Accounting & DisclosureLibor SOFRRisk Management

Libor Transition Puzzle: FASB Provides Clarity, Relief to Corporates

By January 26, 2021No Comments

Guidance from FASB clarifies accounting for all hedges impacted by the discounting transition.

The Financial Accounting Standards Board (FASB) started 2021 by clarifying accounting guidance aimed at facilitating the transition of corporate floating-rate transactions away from the Libor reference rate. The standard setter is also expected to resume progress this year on issues it had set aside to address the Libor transition.
Background. On Jan. 7, FASB issued ASU 2021-01, an accounting standards update that clarifies issues stemming from Topic 848, titled Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The Topic 848 guidance, issued in March 2020, eased the potential accounting burden arising from reference rate reform. The clarifications provide corporates with operational relief as they pursue transactions.
Discounting relief. Last October, the CME and LCH swap clearing houses changed the rate used for discounting, margining and calculating price alignment to the Secured Overnight Financing Rate (SOFR), which has been referred to as the “discounting transition.” That provided a major boost to SOFR, which regulators and major financial institutions have promoted as the replacement for USD Libor.

  • However, concerns arose among market participants that the discounting transition impacted trades that did not reference Libor. They questioned the scope of Topic 848 and whether there were possible hedge accounting consequences.
  • For example, the index is not expected to change for centrally cleared Federal Funds interest rate swaps. However, they were impacted by the discounting transition, prompting questions whether those contracts required reassessment.
  • In ASU 2021-01, “The FASB clarified that trades affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848,” said Brittany Jervis, head of Chatham Financial’s corporate accounting advisory practice.

Saving net investment hedges. Stakeholders also raised concerns that “float-to-float” cross-currency swaps involving receive-variable rate and pay-variable rate legs could, under reference-rate reform, lead to a difference in repricing dates and intervals, disqualifying certain net investment hedges. The recent ASU clarifies that the discrepancy can be disregarded.

  • “The ASU allows companies to make an optional election that permits them to continue with the original designation,” Ms. Jervis said.  “So any of these trades that previously qualified as net investment hedges would continue to qualify and would not need to be de-designated and marked to market.”

What to watch out for. Under the original Libor cessation date, FASB’s Topic 848 guidance had a sunset date of Dec. 31, 2022. The ICE Benchmark Administration’s current proposal to extend support of Libor to June 30, 2023 would give corporate treasury more time to transition existing financial products priced over Libor to SOFR or other alternative reference rates. FASB is expected to consider pushing the sunset date of its guidance past that. 

Another hedging issue. With accounting changes around reference rate reform completed, other issues may advance. One is accounting for changing the hedged risk in a cash flow hedge, say, from one-month Libor to three-month Libor. Prior to ASU 2017-12, guidance triggered a de-designation of the hedging relationship and potential forecasting considerations when the hedged risk changed, putting hedge accounting treatment at risk.

  • FASB issued a proposal in 2019 to help clarify guidance allowing hedge accounting to continue when the hedged risk changed, as long as the hedge met the criteria to remain “highly effective,” raising concerns about the proposal’s application.
  • “FASB has been working on further clarifications based on feedback, and they’re hoping to issue that this year, now that they’ve wrapped up the ASU on reference rate reform,” Ms. Jervis said.
Justin Jones

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