2022, by which time we expect most market participants to have ceased using LIBOR or similar reference rates in financial contracts.

We’re Here to Help

Hedge Trackers has over 100 years of combined hedge accounting experience in the interest rate and foreign currency field. We continuously follow the FASB as well as the latest special hedge accounting strategies and accounting interpretations. Additionally, our team is serving on the AFP task force as a voice for corporates. As a part of the task force for informing Corporate Treasury departments on the LIBOR transition, we’re committed to guiding you throughout the entire process.

Our team of experts can help you evaluate your financial contracts for reference rate reform risk, assist in building a management plan around rate reform and evaluate any special hedge accounting implications. Contact us today!