GASB proposes guidance on LIBOR replacement

The Governmental Accounting Standards Board proposed accounting and financial reporting guidance Thursday for state and local governments to help them transition away from the London Interbank Offered Rate and other interbank offered rates to newer reference rates.

GASB and its affiliated standard-setter, the Financial Accounting Standards Board, have been helping public and private sector accountants with the transition away from the London Interbank Offered Rate (LIBOR) to newer rates like the Secured Overnight Financing Rate (SOFR). Regulators began pushing for banks to move away from LIBOR after a scandal erupted in 2012 over reports of conversations between traders from some of the major banks discussing how the rate could be manipulated to make investment gains (see FASB proposes guidance on LIBOR transition).

Thanks to global reference rate reform, LIBOR is expected to stop existing in its current form in 2021, prompting governments to amend or replace the financial instruments still tied to LIBOR.

Courtesy of GASB

The provisions of GASB’s Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, require governments to terminate hedge accounting if they change a critical term of a hedging derivative instrument, such as the reference rate of its variable payment. In addition, replacement of the rate on which the variable payments depend in a lease contract would require, under Statement No. 87, Leases, that a state or local government apply the provisions for lease modifications, such as remeasurement of the lease liability or lease receivable.

The goal of GASB’s new exposure draft, Replacement of Interbank Offered Rates, is to spell out the accounting and financial reporting implications resulting from replacement of the reference rate. The proposed standard would enable state and local governments to continue using hedge accounting for certain hedging derivative instruments that are amended or replaced to change the reference rate from an Interbank Offer Rate, or IBOR.

The proposed guidance would also clarify the hedge accounting termination provisions when an IBOR is replaced as the reference rate of a hedged item.

It would clarify that the uncertainty associated with reference rate reform does not, by itself, affect the probability that an expected transaction will occur. It would remove LIBOR as an appropriate benchmark interest rate for the qualitative evaluation of the effectiveness of an interest rate swap.

It would also add the Secured Overnight Financing Rate and the Effective Federal Funds Rate as appropriate benchmark interest rates.

It would clarify the definition of a reference rate, and offer an exception to the lease modifications guidance in Statement 87 for certain IBOR-related lease contract amendments.

Removal of LIBOR as an appropriate benchmark interest rate as proposed would be effective for reporting periods starting after Dec. 15, 2020. All the other requirements of the proposed standard would be effective for reporting periods starting after June 15, 2020, although GASB is encouraging earlier application of the standard.

GASB is asking for comments on the proposal by Nov. 27, 2019.

IASB changes

Separately, the International Accounting Standards Board also amended some of its hedge accounting standards Thursday for the change in reference rates. The IASB amended its new and old financial instruments Standards, IFRS 9 Financial Instruments and IAS 39 Financial Instruments: Recognition and Measurement, along with the related standard on disclosures, IFRS 7 Financial Instruments: Disclosures. The amendments modify some specific hedge accounting requirements to provide relief from potential effects of the uncertainty caused by the IBOR reform. In addition, the amendments require companies to provide additional information to investors about their hedging relationships which are directly affected by these uncertainties. The amendments take effect Jan. 1, 2020, but companies can choose to apply them earlier.

“The board has worked to an accelerated timetable to give companies a solution to the accounting challenges they face from the uncertainty surrounding the reform of interest-rate benchmarks,” said IASB Chairman Hans Hoogervorst in a statement. “The amendments provide useful information for investors during this period of uncertainty.”