Comment letter on the IASB Exposure Draft ED/2019/1 Interest Rate Benchmark Reform
Rue Marie-Thérèse, 11 - B-1000 Brussels
ESBG Transparency Register ID 8765978796-80
19 June 2019
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WSBI-ESBG appreciates that the IASB addresses accounting consequences of the reform in an expeditious way. We consider that the proposals bring appropriate solutions. However, we have concerns about the extent of the proposed disclosures. We also note that the 'lower of test' determining how much of the hedging derivative revaluation is recognised in the cash flow hedge reserve also involves forward-looking assessments. In our view, it should be addressed as part of the phase I of the project.
We would also like to encourage the IASB to proceed to the phase II of the project as soon as possible since broad solutions for the interest rate benchmark reform are already known. We describe some of the topics to be addressed in this phase at the end of our comment letter.
Highly probable requirement and prospective assessments
For hedges of interest rate risk that are affected by interest rate benchmark reform, the Board proposes amendments to IFRS 9 and IAS 39 as described below.
(a) For the reasons set out in paragraphs BC8–BC15, the Board proposes exceptions for determining whether a forecast transaction is highly probable or whether it is no longer expected to occur. Specifically, the Exposure Draft proposes that an entity would apply those requirements assuming that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
(b) For the reasons set out in paragraphs BC16–BC23, the Board proposes exceptions to the hedge accounting requirements in IFRS 9 and IAS 39 so that an entity would 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 the entity determines whether:
(i) there is an economic relationship between the hedged item and the hedging instrument applying IFRS 9; or
(ii) the hedge is expected to be highly effective in achieving offsetting applying IAS 39.
Do you agree with these proposals? Why or why not? If you agree with only parts of theproposals, please specify what you agree and disagree with. If you disagree with the proposals, please explain what you propose instead and why.
We agree with the proposals. The highly probable requirement and the prospective test involve forward-looking assessments which could inappropriately result in hedge discontinuations due to uncertainties around the interest rate benchmark reform. As a result, we agree that until the uncertainties are resolved the effects of the reform should be ignored in these assessments.
However, we would like to bring to the IASB attention that under particular circumstances during the transition period to IBOR replacement or once the reform is in progress, a relief of the retrospective test would be needed to avoid that certain hedges fail the hedge accounting only be-cause they are temporarily outside the 80-125% range. Following are the examples of potential ineffectiveness as a result of the IBOR reform:
- New RFR hedges under IAS 39 for which there would not be historical data available that permits to perform the retrospective assessment properly. We would suggest either a temporary exemption to perform the test or the possibility to assume that IBOR historical data is an acceptable proxy to new RFR.
- Mismatch in cash flows of the hedged item and the hedging instrument if current IBOR is replaced with the new RFR at different times. In that case we believe there should be a relief that permits the continuation of hedge accounting when hedge effectiveness fails only because both instruments have transitioned to new RFR at different times.
- Valuation effects resulting from development of new curves used for discounting. The discounting effects may also affect the prospective effectiveness assessment.
Although not all WSBI-ESBG members are applying IAS 39, we would support that the IASB introduces relief on the retrospective but also prospective assessment to avoid that preparers applying IAS 39 would be penalized compared to ones under IFRS 9.
Designating a component of an item as the hedged item
For the reasons set out in paragraphs BC24–BC27, the Board proposes amendments to the hedge accounting requirements in IFRS 9 and IAS 39 for hedges of the benchmark component of interest rate risk that is not contractually specified and that is affected by interest rate benchmark reform. Specifically, for such hedges, the Exposure Draft proposes that an entity applies the requirement—that the designated risk component or designated portion is separately identifiable—only at the inception of the hedging relationship.
Do you agree with this proposal? Why or why not? If you disagree with the proposal, please explain what you propose instead and why.
We agree with the proposal. Assessing the separately identifiable criterion during the life of the hedge could lead to unnecessary hedge discontinuations due to decline in liquidity of hedged benchmark interest rates due to the reform.
Mandatory application and end of application
(a) For the reasons set out in paragraphs BC28–BC31, the Board proposes that the exceptions are mandatory. As a result, entities would be required to apply the proposed exceptions to all hedging relationships that are affected by interest rate benchmark reform.
