Insight

IASB’s two-phase IBOR reform project is complete

Accounting relief is available to help companies transition away from IBOR.

Kevin Bogle

Kevin Bogle

IFRS Institute Advisory Leader, KPMG LLP

+1 212-872-5766

From the IFRS Institute – March 5, 2021

The International Accounting Standards Board (the IASB® Board) has a two-phase IBORreform project. Phase I amendments (now effective) provide targeted relief for hedge accounting. Phase II amendments are effective in 2021 and focus on post-IBOR reform issues. Read this article for an IBOR reform update and to understand how the amendments apply to your company.

What’s the latest on IBOR reform?

The sunset date for discontinuation of most tenors of IBOR is December 31, 2021. In November 2020, Intercontinental Exchange (the administrator of LIBOR) proposed to extend the use of certain USD LIBOR tenors to June 30, 2023. This was based on feedback from panel banks and regulators, and excludes one-week and two-month tenors, which are intended to cease being published by December 2021.

This move, if confirmed, could be misread as an extension of LIBOR. Instead, it is designed to smooth transition by allowing most legacy contracts indexed to USD LIBOR to mature before LIBOR is discontinued. US federal banking agencies issued a joint statement encouraging companies to cease using LIBOR for new contracts as soon as practicable or no later than December 31, 2021, to facilitate an orderly LIBOR transition.

Global efforts are well underway to transition from IBORs to alternative benchmark rates – e.g. the Secured Overnight Financing Rate (SOFR) in the US – but progress is slow. For example, the issuance of SOFR-linked debt and SOFR futures trading activity increased steadily throughout 2020; however, issuance of SOFR-linked debt is significantly concentrated in government-sponsored enterprises (> 60%) and banks (~ 30%), rather than corporates.2 Additionally, USD derivatives have been slow to transition to SOFR when compared to other markets – e.g. UK GBP derivatives.3,4

While some progress has been made in transitioning LIBOR-based derivatives to SOFR-based derivatives, only 5.6% of all USD risk in cleared over-the-counter and exchanged-traded interest-rate derivative transactions were tied to SOFR as of November 2020. The slow progress in transitioning to SOFR could undermine a smooth transition away from LIBOR – posing risk to financial stability, and delaying the Alternative Reference Rate Committee’s ability to develop a forward-looking term reference rate.5

Transition delays related to COVID-19 have also been reported, and recent SEC filings6 show companies are increasingly disclosing risks related to the transition to meet regulatory and accounting disclosure requirements.7 Although companies have had to focus on the urgent matter of dealing with COVID-19, regulators and central banks have been clear that preparation for the IBOR transition process should not be delayed.

In June 2020, the SEC’s Office of Compliance Inspections and Examinations announced its intention to conduct examinations to assess companies’ preparation for IBOR transition. Further, a November 2020 public statement by the SEC Chairman “encourage[s] registrants to proactively transition to market-based reference rates and stand ready to assist market participants.” These explicit statements by the SEC should serve as motivation for all companies to be proactive about transitioning away from LIBOR.

Reza van Roosmalen, KPMG Principal – US Accounting Advisory, observed: “Despite the COVID-19 pandemic disruption, companies should not lose sight of fully transitioning away from IBOR. Companies need to identify the accounting and operational impacts to their organization and then apply the practical expedients provided by the IASB Board’s two-phase project.”

The IASB Board’s IBOR reform project

In August 2020, the IASB Board published its IBOR reform Phase II amendments, the final touch to its two-phase IBOR reform project. 

Phase I amendments provide targeted and temporary relief to hedge accounting in the period leading up to IBOR replacement, which is discussed in KPMG article, IFRS Perspectives: Accounting standards boards respond to IBOR reform.

The Phase II amendments are broader. They address the accounting once a new benchmark rate is in place and companies update reference rates in their contracts. This includes dealing with the effects of changes to contractual cash flows or hedging relationships arising from benchmark rate replacement. The relief comes in the form of mandatory practical expedients and temporary exceptions.

The Phase II amendments apply retrospectively for annual periods beginning on or after January 1, 2021, with earlier application permitted.

