LIBOR Will be Gone—The Reference Rate Reform is Here

The London Interbank Offered Rate, or LIBOR, has been the go-to rate to set interest rates for a financial contract, hedge relations, and other agreements like lease, bond or loan covenants since the 1980s. The clock for a new referenced rate for financial transactions started ticking far back in 2003 when the investigation into the LIBOR revealed the manipulation by panel banks for profit. Due to the lack of confidence and the unsustainability of LIBOR, the Federal Reserve Board and the Federal Reverse Bank of New York created the Alternative Reference Rate Committee (ARRC) to identify a suitable alternative to LIBOR.

In June 2017, ARRC announced the alternative reference rate as the replacement for LIBOR. Fast forward to March 2020, Financial Accounting Standards Board issued Accounting Standard Update No. 2020-04, Reference Rate Reform: (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04). ASU 2020-04 includes the ARRC identified rate as a reference rate for financial transactions and provides guidance to address foreseen operational issues that will arise in accounting in light of the LIBOR ending in the near future.

ASU 2020-04 was issued to provide optional expedients and exceptions on accounting treatment for certain financial transactions to address issues that may arise when LIBOR ends. Entities that referenced LIBOR rates in their financial transactions will need to replace those rates which can cause unintended consequences. For example, hedge relationships may no longer qualify as “highly effective”. This can result in financial reporting outcomes that do not reflect an entity’s intended hedging strategy. To address this, ASU 2020-04, allows modification of contracts, hedges, debt agreements, lease agreements, and derivative instruments to replace references to discontinued rates with those of replacement rates. This codification is only issued to allow minor modification to existing contracts before January 1, 2020. The ASU 2020-04 only applies to modifications related to the replace of a reference rate.

The second issue relates to held-to-maturity debt securities. Debt securities that reference the LIBOR rate may not have a LIBOR published rate to refer to at maturity. To address this, the ASU 2020-04 allows a one-time election for entities to transfer held-to-maturity securities to available for sale or trading securities or sell them without calling to question the prior intent and/or ability to hold the security to maturity. The election can be made to some or all held to maturity securities held before January 1, 2020 and the security must be referring to the LIBOR rate or a rate that is expected to be discontinued.

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