Planning for Reference Rate Reform

The FASB recently issued ASU 2020-04 to provide accounting relief from the impact of reference rate reform.  Reference rate reform is the expected cessation of the London Interbank Offered Rate (LIBOR), the most commonly used benchmark interest rate in the world, which is expected to cease publication after 2021.  Due to the significant volume of debt, lease, and derivative contracts referencing the LIBOR, stakeholders raised concerns with the FASB about the cost and complexity of accounting for reference rate induced changes including contract modifications, debt modification versus debt extinguishment analyses, and dedesignating and redesignating derivative instruments in hedge accounting relationships. The FASB listened and issued ASU 2020-04 to provide temporary expedients to existing accounting guidelines only in situations precipitated by reference rate reform.

Greatest benefit of ASU 2020-04 provision: 

The main provision of ASU 2020-04 that could have the greatest benefit to organizations is the optional expedient for contract modifications. This provision of the amendment stipulates that a contract modification resulting from reference rate reform may be accounted for as a continuation of the existing contract rather than the creation of a new contract, thus easing the accounting complexity and cost burden of accounting for these changes. 

Additionally, changes to reference rates in derivative contracts could adversely impact certain hedge accounting relationships and cause otherwise highly effective relationships to appear ineffective. ASU 2020-04 stipulates that changes in the critical terms of hedging relationships, caused by reference rate reform, should not result in the dedesignation of the instrument, provided certain criteria are met. This relief will help organizations avoid earnings volatility and costs to amend derivative contracts. 

Given the far-reaching impact of reference rate reform, now is the time to assess the risk of each LIBOR-based financial contract that your organization holds. Any contracts that extend past 2021 should avoid using LIBOR as a benchmark, or should ensure that appropriate fallback language is incorporated into the contract. Monitor ongoing contract negotiations and identify a comprehensive list of all LIBOR-based contracts that extend beyond 2021. Watch out for existing long-term debt agreements that extend beyond 2021, as these contracts may include provisions that grant the lender power to determine the rate adjustment if the existing rate written into the contract becomes unavailable.   For long term contracts where this type of renegotiation is unavoidable, the FASB has issued ASU 2020-04 which provides expedients for contract modifications and hedge accounting as it relates to reference rate reform.