Proposed FRS 102 amendments in response to interest rate benchmark reform

Interest rate benchmarks such as LIBOR (the London Interbank Offered Rate) are being reformed. You will often hear this subject referred to as ‘IBOR reform’, where ‘IBOR’ means interbank offer rates. This process has led to uncertainty about the long-term viability of the existing interest rate benchmarks, for example it is anticipated that LIBOR will not be available after 2021, however the replacement benchmarks have not yet been determined.

Uncertainty about cash flows arising from interest rate benchmark reform could affect an entity’s ability to meet the criteria that permit hedge accounting to be used. In view of this uncertainty, the International Accounting Standards Board (IASB) decided to add a project to its agenda to consider the financial reporting implications of IBOR reform. In May this year, they issued an Exposure Draft (ED) that explicitly considers the hedge accounting requirements of the relevant International Standards, namely IFRS 9 and IAS 39. The ED proposes amendments to those requirements, in order to provide relief during the period of uncertainty before the interest rate benchmark is replaced, and avoid unnecessary discontinuation of hedge accounting due to uncertainty over interest rate benchmark reform.

The hedge accounting requirements of FRS 102 are based on IFRS 9, and an FRS 102 user can also chose to apply IFRS 9 (or even IAS 39) instead of FRS 102 for the recognition and measurement of financial instruments. It was therefore important that FRS 102 was updated to reflect the changes in the IASB’s ED, so that the proposed relief would be available to all entities, regardless of their choice of accounting standard. This is why the Financial Reporting Council (FRC) has issued FRED 72 “Draft Amendments to FRS 102 interest benchmark reform”. FRED 72 has a proposed effective date for accounting periods beginning on or after 1 January 2020, with early application permitted.

The detailed proposals

So what does FRED 72 propose? As for IFRS reporters, uncertainty about the timing and amount of cash flows arising from interest rate benchmark reform could affect an FRS 102 preparer’s ability to meet the criteria that permit the application of hedge accounting under the standard. For example, these uncertainties could impact on whether a forecast transaction can be assessed as highly probable or on the assessment of whether there is an economic relationship between the hedged item and the hedging instrument. As a result, entities could be required to discontinue hedge accounting or be prevented from making new designations for hedging relationships. The proposed amendments address this, but please note that they only apply to those hedging relationships of interest rate risk that are affected by the uncertainties created by interest rate benchmark reform.

The amendments are temporary and will cease to apply once benchmark reform is complete.

FRED 72 proposes that:

  • If the hedged item is a highly probable forecast transaction, the entity should determine whether the forecast transaction is still highly probable assuming that the interest rate benchmark does not alter as part of the interest rate reform.
  • An entity shall assume that the interest rate benchmark on which the hedged cash flows are based, and/or the interest rate benchmark on which the cash flows of the hedging instrument are based, are not altered as a result of interest rate benchmark reform.
  • When advantages are created for the entity by the temporary amendments to specific hedge accounting requirements, the entity shall disclose that fact.
  • An entity will stop applying the amendments when the uncertainty from interest rate benchmark reform is no longer present, the hedging relationship is discontinued, or when the entire amount in the cash flow hedge reserve in respect of that specific hedge is reclassified to profit or loss.

The consultation period closes on 20 September 2019.

If you have any further queries, please speak to Lee Marshall.