(b) For the reasons set out in paragraphs BC32–BC42, the Board proposes that the exceptions would apply for a limited period. Specifically, an entity would prospectively cease applying the proposed amendments at the earlier of:
(i) when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmarkbased cash flows; and
(ii) when the hedging relationship is discontinued, or if paragraph 6.8.9 of IFRS 9 or paragraph 102I of IAS 39 applies, when the entire amount accumulated in the cash flow hedge reserve with respect to that hedging relationship is reclassified to profit or loss.
(c) For the reasons set out in paragraph BC43, the Board is not proposing an end of application in relation to the separate identification requirement.
Do you agree with these proposals? Why or why not? If you agree with only parts of the proposals, please specify what you agree and disagree with. If you disagree with the proposals, please explain what you propose instead and why.
We agree with the proposals. We consider the reasons discussed in the basis for conclusions of the ED as appropriate.
For the reasons set out in paragraph BC44, the Board proposes that entities provide specific disclosures about the extent to which their hedging relationships are affected by the proposed amendments.
Do you agree with these proposed disclosures? Why or why not? If not, what disclosures would you propose instead and why?
We note that the disclosures copy most of the regular disclosure requirements in IFRS 7 for the hedging instruments and the hedged items. We consider that the proposed disclosures may be too extensive to meet the purpose of informing users about the extent of hedges to which the reliefs are applied. These disclosures might be appropriate if all the hedges affected by the reform were to be terminated in which case they could inform about the discontinuation effects. But we believe that this is far from happening. To what extent the hedges will be discontinued will also depend on the outcomes of the phase II.
In our view, the IASB should liaise with users to identify their needs and consider whether they cannot be fulfilled by reduced disclosures.
Effective date and transition
For the reasons set out in paragraphs BC45–BC47, the Board proposes that the amendments would have an effective date of annual periods beginning on or after 1 January 2020. Earlier application would be permitted. The Board proposes that the amendments would be applied retrospectively. No specific transition provisions are proposed.
Do you agree with these proposals? Why or why not? If you disagree with the proposals, please explain what you propose instead and why.
We consider that entities, would be in a need to apply the amendments as soon as possible. As a result, we welcome that the effective date of 1 January 2020 with earlier application permitted allows for the earliest application possible after the standard is issued. From this perspective it is vital that the standard is issued by the IASB by end of 2019 considering that in the EU the effective date will be further affected by the endorsement process.
We also agree with the retrospective application of the requirements and no specific transition provisions.
We note that the 'lower of test' determining how much of the hedging derivative revaluation is recognized in the cash flow hedge reserve in paragraph 6.5.11(a) of IFRS 9 refers to present value of the cumulative change in the hedged expected future cash flows. Similar wording is used in paragraph 96(a) of IAS 39. The values determined in this test are often also used for measuring the retrospective hedge effectiveness for hedges under IAS 39.
The proposed amendments focus on hedge accounting requirements which require forward-looking analysis (see e.g. paragraph BC4 of the exposure draft). We consider that the term expected future cash flows also includes similar forward-looking aspect. In the area of cash flows hedges of interest risk the expected future cash flows are determined by using forward interest rates (usually included as one leg of hypothetical derivatives replicating the hedged cash flows). The time horizon of such expected future cash flows can span over the benchmark rates reform time point in which case they would be affected by the new rates after the reform takes place.
We understand that the retrospective assessment and the 'lower of test' are based on the actual results. From this perspective we understand that, as discussed in paragraph BC23 of the exposure draft, the IASB decided not to propose any exception for the retrospective assessment.
But we consider that, in order to avoid misunderstanding, the IASB should explain how future expected cash flows in the 'lower of test' should be understood in the context of the proposed amendments. In our view, similarly to other areas addressed in the exposure draft, the future expected cash flows should be analyzed assuming that the interest rate benchmark on which the hedged cash flows are based is not altered. This clarification should be part of the phase I of the project.
We would like to emphasize the particular situation of EURIBOR with respect to other
IBORs. EURIBOR is not being replaced but there is just an evolution in its estimation methodol-ogy. We consider that a change in calculation methodology is not a change in the benchmark, and therefore amendments to IFRS 9 and IAS 39 would not be applicable. We suggest that the amendments should clearly state that proposed reliefs are not applicable in cases of modification of methodology and hence, preparers would maintain its current accounting.
