With the London Inter-bank Offered Rate (aka LIBOR) on its way out, U.S. companies are searching for off-ramps to shift to new lending benchmarks. The Financial Accounting Standards Board (FASB) offered them some clarity last week on how the change will impact financial reporting.
The UK’s Financial Conduct Authority is phasing out LIBOR by the end of 2021. For decades, LIBOR has served as an industry-standard benchmark for short-term lending rates between international banks. It undergirds a range of financial instruments including swaps, corporate debt and other derivatives.
A rate-rigging scandal in the past decade damaged LIBOR’s integrity to the point that UK regulators decided alternative benchmarks would be necessary. Yet, the process of finding reliable alternatives has proved to be a rocky one, with companies being advised to prepare to use multiple benchmarks. Speculation has turned to the New York Federal Reserve’s Secured Overnight Financing Rate (SOFR) as the standard most likely to replace LIBOR. Transactions in the Treasury repurchase market form the basis of the daily SOFR.
According to the Federal Reserve, more than $35 trillion of the approximately $200 trillion in cash and derivatives transactions that reference LIBOR will have yet to mature by the end of 2021. FASB has been evaluating how to ease the changes coming from reference rate reform since 2018. Securities and Exchange Commission Chairman Jay Clayton has also expressed concerns about the impact of the new reference rate.
In September, the Board issued a proposed accounting standards update to ease the transition in financial reporting to new reference rates. Specifically, the update provided “optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met.”
On Nov. 13, FASB announced the approval of the rate reform update, with guidance slated to come in early 2020. A day earlier, FASB released a proposed update to the related issue of accounting standards for derivatives and hedging.
Regarding the LIBOR transition, FASB said changes to the reference interest rate in a qualifying contract would be considered a continuation of that contract, as opposed to the creation of a new contract. Additionally, “a company or other organization would be permitted to preserve its hedge accounting when updating its hedging strategies in response to reference rate reform,” according to FASB. That guidance will have a limited timeframe for contract modifications and hedging strategies, sunsetting at the end of 2022.