FASB offers changes to ease reference rate transition

FASB has formally proposed an accounting standards update to provide temporary optional guidance for recognizing the effects of moving away from the London Interbank Offered Rate as a reference rate in various types of loans, derivatives, and other financial contracts. The guidance would provide relief by introducing new exceptions and practical expedients around the existing rules for contract modifications and hedge accounting.

Regulators globally are working on a number of initiatives to develop new reference rates after the reliability of LIBOR and other interbank offered rates came into question amid allegations of tampering. FASB says entities are managing trillions of dollars in loans, derivatives, and other financial contracts that reference LIBOR, all of which need to transition to new reference rates as LIBOR is expected to sunset in 2021.

Under GAAP, contract modifications must be evaluated to determine if the changes represent the continuation of contracts under altered terms or the ending of one contract with the establishment of another. Given the significant number of contracts that will be altered across markets, stakeholders told FASB the application of existing rules on a large number of contracts for the purpose of reference rate reform could be costly and burdensome.

With respect to hedging, FASB also has heard from stakeholders that changes resulting from reference rate reform could disallow the application of certain hedging guidance as it currently exists. That would lead to financial reporting outcomes that would not reflect hedging strategies, FASB says.

The proposed guidance would provide temporary optional expedients and exceptions that are intended to smooth over the accounting consequences of reference rate reform. So long as contract modifications meet some specific criteria spelled out in the proposal, modifications would quality for simplified accounting evaluations scaled for high volume. In addition, the proposal would allow for hedge accounting to be preserved with contracts are modified for reference rate reform, also assuming a long list of criteria are met.

FASB is committed to provide guidance for stakeholders to ease the process of migrating away from LIBOR and other IBORs, said FASB Chairman Russ Golden in a statement. “The board’s proposal will address operational challenges they have raised and ultimately help simplify the process while reducing related costs,” he said.

The LIBOR transition release will be “one of the most important standards that we release,” said Shayne Kuhaneck, FASB’s acting technical director, at recent banking conference. “If you haven’t seen that and you haven’t read it, please read it and provide comments.”

FASB is accepting comments on the proposal through Oct. 7, 2019.