Interest Rate Benchmark Reform – changes to accounting standards

The London Interbank Offered Rate (LIBOR) is being replaced from 31 December 2021, with different jurisdictions setting their own rates. The UK will move to the Reformed Sterling Overnight Index Average (SONIA).

The International Accounting Standards Board (IASB) has issued amendments to IFRS 9 ‘Financial Instruments’, IAS 39 ‘Financial Instruments: Recognition and Measurement’, IFRS 7 ‘Financial Instruments: Disclosures’, IFRS 4 ‘Insurance Contracts’, and IFRS 16 Leases’. These amendments have also been UK-adopted IAS.The amendments only apply to changes required by the reforms to financial instruments and hedging relationships.

Key changes

A practical expedient for changes to contractual cash flows when assessing a modification of financial instruments.

• IFRS 9 has been amended to include a practical expedient which will enable a company to account for a change in the contractual cash flows of financial assets or financial liabilities required by the reform. This expedient allows companies to update the effective interest rate to reflect the change in an interest rate benchmark from IBOR to an alternative benchmark rate without the recognition of an immediate gain or loss.
• If there are any changes to the contractual cash flows beyond those required by the reform, the company will need to:
  • first apply the practical expedient to the changes required by the reform; and
  • then apply the applicable requirements in IFRS 9 to any other changes.
• To enable insurers and lessees to apply a similar practical expedient in relation to their financial instruments and leases respectively, IFRS 4 and IFRS 16 have also been amended.

Relief from specific hedge accounting requirements

The amendment enables, and requires, companies to continue hedge accounting in circumstances when changes to hedged items and hedging instruments arise as a result of the reform.

• Companies are required to amend their hedging relationships to reflect:
  • designating an alternative benchmark rate (contractually or non-contractually specified) as the hedged risk;
  • amending the description of the hedged item, including the description of the designated portion of the cash flows, or fair value being hedged; or
  • amending the description of the hedging instrument.

Because a company would make changes required by the reform to the hedged items and hedging instruments at various times, companies may need to amend a hedging relationship more than once.

Disclosures

The amendments to IFRS 7 require a company to make additional disclosures in its financial statements so that investors can better understand the reform’s effects on that company.

A company is required to disclose:

• how it is managing the transition to alternative benchmark rates, its progress at the reporting date, and the risks it is exposed to arising from financial instruments as a result of the transaction;
• quantitative information about non-derivative financial assets, non-derivative financial liabilities and derivatives (each shown separately), that have yet to transition to an alternative benchmark rate as at the end of the reporting period. This information should be disaggregated by each significant interest rate benchmark; and
• a description of any changes to the company’s risk management strategy arising from the risks identified above.

Transition and effective date

The amendments apply retrospectively, but companies are not required to restate comparative information. The amendments are effective for annual reporting periods beginning on or after 1 January 2021, with early adoption permitted.

If you would like to know how to prepare or require any further information, please contact Paul Merris.