Phase II: post-IBOR reform relief for financial assets and liabilities, and leases

The Phase II amendments cover the following issues:

Accounting area Phase II amendments require companies to:

Modification of a financial asset or financial liability
(IFRS 98)

  • First apply the practical expedient if the transition to an alternative benchmark rate is necessary as a direct consequence of IBOR reform and the change occurs on an ‘economically equivalent’ basis.
  • Do not recognize a modification gain or loss or change the carrying amount of the financial instrument; instead, update the effective interest rate prospectively to reflect the change in benchmark rate.
  • If there are other changes to the contractual cash flows, apply appropriate requirements of IFRS 9.
  • Insurers applying IAS 399 will also apply similar amendments.

Modification of a lease – lessees only
(IFRS 1610)

  • Apply the practical expedient for a lease modification required by IBOR reform by remeasuring the lease liability using a revised discount rate reflecting the change in interest rate.
Transition – No requirement to restate prior periods Amendments are applied retrospectively. Prior periods may be restated only if possible without the use of hindsight.

New disclosures
(IFRS 711)

Required disclosures include:

  • qualitative information about how the company is managing its IBOR transition, its transition progress at the reporting date, and the risks arising from financial instruments because of the transition;
  • quantitative information about the financial instruments yet to be transitioned at the reporting date, disaggregated by each significant interest rate benchmark, and showing nonderivative financial assets, nonderivative financial liabilities and derivatives separately; and
  • to the extent that IBOR reform has resulted in changes to the company’s risk management strategy, disclose them.


Phase II: post-IBOR reform relief for hedging relationships

The Phase II amendments do not provide exceptions to the measurement requirements for hedged items and hedging instruments. Once the hedged risk or the hedging instrument transitions to the new benchmark rate, it is remeasured based on the new rate and subject to normal hedge accounting rules – e.g. hedge ineffectiveness is recognized in profit or loss.

However, under the amendments, a company can avoid discontinuing existing hedging relationships, if that relationship would be discontinued solely due to IBOR reform. If so, the IBOR reform temporary exceptions are applied; if not, existing guidance applies.

The Phase II amendments may require companies to reinstate hedging relationships that were previously discontinued solely due to changes required by IBOR reform had the Phase II amendments been applied at the time of discontinuation and the discontinued hedging relationship meets all qualifying criteria for hedge accounting at the beginning of the reporting period in which the Phase II amendments are applied.

Once a company ceases to apply the IBOR Phase I amendments to a hedging relationship, it will apply the following Phase II amendment exceptions.

Hedge accounting regular requirements Phase II amendment exceptions to a hedging relationship will require companies to:
Discontinuance of hedging relationship after certain updates to hedge documentation

In the same reporting period that changes are required by IBOR reform to the hedged risk, hedged item or hedging instrument:

  • amend the formal designation of a hedging relationship to reflect these changes – e.g. to redefine the hedged risk using an alternative benchmark rate and redefine the description of the hedging instrument and/or hedged item to reflect the alternative benchmark rate;
  • avoid discontinuing the existing hedging relationship or de-designating and re-designating a new hedging relationship.
Amounts accumulated in the cash flow hedge reserve are reclassified to profit or loss when forecasted hedged cash flows occur
  • Deem the amount accumulated in the cash flow hedge reserve to be based on the alternative benchmark rate on which the hedged future cash flows are determined.
Specific requirements for hedging groups of items (i.e. similar risk characteristics and shared risk exposure)

When a group of items is designated as a hedged item and an item in the group is amended to reflect changes required by IBOR reform:

  • allocate the hedged items to sub-groups based on the benchmark rate being hedged and designate the benchmark rate for each sub-group as the hedged risk; and
  • assess each sub-group separately to determine whether it is eligible to be a hedged item. If any sub-group is not eligible, the hedging relationship is discontinued prospectively in its entirety.
Separately identifiable risk requirement for non-contractually specified risk components
  • Designate an alternative benchmark rate as a non-contractually specified risk component, even if it is not separately identifiable at the designation date.
  • To apply, the company needs to reasonably expect that the alternative benchmark rate will be separately identifiable within 24 months.
  • This amendment is applied on a rate-by-rate basis and also applies to a new hedging relationship.
Performance of retrospective effectiveness assessment under IAS 39
  • On a hedge-by-hedge basis, the company may elect to reset the cumulative fair value changes of the hedged item and hedging instrument to zero immediately after ceasing to apply the Phase I relief. 


