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IBOR reform and the effects on financial reporting

Date recorded:

Cover paper and summary of tentative decisions to date (Agenda Paper 14)

This paper summarised the objective, plan, current stage and high-level timeline of the project and the Board’s tentative decisions to date.

The objectives of this project are to provide useful information about the effects of the transition to alternative benchmark rates on an entity’s financial statements and to support preparers in applying the requirements of the IFRS Standards during IBOR reform.

The Board has discussed and tentatively decided to make amendments to:

  • IFRS 9, for classification and measurement of financial instruments
  • IFRS 9 and IAS 39, for hedge accounting
  • IFRS 16
  • IFRS 4
  • IFRS 7

The staff recommend publishing an Exposure Draft (ED) in April 2020 with a 45-day comment period.

Sweep issue—Modification of financial instrument (Agenda Paper 14A)

In the October 2019 meeting, the Board tentatively decided to amend IFRS 9 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 in accordance with IFRS 9.

It was decided that this proposed amendment would be a permanent change to IFRS 9 and not limited to modifications made in the context of IBOR reform.

In this meeting, the staff asked the Board if they could limit the scope only to changes made in the context of IBOR reform and incorporate the amendment into the permanent requirements of IFRS 9 at a later date. This is more in line with the objective of the project and will provide staff with more time to ensure unintended consequences are avoided.

Board discussions and voting

All Board members (note 1 absent) voted in favour of the staff’s recommendations.

The Vice-Chair confirmed that the Board are not backing away from including this as a permanent requirement in IFRS 9, however believe it is going to require precise wording to ensure it is clear what a change in basis is, which will take longer to draft.

In the context of IBOR reform, however, she believes it is critical this is added in the Phase 2 amendments on a timely basis, especially in relation to EONIA and due to the possibility of a synthetic IBOR being introduced.

Hedges of risk components—separately identifiable criteria (Agenda Paper 14B)

In Phase 1 of the project, a requirement was added to IFRS 9/IAS 39 for hedging relationships affected by IBOR reform. The amendment states that the 'separately identifiable' requirement for hedges of the benchmark component of an interest rate risk be applied only at the inception of the hedge. No 'end-of-application' requirement was given in respect of this relief. In Phase 2, the Board tentatively agreed that amending a hedging relationship to reflect modifications directly required by the reform may not trigger discontinuation of hedge accounting.

In the context of the Phase 2 proposed changes the staff are proposing that the relief provided in Phase 1 would cease to apply at the earlier of:

  • a) when changes to the hedging relationship are made for the hedged risk to reflect modification directly required by the reform; and
  • b) when the hedging relationship is discontinued.

In the early stages of transition to alternative benchmark rates, there may be issues around whether the alternative benchmark rate meets the requirements that a risk component must be separately identifiable and reliably measureable. This is because in the early stages of IBOR reform, the particular market of the alternative benchmark rate may not yet have sufficiently developed.

In this meeting, the staff are asking the Board for temporary relief for hedging relationships that are amended to reflect modifications directly required by the reform so that a component is considered to satisfy the separately identifiable requirement if, and only if:

  • a) the entity reasonably expects that the alternative benchmark rate will satisfy the requirement in IFRS 9 or IAS 39 to be a separately identifiable component within the particular market structure within 12 months from the date it is designated as a risk component for hedge accounting purposes; and
  • b) the component can be measured reliably from the date it is designated as the risk component.

Board discussion and voting

The Vice-Chair supported the staff recommendation, but mentioned that she had discussions with preparers and they are not fully in agreement for two reasons: (i) it is inconsistent with Phase 1 and (ii) 12 months may not be a sufficient time period.

In response to these comments, the Vice-Chair noted that the population of hedges that qualify for this relief is different to Phase 1. For Phase 1, the relief was to allow current hedges (which previously met the separately identifiable criterion, but could fail to meet it now due to IBOR reform) to continue hedge accounting. The Phase 2 relief is for new hedges, over and above the Phase 1 relief. She also mentioned that, given the amount of uncertainty in the market, she would support an increase in the period of time to 24 months.

A Board member asked whether at the end of the 12-month period, if the risk was still not separately identifiable, hedge accounting would be discontinued from that point or from the point the entity entered into the hedge. The staff confirmed that the entity would discontinue from the end of the 12-month period.

Another Board member asked whether at the point at which an entity no longer expects the alternative benchmark rate to be a separately identifiable component within the particular market structure, if an entity discontinues hedge accounting from that point onward or waits for the 12-month period to end. The staff confirmed that the entity would discontinue at the point it no longer reasonably expects the alternative benchmark rate to be separately identifiable. There were concerns from Board members that this would create the risk that hedges may be de-designated earlier than they should be (i.e. voluntarily discontinue hedges).

