IBOR Reform and the Effects on Financial Reporting — Due process steps (Agenda Papers 14 and 14A)

Back­ground

In December 2018, the Board decided to add to its standard-setting programme the IBOR Reform and its Effects on Financial Reporting project. In February 2019, the Board tentatively decided to provide relief from the effects of IBOR reform uncertainties on particular hedge accounting requirements in IFRS 9 Financial Instruments and IAS 39 Financial Instruments: Recognition and Measurement. The proposed relief would require amendments to IFRS 9 and IAS 39.

This session has two purposes:

• discuss two issues raised at the February Board meeting, and
• a review by the Board of the due process steps it has taken, so that the formal balloting of the exposure draft can start.

Staff analysis

Applicability of relief

The staff clarify that there could be instances where the relief is not applicable, for example if there is no IBOR reform in a particular jurisdiction, or where one aspect of the relief may not be applicable depending on facts and circumstances.  

Mandatory versus voluntary application of the proposed relief

The staff have considered three alternative approaches regarding whether application should be mandatory or voluntary, assuming relief is applicable in the first place:

• Approach A: voluntary application on a relationship-by-relationship basis (i.e. entities could make an election to apply the relief to a specific hedging relationship or group of hedging relationships of interest rate risk);
• Approach B: voluntary application to all hedging relationships (i.e. entities could elect to apply the relief to all hedging relationships of interest rate risk); and
• Approach C: mandatory application (i.e. entities must apply the relief to all hedging relationships of interest rate risk).

The staff believe that Approach C should be followed as it addresses the concerns around arbitrary discontinuation of hedge accounting and would be consistent with the Board’s decision to prohibit voluntary discontinuation of hedge accounting in IFRS 9.

End of relief

The staff previously proposed that entities should cease applying the proposed relief at the earlier of contractual amendment or the termination of the hedge relationship. The Board questioned whether the amendment of the relevant contracts would provide sufficient certainty regarding the timing and amount of the resulting cash flows. They noted that it is possible for uncertainty to remain even after contracts are amended. The staff acknowledge that, while it is possible for entities to amend contracts stipulating how IBOR reform will impact those contracts (‘fall-back clause’), the mere existence of such a clause may not eliminate the uncertainty regarding the nature and timing of designated future cash flows. The staff also consider that contractual amendments are necessary but not sufficient to remove the uncertainty arising from IBOR reform and have amended their recommendation on the end of relief accordingly. The Agenda paper includes five scenarios to illustrate the staff’s recommendation.

Staff recommendations and questions

The staff recommend that the Board proceed to publish the Exposure Draft (in April or May), with a comment period of 45 days.

The shortened comment period is necessary if the proposed amendments are to be finalised before the end of 2019. The staff note that the proposed amendments are narrow in scope and are required urgently to address the uncertainty introduced by IBOR reform.

The staff also recommend that:

• The application of the relief should be mandatory and irrevocable.
• Entities should stop applying the proposed relief at the earlier of:
  • when the uncertainty regarding the timing and amount of the resulting cash flows is no longer present; and
  • the termination of the hedging relationship.
• End of relief, prior to the termination of the hedge relationship, is not applicable for separately identifiable risk component.
• When a highly probable assessment is based on future transactions not recognised on the balance sheet, relief should end when the uncertainties regarding IBOR reform are no longer present.

Board discussion

Board members agreed that the relief should not be voluntarily applicable on a relationship-by-relationship basis to avoid accounting structuring.

One Board member challenged whether a voluntary application to all hedging relationships should necessarily be rejected. In response, other Board members stressed that a voluntary application would not be consistent with the Board’s decision to prohibit voluntary discontinuation of hedge accounting in IFRS 9. In addition, they considered that the application of the relief would not add any costs or complexity to the application of the hedge accounting requirements. On the contrary, the application of the relief would remove a source of complexity given that, in the absence of any relief, entities would have to estimate and model the uncertainty.

One Board member also noted that a mandatory application would help to provide clear and consistent information to the users of the financial statements.

The Board discussed the general principle of ceasing to apply the relief when the uncertainty regarding the timing and amount of the resulting cash flows is no longer present, noting that the illustrative examples included in the Agenda Paper are useful. Examples will be included in the Exposure Draft. One Board member stressed that the principle does not require a contractual amendment. Although in most circumstances the uncertainty would not be resolved until the contract is amended, this may happen.  

The staff provided the following clarifications:

• The relief enables entities to assume that the contractual IBOR-based cash flows of the hedged item will remain in place. This assumption is carried out when performing the retrospective test and measurement. Measurement will nevertheless use market inputs and therefore factor the market’s expectations regarding the IBOR reform.
• If the hedged item is contractually amended to replace IBOR with an alternative risk-fee rate but the hedging instrument is not, when applying the hedge accounting requirements, the alternative rate would be used for the hedged item whereas for the hedging instrument it would be assumed that the IBOR-based cash flows will continue.

Concerning Phase II of the Project the Board will consider whether any action is required, i.e. it would be possible for the Board to conclude that no amendments to the Standards are necessary. The staff also noted that Phase II is dependent on clarifications on the way the IBOR reform will be implemented.

Board decisions

All the staff recommendations were approved by all Board members present (13).