In 2020, FASB issued Accounting Standards Update (ASU) 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provided temporary, optional expedients and exceptions for applying generally accepted accounting principles to held-to-maturitysecurities, contracts, hedging relationships, and other transactions affected by reference rate reform, most notably to:
- Simplify contract modification accounting
- Allow hedging relationships to continue without dedesignation upon a change in certain critical terms
- Allow a change in the designated benchmark interest rate to a different eligible benchmark interest rate in an existing fair value (FV) hedging relationship and allow flexibility in the accounting method for the effect of that change
- Simplify or temporarily suspend the assessment of hedge effectiveness for cash flow hedges
- Suspend the assessment of certain qualifying conditions for FV hedges for which the shortcut method for assuming perfect hedge effectiveness is applied
For additional details, see “FASB Finalizes LIBOR Transition Relief.”
On April 20, 2022, FASB issued an exposure draft that would extend this relief’s effective date and expand the definition of the replacement reference rate approved by U.S. regulators, the Secured Overnight Financing Rate (SOFR). Comments were due by June 6, 2022.
Extend Effective Date
Due to the unique nature of the London Interbank Offered Rate (LIBOR) sunset, the ASU had an unusual effective date. ASU 2020-04 applied transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. This relief was set to expire for contracts entered into or evaluated after December 31, 2022, which was one year after the then-expected LIBOR cessation date. However, on March 5, 2021, LIBOR’s regulator announced that certain tenors of USD LIBOR will continue to be published until June 30, 2023. As a result, FASB is proposing that the accounting relief also be extended.
Expand SOFR Definition
When issued, ASU 2020-04 was crafted to allow flexibility due to market uncertainties around LIBOR’s sunset. Although SOFR was the preferred LIBOR replacement rate, FASB did not want to limit relief in case other existing rates or new reference rates might be more appropriate. ASU 2018-16 added the SOFR Overnight Index Swap (OIS) Rate as a benchmark interest rate for hedge accounting. Recently, the Alternative Reference Rates Committee issued a formal recommendation of a SOFR term rate. FASB is proposing to amend the definition of the SOFR OIS rate so that any swap rate based on SOFR qualifies as a benchmark interest rate when applying fair value hedge accounting.
The transition away from LIBOR will be complicated and likely will require significant hours to implement correctly for companies with a large volume of contracts. If you would like assistance with reference rate reform, contact a professional with FORVIS.