For more on IASB Board standard-setting activity related to IBOR reform, visit our resource center, KPMG Insights: IBOR reform.

FASB response to IBOR reform

The FASB has also provided relief through ASC 848 (reference rate reform). Unlike the IASB Board’s amendments, the practical expedients in ASC 848 are optional and short- lived – they will remain effective until December 31, 2022 only. A company must disclose which practical expedients are elected and the reason for electing them.

Similar to the IASB Board’s amendments, ASC 848 provides a practical expedient in the event of a modification to contractual cash flows. The expedient allows companies to update the effective interest rate instead of derecognizing or changing the carrying amount of a financial asset or financial liability.

Under FASB’s relief for hedge accounting, any hedge ineffectiveness that occurs after the new benchmark rate will affect current period profit or loss12.

For more on IFRS® Standards compared to US GAAP related to interest rate benchmark reform, see chapter 7 of KPMG Handbook, IFRS compared to US GAAP.

For more on FASB standard-setting activity related to IBOR reform, visit our resource center, KPMG Insights: Evolving LIBOR.

Key takeaways

  • Markets will continue their shift away from LIBOR and other IBORs to alternative benchmark rates through the end of 2021.
  • Although the economic effects of COVID-19 may have slowed companies’ IBOR transition plans, US banking regulators expect very limited use of LIBOR in new contracts after 2021 and companies should transition to an alternative benchmark rate in the near term.
  • Progress has been made in transitioning LIBOR-indexed derivatives to SOFR-indexed derivatives; however, progress is slow and the volume of SOFR-based derivatives remains low. 
  • The IASB Board’s Phase II amendments apply to both banks and corporates, and seek to reduce the financial statement effects of actual reference rate replacements associated with IBOR reform that are not informative to financial statement users.
  • The requirement to amend hedge documentation without discontinuing a hedging relationship provides practical relief and results in accounting that reflects the economics of IBOR reform.
  • The Phase II amendments apply to annual periods beginning on or after January 1, 2021, and are mandatory.

Contributing authors

Jason Bui

Jason Bui

Director, Accounting Advisory Services, KPMG US

+1 212-954-2110
Sarah Kindzerske

Sarah Kindzerske

Director, Accounting Advisory Services, KPMG US

+1 617-988-5956
Mahesh Narayanasami

Mahesh Narayanasami

Partner, Dept. of Professional Practice, KPMG US

+1 212-954-7355
Reza Van Roosmalen

Reza Van Roosmalen

Principal, Advisory, Accounting Advisory Services, KPMG US

+1 212-954-6996

Footnotes

  1. In this article, IBOR refers to any Interbank Offered Rate (IBOR) that is affected by the reform. LIBOR refers to the US dollar LIBOR. LIBOR is quoted for five currencies throughout the world.
  2. Bloomberg, LIBOR Transition picking up steam as SOFR linked loans increase
  3. UK market’s transition refers to GBP LIBOR’s transition to Sterling Overnight Interbank Average Rate (SONIA).
  4. ISDA, Transition to RFRs Review: Full Year 2020 and the Fourth Quarter of 2020
  5. Bloomberg, LIBOR proving hard to kill in $200 Trillion derivatives market
  6. In a January 2021 Staff Statement on LIBOR Transition in the Municipal Securities Market, The Office of Municipal Securities urges ‘municipal obligors’ to take action to update language in existing contracts and issue new contracts to reference alternative reference rates in order to mitigate the risks of IBOR Reform.
  7. Trentman, Nina. (2020, December 30). Finance executives look to advance LIBOR transition in 2021. The Wall Street Journal. https://www.wsj.com
  8. IFRS 9, Financial Instruments
  9. IAS 39, Financial Instruments: Recognition and Measurement
  10. IFRS 16, Leases
  11. IFRS 7, Financial Instruments: Disclosures
  12. The IASB introduced this amendment in Phase II.

Related content

Subscribe to our newsletter

 

Sign up now

Meet the IFRS team

 

Learn more

KPMG Executive Education

CPE seminars and customized training

Learn more