IASB Board project Phase II: post-IBOR reform issues
Discussions of Phase II of the IASB Board’s project launched in September 2019 and focuses on accounting matters that will arise once an existing benchmark rate is replaced with an alternative benchmark rate. The topics addressed cover classification and measurement, hedge accounting, the effects of IBOR reform on financial reporting and key disclosure requirements. The IASB Board is considering reliefs for modifications to financial instruments and amendments to hedge documentation that are related to IBOR reform. Other standards, such as leases and insurance contracts, may also be amended.
The following key reliefs are being proposed by the IASB Board5:
- A practical expedient for ‘modifications directly required by the IBOR reform’ would allow the effective interest rate to be updated based on the revised cash flows without adjusting the carrying amount. After applying the practical expedient, companies would apply the current IFRS 9 requirements to assess any other modifications to that financial instrument.
- Amending hedge documentation to reflect modifications directly required by IBOR reform would not result in a discontinuation of the hedge in certain instances.
- Lessees would receive a practical expedient under which they can account for lease modifications directly required by IBOR reform under existing guidance (IFRS 16) related to changes in floating interest rates.
- The currently effective insurance contracts standard (IFRS 4) would be amended so that insurers applying IAS 39 can also apply the amendments and practical expedient in accounting for modifications of financial instruments directly required by IBOR reform.
- As an explicit requirement, companies would disclose the nature and extent of risks arising from IBOR reform to which they are exposed, and how they are managing those risks.
The IASB Board is expected to issue its Phase II exposure draft in April 2020.
For more on IASB Board standard setting activity related to IBOR reform visit our website, KPMG Insights: IBOR reform.
The FASB response to IBOR reform
The FASB also has a proposal6 – expected to be issued as a final standard shortly – to address accounting issues relating to contract modifications and hedge accounting related to reference rate reform. Unlike IFRS Standards, the FASB would provide practical expedients and exceptions to existing US GAAP that may be applied optionally on a Codification Topic-by-Topic basis. The expedients and exceptions would stop applying to contract modifications made and hedging relationships entered into, or evaluated after, December 31, 2022.
For more on FASB standard-setting activity related to IBOR reform visit our website, KPMG Insights, Transitioning to LIBOR.
How have regulators responded?
Regulators around the world are encouraging companies to proactively resolve identified issues, discuss transition plans with counterparties, and implement alternative reference rates in advance of the discontinuation date.
In 2019, the SEC encouraged7 companies to add additional disclosures relating to IBOR reform, including steps to evaluate and mitigate the expected risks, identified material exposures, and potential effects of the reform on the company. In addition, the SEC will closely track and evaluate8 IBOR reform. Companies should evaluate their exposure to IBOR, for example, by reviewing fallback language in contracts and its use of benchmarks and indices. Accounting systems and risk models may also be impacted.
The European Securities and Markets Authority (ESMA) drew attention to the IASB Board Phase I amendments in its 2019 European common enforcement priorities. Regulators in the United Kingdom9 have observed that there continues to be comprehensive reliance on and use of IBOR, and they expect companies to consider tools and metrics to monitor exposure to IBOR.
Regulatory scrutiny is expected to continue to increase in 2020 as LIBOR and certain other IBORs transition away. For example, the New York State Department of Financial Services required its regulated depository and non-depository institutions, insurers and pension funds to submit to the Department their plans to address their LIBOR transition risk plan by February 10, 2020. In addition, LIBOR transition was discussed at the SEC Investor Advisory Committee meeting on February 27, 2020.
Key takeaways
- Certain markets will gradually shift from LIBOR and other IBORs to the designated alternative benchmark rate before the end of 2021.
- Companies need to adequately disclose their exposure to IBOR reform, the expected impacts, and how the entity is managing the financial and operational impacts of the reform.
- All companies applying IFRS Standards must apply the amendments to IFRS 9, IAS 39 and IFRS 7 relating to hedge accounting from Phase I, effective January 1, 2020.
- Phase II of the IASB Board project should provide targeted relief post-IBOR reform for classification and measurement, hedge accounting and other effects on financial statements.
- Dual reporters should monitor standard-setting activity expected in the coming year, for potential differences between IFRS Standards and US GAAP.