The Vice-Chair suggested that the staff could consider amending the wording of the amendment such that an entity cannot de-designate during the 12-month period and the entity only reassesses the separately identifiable criterion at the end of that period. Another Board member suggested including a high hurdle to discontinue, i.e. adding to the amendment that the entity has to be reasonable certain that it will fail to meet the separately identifiable test.

One Board member did not agree with this relief as she believes this is a market structure issue and that this relief is taking away the accounting cost of moving to a new rate. The role of financial reporting is to show what happened in the period and a move in a reference rate to a less liquid market should be presented in the accounts. The challenge to this point by another Board member was that the requirement to be ‘reliably measurable’ has not been amended and any ineffectiveness due to this change will be reported in the income statement.

A Board member asked how management is expected to show that they ‘reasonably expect’ that the separately identifiable criterion will be met. The staff confirmed this is a judgement, however potential indicators would be looking at the liquidity in the market and the projected liquidity of the market, understanding how variable rate loans are being priced and how many issuances in this market have taken place. They confirmed it will be different in each jurisdiction.

The voting was split in two parts:

Option 1—support the staff recommendation, including the requirement that the entity has to be reasonable certain it is going to fail in order to de-designate the hedge during the 12 month period.

Option 2—support the staff recommendation with the period amended to 24 months, including that the entity has to be reasonable certain it is going to fail in order to de-designate the hedge during the 24 month period.

Option 1: 4 Board members in favour.

Option 2: 10 Board members in favour.

Note: 1 Board member was absent and 1 Board member voted for both options.  

End of Phase 2 amendments and voluntary versus mandatory application (Agenda Paper 14C)

The Phase 2 amendments are associated with the point at which transition to an alternative benchmark rate occurs, hence the entity applies the amendments once to an item (i.e. upon transition).

The staff therefore proposed that for:

  1. Classification and measurement of financial instruments: the proposed amendment can only be applied once to a financial instrument (i.e. the contractual cash flows can change only once as a direct consequence of IBOR reform)
  2. Hedge accounting: changes in the hedge documentation may take place over a period of time (i.e. the hedged item may change at a different date to the hedging instrument), however the proposed amendments are only applied once to each element in the hedging relationship.
  3. Lease accounting: the amendment is applied once (at the date the lease payments are modified as a direct consequence of IBOR reform).
  4. Disclosures: information should continue to be provided in a reporting period in which the entity is exposed to risks arising from the reform and the transition to alternative benchmark rates for financial instruments and hedging relationship is not complete.
  5. Separately identifiable requirement for risk components: this will cease applying 12 months after the date that the alternative benchmark rate was designated as a risk component for hedge accounting purposes.

The staff recommend that the proposed amendments should apply mandatorily.

Board discussion and voting

The Vice-Chair suggested that rather than having a strict rule to be able to apply it only once (especially in relation to the separately identifiable requirement) that any change should be as a direct consequence of reform. For example, for those moving from EONIA, they will initially move to €STR+8.5 basis points and then later there will be another amendment to the rate.

She suggested that rather than having a termination date, it should be scoped clearly that only a certain and clear population of hedges will be impacted by these amendments.

All Board members (1 absent) that the nature of the proposed amendments is such that they can only be applied to modifications of financial instruments and changes to hedging relationships that satisfy the relevant criteria and, as such, no specific end of application requirements need to be specified.

All Board members (1 absent) agreed that the amendments should apply mandatorily.

Effective date and transition requirements (Agenda Paper 14D)

The staff recommended in this meeting:

  • i) an effective date for annual periods beginning on or after 1 January 2021 with earlier application permitted.
  • ii) that the proposed amendments should apply retrospectively for items that existed at the beginning of the reporting period in which the entity first applies the proposed amendments and includes the reinstating hedging relationship that was discontinued solely due to the reform and would not have been discontinued if the proposed amendments were available.

Board discussion and voting

All Board members (1 absent) agreed with the effective date.

Board members discussed the staff recommendation of reinstating hedges that have discontinued. It was agreed that it would be amended to state that an entity is required to reinstate hedges that previously failed due to IBOR reform in order to limit cherry picking. All Board members (1 absent) agreed with recommendation (ii) above including making the reinstating hedges a requirement.

All Board members (1 absent) agreed that in the reporting period in which an entity first applies the proposed amendments an entity is not required to present the disclosures required by IAS 8:28(f).

Due process steps (Agenda Paper 14E)

This paper proposed a comment period of 45 days for the ED asked whether any Board member intends to dissent from the proposed amendments, asked the Board to confirm that it is satisfied that it has complied with the application of the due process requirements and seeks the Board’s permission for the staff to begin the process for balloting the ED.

Voting

All Board members (1 absent) agreed with the comment period of 45 days for the ED of the proposed amendments. No Board member intends to dissent from the publication of the ED and all Board members (1 absent) gave permission to begin the balloting process.

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