Separately identifiable and reliably measurable as a topic to be considered in the current Phase I of the project
We support the relief proposed on the separately identifiable requirement that would permit to perform this assessment only at inception of the hedging relationship. However we would like to highlight that during the period of time that IBORs and new RFR will co-exist, and IBORs be-come less liquid, it would be possible that the “reliably measure" requirement could not be ful-filled. Hence, since the “reliably measure" criteria and the “separately identifiable" criteria are normally stated as twins in IAS 39 and IFRS 9 we believe that the IASB should at least discuss in the BCs how the “reliably measurable" criterion should be understood in the context of the relief provide for the “separately identifiable" criterion.
Modification and derecognition
We consider that the changes in the benchmark rates as such should not generally constitute substantial modifications leading to derecognitions of financial instruments. Financial instrument affected by the reform would just turn its previous market rate of interest into a new market rate which is benchmark regulations compliant. This would warrant the floating rate treatment whereby the effective interest rate is updated under paragraph B5.4.5 of IFRS 9. From this perspective we do not consider that recognition of modification gains/losses under paragraph 5.4.3 would be substantiated.
The IASB should discuss issues related to SPPI compliance of backward-looking rates which may serve as benchmark or fall-back rates after the reform. With these backward-looking solutions short term rates replacing the old -IBOR rates with term structure up to 12 months would be determined based on compounding new overnight risk-free rates such as €STR or SONIA.
For example, a 6-month Euro interest rate would be determined as a compounded €STR rate over the 6-month interest cash flow period. As a result, such an interest amount would be known only at the end of the interest period (the backward-looking aspects). We consider that in such a case the instrument could be viewed as bearing current overnight interest rates which are technically paid, including interest on the 'deferred interest', every 6 months in arrears. Such an instrument would not have non-SPPI features, in our view.
However, in order for the contract parties to know the interest amount already at the start of the period the compounded term rate may be determined in advance and relate to a prior period. In the simplest case a 6-month Euro rate would be calculated as a compounded €STR over a prior 6-month period ending on the last day preceding the current 6-month period. At the start of the current 6-month period the resulting rate would be applied for the entire period. Also other alternatives for knowing the interest amount (compounding overnight rates) at the start of the period are possible. All of such 'in advance' solutions would involve certain SPPI challenges because the interest may not include a consideration for the time value of money. We consider that the IASB should discuss their SPPI treatment within the interest rate benchmark reform context. These issues may be relevant not only at the transition to the new rates but would also affect the treatment of the instruments after the reform.
We would like to note that the transition to the new benchmark rates may have valuation impacts resulting from discounting. For example, for fair value hedges of interest risk some of our members use 3M or 6M Euribor or Libor curves for discounting hedged items whereas hedging instruments are discounted using O/N curves. Different transition patterns for these rates might result in valuation outcomes of hedging relationships falling outside the effectiveness corridor. This may concern both retrospective and prospective effectiveness.
We believe that the IASB should consider providing a relief that one-off valuation effects resulting from the transition to the new benchmark rates should not disqualify hedging relationships from meeting the hedge effectiveness requirements. I.e. they should not lead to discontinuation of hedges. When saying this we acknowledge that the economics of the hedging relationship should be captured by recognising the ineffectiveness through standard hedge accounting measurement requirements.
Hedging documentation - Relief should be provided so that when hedge documentation refers to IBOR as the benchmark risk, subsequent amendment to new RFR should not trigger dedesignation of hedge accounting.
About WSBI (World Savings and Retail Banking Institute)
World Savings and Retail Banking Institute - aisbl
Rue Marie-Thérèse, 11 ￭ B-1000 Brussels ￭ Tel: +32 2 211 11 11 ￭ Fax : +32 2 211 11 99
Info@wsbi-esbg.org ￭ www.wsbi-esbg.org
About ESBG (European Savings and Retail Banking Group)
European Savings and Retail Banking Group – aisbl
Info@wsbi-esbg.org ￭ www. wsbi-esbg.org
Published by WSBI-ESBG. June 2019.