On September 16, 2019, the Governmental Accounting Standards Board (GASB) issued proposed statement, Replacement of Interbank Offered Rates. The proposed statement provides exceptions to the existing provisions for hedge accounting termination and lease modifications to ease the accounting requirements related to the transition away from interbank offered rates (IBORs).
The proposed removal of the London Interbank Offered Rate (LIBOR) as an appropriate benchmark interest rate would be effective for reporting periods beginning after December 15, 2020. All other requirements of the proposed statement would be effective for reporting periods beginning after June 15, 2020. Comments on the proposed statement are due by November 27, 2019.
LIBOR is the most commonly used reference rate in the global financial market. LIBOR is used as a reference rate in state and local government contracts, including interest rate swaps and other derivatives, floating rate bonds, loans, and other instruments. However, it’s expected that many private sector banks currently reporting information used to set LIBOR will stop doing so after 2021 when their current reporting commitment ends.
Concerns about the sustainability of LIBOR and other IBORs have led to an effort to identify alternative reference rates, and the GASB launched the Secured Overnight Financing Rate–London Interbank Offered Rate Replacement project in 2018 to address the accounting challenges expected to arise from the transition from IBORs.
As a result of reference rate reform, governments will need to amend or replace agreements in which variable payments made or received are dependent on an IBOR. The proposed exceptions are intended to preserve the consistency and comparability of reporting derivative instruments and leases. They would require agreements with the same economic substance before and after the replacement of a reference rate to continue to be accounted for in the same manner as before the replacement of a reference rate.
Under Statement 53, Accounting and Financial Reporting for Derivative Instruments, a government that amends a critical term of a hedging derivative instrument, such as the reference rate of a hedging derivative instrument’s variable payment, would be required to terminate hedge accounting.
The proposed statement would provide an exception to the termination provision to allow hedge accounting to continue when the reference rate of the original hedging derivative instrument’s variable payment is an IBOR, if all of the following criteria are met:
- The hedging derivative instrument is effective as of the end of the reporting period.
- The hedging derivative instrument is amended or replaced to change the reference rate of the hedging derivative instrument’s variable payment, or to add or change fallback provisions related to the reference rate.
- If the reference rate of the amended or replacement hedging derivative instrument’s variable payment is multiplied by a coefficient or adjusted by addition or subtraction of a constant, the coefficient or constant is limited to what’s necessary to equate the replacement rate and the original rate.
- If the replacement of the reference rate is effectuated by ending the original hedging derivative instrument and entering into a replacement hedging derivative instrument, those transactions occur on the same date.
- The terms that affect changes in fair values and cash flows in the original and replacement hedging derivative instruments are identical, except for the term changes that may be necessary for the replacement of the reference rate.
The proposed statement also clarifies that the term changes that may be necessary for the replacement of the reference rate are limited to the following:
- The frequency with which the rate of the variable payment resets
- The dates on which the rate resets
- The methodology for resetting the rate
- The dates on which periodic payments are made
Additionally, Statement 53 would be amended to define the term reference rate and to remove LIBOR as an appropriate benchmark interest rate.
Under Statement 87, Leases, a government is required to apply the provisions for lease modifications–including remeasurement of the lease liability or lease receivable–when the rate in a contract with variable lease payments is replaced.
The proposed statement would simplify the accounting analysis for lease modifications affected by reference rate reform by adding the following exception to Statement 87:
- If variable payments of a lease contract depend on an IBOR, an amendment of the contract solely to replace the IBOR with another rate—that’s adjusted, if necessary, to essentially equate the replacement rate and the original rate—by either changing the rate or adding or changing fallback provisions related to the rate, isn’t a lease modification.
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