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IBOR reform and its effects on financial reporting

Date recorded:

Cover Paper (Agenda Paper 14)

The key purpose of the meeting was to

  • analyse the key issues for the Board to redeliberate before the proposed amendments to IFRS 9 and IAS 39 are finalised and published (Agenda paper 14A); and
  • ask the Board’s permission to begin the balloting process for the amendments to IFRS 9 and IAS 39 (Agenda paper 14B).

Redeliberation of proposed amendments to IFRS 9 and IAS 39 (Agenda Paper 14A)

Background

This paper analyses the key issues for the Board to redeliberate before the proposed amendments to IFRS 9 and IAS 39 set out in Exposure Draft Interest Rate Benchmark Reform (the “ED”) are finalised and published.

This paper provides an analysis on the following matters:

  • Whether to provide an exception for the IAS 39 retrospective assessment when a hedge is temporarily outside the 80–125% range solely due to uncertainties arising from the reform
  • Whether to provide relief from the separately identifiable requirement for ‘macro hedges’
  • Clarify when the relief ceases to apply to a group of items designated as the hedged item
  • Clarify the scope of the proposed amendments would apply to hedges of both interest rate and foreign currency risks
  • Proposals on how the disclosure requirements proposed in the ED could be simplified

Staff recommendation

  • a) The staff have identified the following possible approaches for providing an exception from the retrospective effectiveness assessment:
    • Approach A: Assume interest rate benchmark is not altered, similar to the prospective assessments
    • Approach B: Continue hedge accounting when ineffectiveness is outside the 80–125% range
    • Approach C: Require the existence of an economic relationship similar to IFRS 9

The staff recommend that Approach B be used as a basis for an exception to the retrospective assessment in IAS 39. This approach does not require the assessment of effectiveness to be separated from the recognition and measurement of ineffectiveness and may be simpler for entities to apply.

The staff recommend that this exception should be mandatory and entities should cease applying the exception at the earlier of (i) when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmark-based cash flows; and (ii) when the hedging relationship is discontinued. This is consistent with the other similar proposals in the ED.

Board discussion

Board members agreed that there was a need to provide an exemption for retrospective effectiveness testing and that it was not appropriate to use Approach C. The pros and cons of Approach A vs. Approach B were discussed in detail.

Approach A was preferred by some, as it is a more disciplined approach and more closely aligned to the amendments for the prospective assessment. In addition, they did not believe that performing two calculations would be a burden as one of the calculations would be very similar to that performed for the prospective calculation. However, many said that it would be more burdensome for the preparers and with Approach B all the ineffectiveness will be shown in the P&L and it is an exemption for a short period of time.

With Approach B, a key concern is that it relies on the prospective assessment to assess whether a hedging relationship will need to be discontinued. The Board’s understanding was that the prospective testing is not always performed as robustly as the retrospective assessment and therefore may not always pick up hedges that will fail the retrospective effectiveness.

A discussion was then held about measurement. The fair value of the derivative would follow IFRS 13, however the measurement of the hedged item has two elements: (1) the cash flows—which a Board member wanted to make clear should continue as IBOR cash flows whilst there is uncertainty around the IBOR reform and (2) the discount rate—which is a market discount rate and will likely include the uncertainties surrounding the IBOR reform. If Approach A was chosen, the hedged item would need to use a discount rate assuming the uncertainties around the IBOR reform did not exist, which would be complex and would incur additional costs.

Ten Board members (out of 14) agreed with the staff’s recommendation to use Approach B. 

Staff recommendation

  • b) For ‘macro hedges’ designated under either IFRS 9 or IAS 39, the staff recommend that an entity should assess whether a non-contractually specified risk component is separately identifiable only at the time the hedged item is initially designated in the ‘macro hedge’. Once a hedged item is designated within a ‘macro hedge’, the separately identifiable requirement should not be reassessed for that same hedged item at subsequent redesignations. This should be mandatory and no end of application requirement specified, in order to be consistent with the other similar proposal in the ED.

Board discussion

One Board member requested that the population for these amendments be clearly defined in the final Standard. 14 Board members (out of 14) agreed with staff recommendation (b).

Staff recommendation

  • c) The staff recommend that the final amendments should clarify that, when an entity designates a group of items as the hedged item in accordance with IFRS 9:6.6.1 or IAS 39:83, the end of application requirement proposed in the ED should apply to each individual item within the designated group of items.

Board discussion

Board members said that the end of the application requirement in general should be made clear in the Basis for Conclusions. If a contract is amended due to the IBOR reform and there is still uncertainty around the timing and amount of the new cash flows, the amendments would still apply. The staff confirmed that clarity around this will be added to the final amendments.

14 Board members (out of 14) agreed with staff recommendation (c).

Staff recommendation

  • d) The staff recommend that the scope of the proposed exceptions should be clarified so that the exceptions only apply to those hedging relationships that are directly affected by uncertainties about the timing and/or amount of interest rate benchmark-based cash flows of the hedged item and/or hedging instrument arising from the reform.

It was not the intention of the Board to exclude from the scope of the proposals hedging relationship where interest rate risk is not the only hedged risk being designated, however the exceptions only apply to the interest rate benchmark-based cash flows.

Board discussion

It was made clear that all hedging relationships are indirectly affected by the IBOR reform (as discounting of cash flows will use an IBOR-related curve), however the amendments should only be provided for those cash flows that are directly impacted by the IBOR reform. Net investment hedges are out of scope of these amendments.

14 Board members (out of 14) agreed with the staff’s recommendation.

Staff recommendation

  • e) The staff carried out some informal outreach to understand what disclosures would be considered useful to the users of the financial statement about the uncertainties arising from the reform. They concluded that the following information should be included in the notes to the financial statements:
    • An indication of the interest rate benchmarks to which the entity’s hedging relationships are exposed
    • The impact of the uncertainties arising from the reform on an entity’s risk management strategy, and how the entity is managing the process to transition to an alternative benchmark interest rate
    • An explanation of significant assumptions or judgements the entity had to make in applying the exceptions to those hedging relationships within the scope of the amendments
    • The nominal amount of the hedging instruments and the extent of risk exposure the entity managed that is impacted by the reform

The staff also concluded that an exemption be provided from the disclosure requirements in IAS 8:28(f), which would require an entity to determine the amount of the adjustment for each financial statement line item affected by discontinuation of hedge accounting should the exceptions proposed in the ED had not been applied.

Board discussion

The Board requested clarity around when to apply these disclosure requirements. The staff replied that it was only for hedging relationships where the amendments have been applied.

Discussion mainly revolved around points B and C above. The staff made it clear that point B, ‘impact of uncertainty’ was not requiring entities to provide a number but rather quantitative disclosure. The staff made it clear that point B was also for entities to explain their approach to realigning the risk between the hedged item and the hedging instrument due to the IBOR reform.

The staff also made clear that the significant assumptions or judgements in point C relate to the ‘end of relief’ assumption and how an entity decides that the uncertainty around the IBOR reform has ended.

12 Board members (out of 14) agreed with the staff’s recommendation.

Due process steps and permission for balloting (Agenda Paper 14B)

This paper sets out the due process steps that the Board has taken in developing the amendments to IFRS 9 and IAS 39 and asks the Board for permission to begin the balloting process assuming that the Board will conclude on the matters set out in Agenda Paper 14A.

Board discussion

The Board agreed not to re-expose the amendments to IFRS 9 and IAS 39. None of the Board members signalled intent to dissent from the issuance of the amendments to IFRS 9 and IAS 39. The Board gave permission to begin the balloting process for the amendments to IFRS 9 and IAS 39.

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