You may recall that, for a while now, the SEC has been actively warning about risks associated with the LIBOR phase-out, which is expected to occur in 2021. LIBOR, the London Interbank Offered Rate, is a widely used reference rate calculated based on estimates submitted by banks of their own borrowing costs. In 2012, the revelation of LIBOR rigging scandals made clear that the benchmark was susceptible to manipulation, and British regulators decided to phase it out. SEC Chair Jay Clayton has advised that, according to the Fed, “in the cash and derivatives markets, there are approximately $200 trillion in notional transactions referencing U.S. Dollar LIBOR and… more than $35 trillion will not mature by the end of 2021.” In July, the SEC staff published a Statement that “encourages market participants to proactively manage their transition away from LIBOR.” (See this PubCo post.) However, the substantial uncertainties and challenges associated with implementing the transition have led to delays and triggered a high level of anxiety among companies faced with addressing the issue. (See this PubCo post.) As reported in Bloomberg BNA, to ease the strain of the transition, FASB has jumped in with some proposed temporary financial reporting relief.

FASB’s proposed new Accounting Standards Update, released this month, is designed “to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.” FASB reported that stakeholders had raised operational challenges associated with the LIBOR phase-out related to the volume of contracts and other arrangements that will require modification as a result of the shift to a new reference rate. For accounting purposes, stakeholders grumbled, these contract modifications would all need to be evaluated to determine whether the changes “result in the establishment of new contracts or the continuation of existing contracts.” In light of the volume of agreements that are affected, the effort appeared costly and overwhelming. Stakeholders also indicated that there were accounting issues specific to hedge accounting because the shift could “disallow the application of certain hedge accounting guidance, and certain hedging relationships may not qualify as highly effective during the period of the market-wide transition to a replacement rate.”

According to BNA, “FASB officials have said they realize how much Libor’s demise could disrupt financial markets. They’ve said they don’t want accounting headaches to add to the problems companies will face when they search for new interest rates to replace Libor and other lesser-used benchmark interest rates regulators are phasing out.” According to the press release, the FASB Chair indicated that the “FASB is committed to providing stakeholders with the guidance they need to ease the process of migrating away from LIBOR and other interbank offered rates to new reference rates….The Board’s proposal will address operational challenges they have raised and ultimately help simplify the process while reducing related costs.”

The ASU describes various accounting treatments applicable in a number of different contexts, but the bottom line is that, as summarized by BNA, under the proposed change, “if a loan, lease, or debt contract has to be changed to insert a new interest rate, the modification would be accounted for as a continuation of the contract rather than the creation of a brand new deal.” Similarly, hedge accounting would be preserved when the contract is modified and during the temporary transition period, and companies would not “have to unravel certain contracts like forwards or swaps tied to Libor to determine whether applying a new interest rate disqualifies them from a favorable hedge accounting treatment.”

Under the proposal, the changes would be elective and “would apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. The proposed expedients and exceptions provided by the amendments would not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022.” The proposed amendments would be effective on the issuance of a final Update.