LIBOR transition—impact on hedge accounting

LIBOR transition—impact on hedge accounting

Robert Pickel, Chair of P.R.I.M.E. Finance, explains the concerns around hedge accounting in the context of the transition away from LIBOR and discusses how these concerns are being addressed.

Background

After 30 years, the London Interbank Offered Rate (LIBOR) and other IBORs are being phased out. An estimated $370 tln global financial contracts are referenced to LIBOR, see here. Therefore, the transition to alternative risk-free rate (RFRs) is likely to have far reaching effects, impacting areas beyond merely the terms of a contract. Contracts referencing LIBOR, such as cross currency swaps, inflation swaps and swap options, will all be affected by this transition, as will bonds, loans and mortgages. 

This News Analysis addresses the impact of this transition on financial reporting by thousands of derivatives users. In particular, the change in benchmark rates is likely to trigger issues relating to accounting standards under US Generally Accepted Accounting Principles (US GAAP) promulgated by the Financial Accounting Standards Board (FASB) and the International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board (IASB). The widely-used practice of hedge accounting and the continued effectiveness of existing hedges could be undermined if not addressed by the FASB and the IASB in a timely fashion. The effect will be to introduce volatility into financial statements of public reporting companies if hedges are no longer effective.

This News Analysis generally refers to LIBOR instead of IBORs more generally. The issues addressed in this News Analysis are applicable to any situation where underlying instruments and a related hedge reference an IBOR, but the sheer size of financial contracts referencing LIBOR make it the LIBOR of greatest concern.

What is hedge accounting?

Hedge accounting is an accounting standard thatallows the offsetting of cash flows between an underlying instrument and a hedge related to thatinstrument. The illustration below provides an example of where Company A issues bonds to the public with interest payable by reference

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About the author:

Miranda is a solicitor specialising in leveraged and acquisition finance. She trained at Hogan Lovells International LLP and qualified into the international banking and finance team. During her time at Hogan Lovells she worked on a variety of domestic and cross-border transactions, acting for both borrowers and lenders. She also experienced secondments to Barclays Bank PLC and Kaupthing Bank hf.