IBOR Reform – Accounting Implications
Tuesday 19 November 2019
Interest rate benchmarks (such as LIBOR, EURIBOR and TIBOR) play a key role in global financial markets. These benchmarks index trillions of dollars in a wide variety of financial products, from derivatives to residential mortgages. However, the veracity of these benchmarks has been in question since the financial crisis. Regulators worldwide have decided to change these existing interest rate benchmarks to alternative benchmarks that are more representative of risk-free rates (RFRs) and that are set using a more transparent market-based process. The discontinuation of interest rate benchmarks will have a significant and widespread impact across financial markets, including financial reporting.
The demise of IBOR will have a number of financial reporting consequences, as well as implications for the valuation of financial instruments, ranging from simple loans to complex derivatives.
In the area of financial reporting these consequences will be different at different points. Firstly, these arise in the period leading to the date of transition from the existing interest rate benchmark to the new risk-free rates (RFRs). This is the period in which we are now. During this phase, areas such as hedge accounting that require forward-looking analyses, for example the ‘highly probable’ requirement for forecast transactions and the demonstration of the existence of an economic relationship, according to IFRS 9: Financial Instruments, or expectation that the hedge will be highly effective in achieving offsetting, as per IAS 39: Financial Instruments: Recognition and Measurement will be impacted. Given the uncertainty regarding the continuation of IBORs it is possible that interest rate hedges will fail in the near future without relief from the IASB.
The second group of issues will arise when a jurisdiction actually moves or transitions from IBORs to the new RFRs. For example, issues will arise concerning the assessment of whether a change in the contractual cash flows or terms of a financial instrument is a substantial modification or if such modifications result in the derecognition of existing financial instruments and the accounting implications of recognising modified financial instruments as ‘new’ financial instruments.
The IASB has on its agenda a fast track project to address the accounting challenges arising from IBOR reform. It has already published one set of amendments to IFRS 9 and IAS 39 to address problems arising from the first phase, i.e. in the period leading up to IBOR reform. The IASB has provided relief from certain requirements that enable hedge accounting to continue in the period leading to IBOR reform. It is currently deliberating what relief to provide when the transition from IBORs to new RFRs actually happens, i.e. for the second phase. The amendments already published by the IASB provide timely relief to preparers of financial statements and should be considered by all those who are impacted by IBOR reforms.
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