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IBOR reform and the effects on financial reporting

Date recorded:

Classification and measurement—modification of financial instruments (Agenda Paper 14A)

This paper focused on the modification of debt when contractual cash flows of a financial instrument are renegotiated or otherwise modified as a result of interest rate benchmark reform (IBOR reform).

The paper discussed the following questions:

1) What is a modification of a financial instrument in relation to the IBOR reform?

The staff recommended that in light of the IBOR reform, IFRS 9 should be amended to clarify that, even in the absence of an amendment to the contractual terms of a financial instrument, a change in the basis on which the contractual cash flows are determined that alters what was originally anticipated constitutes a modification of a financial instrument.

Board discussion

The staff confirmed its objective to provide support to entities that are having to make modifications due to the change in benchmark rate, whilst ensuring substantial modifications would not be hidden due to the IBOR reform.

Since IFRS 9 has two different definitions for modification currently, one for financial assets and one for financial liabilities, the Board agreed that this is a good opportunity to add clarification and the above amendment will be added and relate to all modifications and not just in relation to IBOR reform.

A vote was taken and the Board agreed with this proposal (12 of 14 agreed).

2) How to determine whether a modification is substantial?

The staff would like examples of modifications to be added to IFRS 9 to highlight those that would be deemed substantial on a qualitative basis and those that would not.

Board discussion

It was decided during the meeting that the example of modifications would be removed. The example was to highlight those modifications that would be deemed substantial on a qualitative basis and those that would not. The example would be of a wider scope than needed for this narrow-scope project. No vote was taken on this.

One Board member recommended to instead add a principle to the amendments to state that a substantial modification could occur even if the present value of the modified instrument is the same as before it was modified as the risks assigned to the new instrument is substantially different.

3) How to account for the modifications related to the reform?

The staff’s view is that modifications related to the reform are those that result in changes to the interest rate benchmark on which the financial instrument contractual cash flows are based, on an economically equivalent basis. For these modifications the staff recommend that a practical expedient should be included in IFRS 9 so that entities apply IFRS 9:B5.4.5. If the entity amends other terms in the contract which are not considered substantial, then the entity applies IFRS 9:5.4.3.

The staff recommended that IFRS 9 should be amended to clarify that an entity should first apply the practical expedient (to account for the modifications related to the reform) by updating the effective interest rate based on the alternative benchmark rate, and then apply IFRS 9 current requirements to determine if any other modifications to that financial instrument are substantial and apply the relevant accounting thereafter. The staff recommended providing an example in IFRS 9 to illustrate this.

Board discussion

One Board member wanted to ensure the communication of these points were made clear, and that the practical expedient was only relevant to modifications of instruments that are a direct consequence of the reform and results in economic equivalence.  In addition, it should be clarified that the economical equivalent modification is accounted for first and then all other modifications are accounted for subsequently.

One Board member asked if the staff could define economic equivalence.

One Board member asked if this was similar to the FASB proposals. The staff confirmed that the outcome would be similar under both. However, the approach to get there would be slightly different due to the difference in the standards.

A vote was taken and the Board agreed with these proposals (13 of 14 agreed).

Accounting implications from derecognition of a modified financial instrument (Agenda Paper 14B)

This paper focused on those modifications that result in the derecognition of the financial instrument and the accounting implications arising from the recognition of the ‘new’ modified financial instrument in the context of the IBOR reform. The accounting issues include:

  • (a) Derecognition of a financial asset or a financial liability from the statement of financial position and the effect in P&L.
  • (b) Implications of recognising a new financial asset for the purpose of:
    • (i) determining the entity’s business model for managing the financial assets.
    • (ii) assessing the contractual cash flow characteristics of the financial asset, specifically, whether the contractual cash flows of the new financial asset meet the criteria for solely payments of principle and interest (SPPI.)
    • (iii) recognition of the expected credit losses (ECL).
  • (c) potential effects on the accounting for embedded derivatives for financial liabilities in the context of the IBOR reform.

The staff notes that with further development of the IBOR reform and the incorporation of alternative benchmark rates into contractual terms, new information and accounting implications could be identified that may affect the analysis in the paper. 

In this paper the staff recommended that, in the context of the IBOR reform, existing requirements in IFRS 9 provide an adequate basis to account for the issues highlighted above. The staff think, however, that adding an example to IFRS 9 to illustrate the application of the SPPI assessment in the context of the IBOR reform could be useful, but propose no other amendments to IFRS 9.

Board discussion

Board members agreed with the above. One Board member also pointed to IFRS 9:BC4.145 which states that if there is a one-off regulatory change, this would not mean a change in business model which is deemed to be analogous to this situation.

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