On 27 August 2020, the International Accounting Standards Board (IASB) published 'Interest Rate Benchmark Reform — Phase 2 (Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16)' with amendments that address issues that might affect financial reporting after the reform of an interest rate benchmark, including its replacement with alternative benchmark rates. The amendments are effective for annual periods beginning on or after 1 January 2021, with earlier application permitted.
Interbank offered rates (IBORs) are interest reference rates, such as LIBOR, EURIBOR and TIBOR, that represent the cost of obtaining unsecured funding, in a particular combination of currency and maturity and in a particular interbank term lending market. Recent market developments have brought into question the long-term viability of those benchmarks. Therefore, work is underway in multiple jurisdictions to transition to alternative risk free rates (RFRs). Such rates will be based on liquid underlying market transactions, and not dependent on submissions based on expert judgement. This will result in rates that are more reliable and provide a robust alternative for products and transactions that do not need to incorporate the credit risk premium embedded in the IBORs.
The IASB addressed the issues in a project split into two phases: Phase 1 dealt with pre-replacement issues (issues affecting financial reporting in the period before the replacement of an existing interest rate benchmark). This part of the project was concluded on 26 September 2019 by publishing Interest Rate Benchmark Reform (Amendments to IFRS 9, IAS 39 and IFRS 7). You can find more information about the first part of the project in our Accounting news from October 2019.
Phase 2 of the project dealt with replacement issues, therefore, the amendments published in August 2020 address issues that might affect financial reporting when an existing interest rate benchmark is actually replaced. This part of the project has been concluded by the issuance of these amendments.
The amendments affect many entities and in particular those with financial assets, financial liabilities or lease liabilities that are subject to interest rate benchmark reform and those that apply the hedge accounting requirements in IFRS 9 or IAS 39 to hedging relationships that are affected by the reform. The amendments apply to all entities and are not optional.
The changes in Interest Rate Benchmark Reform — Phase 2 (Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16) relate to the modification of financial assets, financial liabilities and lease liabilities, specific hedge accounting requirements, and disclosure requirements applying IFRS 7 to accompany the amendments regarding modifications and hedge accounting.
- Modification of financial assets, financial liabilities and lease liabilities
The IASB introduces a practical expedient for modifications required by the reform (modifications required as a direct consequence of the IBOR reform and made on an economically equivalent basis). These modifications are accounted for by updating the effective interest rate. All other modifications are accounted for using the current IFRS requirements. A similar practical expedient is proposed for lessee accounting applying IFRS 16.
- Hedge accounting requirements
Under the amendments, hedge accounting is not discontinued solely because of the IBOR reform. Hedging relationships (and related documentation) must be amended to reflect modifications to the hedged item, hedging instrument and hedged risk. Amended hedging relationships should meet all qualifying criteria to apply hedge accounting, including effectiveness requirements.
In order to allow users to understand the nature and extent of risks arising from the IBOR reform to which the entity is exposed and how the entity manages those risks as well as the entity’s progress in transitioning from IBORs to alternative benchmark rates, and how the entity manages this transition, the amendments require that an entity discloses information about:
- how the transition from interest rate benchmarks to alternative benchmark rates is managed, the progress made at the reporting date, and the risks arising from the transition;
- quantitative information about non-derivative financial assets, non-derivative financial liabilities and derivatives that continue to reference interest rate benchmarks subject to the reform, disaggregated by significant interest rate benchmark;
- to the extent that the IBOR reform has resulted in changes to an entity’s risk management strategy, a description of these changes and how the entity manages those risks.
The IASB also amended IFRS 4 to require that insurers applying the temporary exemption from IFRS 9 apply the amendments in accounting for modifications directly required by the IBOR reform.
The IASB has come to the conclusion that the application of all proposed amendments is mandatory. It also concluded that the nature of the proposed amendments is such that they can only be applied to modifications of financial instruments and changes to hedging relationships that satisfy the relevant criteria and, as such, no specific end-of-application requirements needed to be specified.
Effective date and transition
The amendments are effective for annual periods beginning on or after 1 January 2021 and are to be applied retrospectively. Early application is permitted. Restatement of prior periods is not required, however, an entity may restate prior periods if, and only if, it is possible without the use of hindsight.
Sources: www.iasplus.com, IFRS in Focus (September 2020)