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IBOR reform and the effect on financial reporting

Date recorded:

Cover Paper (Agenda Paper 14)

The Board published the Exposure draft (ED) Interest Rate Benchmark Reform—Phase 2 (Proposed Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16) in April 2020 with the comment period until 25 May 2020. The feedback received and the staff analysis and recommendations of the ED were discussed in the Board’s June meeting with the exception of Q3 of the ED which relates to the proposals on accounting for qualifying hedging relationships and groups of items. The objective of this meeting was to summarise the feedback on Question 3 and seek the Board’s permission to begin the balloting process for the final amendments.

Feedback analysis—Accounting for qualifying hedges (Agenda Paper 14a)

Remeasurement of the hedged item and the hedging instrument: The ED proposes that once a change to the hedging relationship has been made the requirements in IFRS 9 and IAS 39 would be applied to remeasure the hedging instrument and the hedged item based on the alternative benchmark rate. Any resulting gain or loss would be recognised as part of ineffectiveness.

Most respondents agreed with this and agreed they would not expect significant changes in fair value to arise from the remeasurement of the hedged item or hedging instrument because these proposed amendments would apply when changes are made on an economically equivalent basis.

However some noted that for a fair value hedge amounts recognised in the profit or loss could arise that is not ineffectiveness because the fair value hedge adjustment on the hedged item will be remeasured based on the alternative benchmark rate alone (excluding the basis spread) whereas the hedging instrument will be remeasured at the full replacement rate (risk-free rate plus a spread).

The staff continue to agree with the Board’s view that no exceptions should be made from the measurement requirements for hedged items and hedging instruments. However they do acknowledge that the changes to the hedging instrument are based on the alternative benchmark rate plus a basis spread, while the changes to the hedged item are only based on the alternative benchmark rate. The Board’s tentative decision at its June 2020 meeting to include the designated hedged portion as a required change to the hedged item, will enable entities to amend their hedging relationships in a way that minimises valuation differences on the remeasurement of the hedged item or the hedging instrument. They therefore do not recommend any further changes to this requirement however will consider drafting improvements.

Some respondents asked the Board to clarify how and when entities would be required to apply the amendment (i.e. would it be applied the first time, the last time or each time the hedge designation is amended). The staff agree that this could be better articulated in the final amendments but confirmed they require changes in the fair value of the hedged item or hedging instrument to be measured based on the contractual terms and the assumptions that market participants would consider as required by IFRS 13.

Amounts accumulated in the cash flow hedge reserve: The ED proposed that the amount accumulated in the cash flow hedge reserve at the date the entity amends the description of the hedged item would be deemed to be based on the alternative benchmark rate on which the hedged future cash flows are determined. Almost all respondents agreed but some requested clarifications around whether retrospective measurement would be required to the cash flow hedge reserve. The staff noted that when applying IFRS 9 and IAS 39 that the cash flow hedge reserve is not subject to separate measurement requirements, but is derived from the cumulative changes in the fair values of the hedged item and hedging instrument. The staff are proposing no substantial changes but will consider drafting improvements when preparing the final amendments.

Groups of items: When making a change to the hedging relationship, groups of items designated as hedged items, the hedged items would be allocated to sub-groups within the same hedging relationship based on the benchmark rate to which they are referenced and that the proportionality test would be applied to each sub-group separately. Almost all respondents agreed with the proposals however some asked for clarification on various aspects and the staff recommend clarifying wording for these various aspects.

Retrospective effectiveness assessment (IAS 39 only):The ED proposed that for the purpose of assessing retrospective effectiveness as required by IAS 39, the cumulative fair value changes of the hedged item and the hedging instrument would be reset to zero when paragraph 102G of IAS 39 ceases to apply. Most agreed with the proposals however some noted that proposed relief could unintentionally cause some hedging relationships to fail the retrospective effectiveness assessment.

The staff agreed that the proposals should be available to entities to apply when needed, rather than being required.

Staff recommendation

The staff asked whether the Board agree to:

  • permit, rather than require, entities to reset cumulative fair values to zero for the purpose of performing the retrospective effectiveness assessment as proposed in paragraph 102S of the ED and
  • confirm the proposals in the ED related to the accounting for qualifying hedging relationships subject clarifications and drafting suggestions as explained in the staff analysis.

Board discussion and voting

One Board member asked for clarification on two points:

  • She wanted to confirm that the response to the issue that respondents raised in paragraph 10 of the agenda paper is answered by paragraph 17. Paragraph 10 states that some respondents believe once the hedged risk is updated to reflect the alternative benchmark rate, the adjustments to the hedged item will not be equal and offsetting to the adjustments to the hedging instrument). In Paragraph 17, the staff say that they do not believe any significant differences should arise as if they did this would indicate a disconnect between the changes made to the hedged item and the hedging instrument and therefore have not been done on an economically equivalent basis. The staff confirmed that is the case. The Board member believes it is an important point to highlight.
  • In paragraph 35, respondents asked for an additional relief for the hypothetical derivative. The Board member wanted to confirm that the hypothetical derivative is solely a measurement tool to measure the changes in the hedged item. The staff confirmed that is correct and therefore do not believe any amendments are required.

The Vice-Chair agreed with the staff approach to the feedback on the hypothetical derivative.  She made it clear that the hypothetical derivative is used to measure the hedged item based on the risk that is being hedged.

Another Board member asked whether the optional relief provided (i.e to permit entities to reset cumulative fair values to zero) would be applicable on a hedge by hedge basis. The staff confirmed that this is a voluntary relief and can be applied on a hedge by hedge basis.

The Vice-Chair made a couple of observation on the agenda paper to ensure the staff clarify when writing the final amendments:

  • In paragraph 28 of the agenda paper, it references IFRS 13 when talking about the measurement of the hedged item and hedging instrument. The Vice-Chair wanted to ensure it was very clear that for the hedged item in a fair value hedge, it is remeasured only for the effect of the hedged risk by applying the principles in IFRS 13 and not remeasured in total in accordance with IFRS 13. The staff confirmed they will ensure this is clear in the final drafting.
  • In paragraph 48, some respondents requested that the relief in phase 1 of the 80-125% rule on prospective effectiveness assessment is extended to Phase 2. The Vice-Chair mentioned that the staff do not comment on this further in the paper and requested confirmation that we will not be making any changes to this. The staff confirmed that the Board discussed this previously when working on the ED and agreed not to make any changes in this regard.

All Board members agree with the staff recommendation.

Due process steps and permission for balloting (Agenda paper 14b)

The objective of this paper is to ensure that the Board is satisfied that the due process requirements have been complied with, to seek the Board’s permission to begin the balloting process and ask whether any Board member intends to dissent from the publication of the final amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16. The staff also asked the Board whether they agree with the staff recommendation not to re-expose the amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16.

All Board members agreed with the staff recommendation not to re-expose the amendments. No Board member intends to dissent from the publication of the publication and all Board members gave permission to begin the balloting process.

Correction list for hyphenation

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