FASB Proposes Guidance for Interest Rate Reform Transition

Chris Gaetano
Published Date:
Sep 6, 2019
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The Financial Accounting Standards Board (FASB) has released proposed guidance aimed at helping entities ease through the transition away from the London Interbank Offered Rate (LIBOR), which is due to be phased out in the wake of a rate-fixing scandal.

“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,” said FASB Chairman Russell G. Golden. “The Board’s proposal will address operational challenges they have raised and ultimately help simplify the process while reducing related costs,” he added.

The LIBOR is the most widely used benchmark interest rate used by financial institutions when making short-term loans to each other in the international market. It serves as a globally accepted key benchmark interest rate that indicates how much it costs to the banks to borrow from each other. However, the rate became suspect during the financial crisis when it was found that, for years, currency brokers at major banks had been coordinating with each other over instant messaging to fix the rates in order to boost profits and obscure financial difficulties. The scandal rocked the LIBOR's previously sterling reputation as a reliable rate. In the wake of the scandal, the United Kingdom's Financial Conduct Authority, its chief financial regulator, said that the rate is no longer tenable and so would phase out its use by 2021.

Since the scandal, a number of alternatives have been developed, such as the U.S. Federal Reserve's Secured Overnight Financing Rate (SOFR) but none has gained the market traction that LIBOR had. This leaves many open questions on the part of every major player connected to the financial system that had used the LIBOR as a benchmark. For example, loans that had previously based their rates on the LIBOR may need to be renegotiated, as a new benchmark will likely produce different financial conditions that must be considered. Similarly, U.S. GAAP rules on debt modifications call for a new contract if the terms change to the point that it could be considered a new agreement, which could happen if the lender, which had previously based terms on the LIBOR rate, now uses another metric.

A few months back, the FASB offered tentative guidance, which provided that a change in that contract’s reference interest rate would be accounted for as a continuation of that contract rather than the creation of a new contract. The new proposed guidance would offer a more formal set of alternatives to account for reference rate reform.

The proposal contains a wide variety of optional expedients for dealing with the soon-to-be-discontinued LIBOR. They encompass contract modifications, changes to critical terms in a hedging relationship, fair value hedges and cash flow hedges.

The amendments 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 Dec. 31, 2022.

Comments on the proposed guidance are due on Oct. 7. Interested parties may submit comments in one of three ways:
• Using the electronic feedback form available on the FASB website at Exposure Documents Open for Comment
• Emailing comments to director@fasb.org, File Reference No. 2019-770
• Sending a letter to “Technical Director, File Reference No. 2019-770, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.

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