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Issue 172 / July 2020

IFRS Developments

What you need to know

On 25 June 2020, the IASB

held the first of two meetings to discuss the comments received on the phase two ED and tentatively agreed responses to be reflected in the final amendments.

At its July meeting

, the

IASB plans to complete

redeliberations on the ED. It will discuss feedback on the phase two proposals as they relate to qualifying hedging relationships and hedges of groups of items.

The phase two amendments

will address the accounting issues that arise when financial instruments that reference

IBORs transition to alternative

nearly risk free rates.

The phase two amendments are

expected to be finalised and published in Q3 or Q4 2020.

The proposed effective date is

for annual periods beginning on or after 1 January 2021, but earlier application is permitted.

Introduction

On 25 June 2020, the International Accounting Standards Board (IASB or the Board) held its first discussion on the feedback received on the Exposure Draft, Interest Rate Benchmark Reform - Phase 2, Proposed amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16 (the ED). The comment period for the ED closed on 25 May 2020 and, at its June meeting, the IASB considered the analysis of responses to the majority of its questions and tentatively agreed the responses to be included in the final amendments.

In this publication, we summarise the

decisions taken by the

IASB and provide our views.

Following the decision taken by global regulators to replace Interbank Offered

Rates (IBORs) with

alternative nearly risk-free rates (RFRs), in 2018, the IASB commenced work to address the effects of IBOR reform on financial reporting.

The IASB divided its work into two phases: Ź Phase one addressed issues affecting financial reporting in the period before

the replacement of an existing interest rate benchmark with an RFR. Ź Phase two is focused on issues that affect financial reporting when an existing

interest rate benchmark is replaced with an RFR. The IASB completed phase one with the publication, in September 2019, of Interest Rate Benchmark Reform, Amendments to IFRS 9, IAS 39 and IFRS 7. In April 2020, the IASB published the ED with a forty-five day comment period. At the June meeting, the IASB tentatively agreed responses to comments on the majority of the questions in the ED. In July, the IASB will discuss comments on the ED's proposals for qualifying hedging relationships and groups of items, and any remaining issues. After the July meeting, the IASB will finish drafting, then publish the phase two amendments in the third or fourth quarters of this year. The IASB will then have completed its project in response to IBOR reform.

For the background to the

IASB's project, see our publications, IFRS Developments

144 and 145; we describe the phase one amendments in IFRS Developments 152

and summarise the ED in IFRS Developments 165. These publications can be found at www.ey.com/ifrs.IBOR reform: IASB responds to comments on phase two exposure draft

2 IBOR reform: IASB responds to comments on phase two exposure draft

1.

Modifications of financial assets and

financial liabilities The Board agreed to retain the proposals for modifications required as a direct consequence of IBOR reform, with some minor drafting amendments to ensure the reliefs can be applied as the IASB intended.

For such modifications, the ED proposed a

practical expedient to allow contractual changes or changes to cash flows to be treated as changes to a floating interest rate, equivalent to a movement in a market rate of interest. The Board will consider whether 'necessary due to' IBOR reform rather than 'required as a direct consequence of' better reflects the intended scope of the reliefs. To apply the practical expedient, the transition from an IBOR to an RFR should take place on an 'economically equivalent' basis, which the IASB will clarify should be assessed qualitatively rather than quantitatively.

2. Amendments to hedging relationships

Some minor amendments were agreed to ensure permitted changes to hedge documentation include all aspects that could be affected by IBOR reform. Clarification was requested by some respondents that on transition from IBOR, a hedged portion could be amended to include the basis spread between the IBOR and RFR which is present at the time the RFR is designated as the hedged risk. The Board considered an example of a loan issued with a rate fixed at 6% when the equivalent IBOR rate was 5% . The entity designated the hedged portion in a fair value hedge, as the coupon cash flows equivalent to 5% plus the principal on the loan. If at the date the hedge designation is changed, IBOR is 4% and the RFR is

10 basis points less than IBOR at 3.9%, the entity could change the hedged portion

to the equivalent of 4.9% plus the principal on the fixed rate debt. To ensure this is clear in the final amendments, the Board agreed to include a specific reference to changes to the hedged portion.

The Board

responded to the concern that making the changes to hedge documentation 'as and when' the uncertainty arising from IBOR reform is resolved, might not be practicable where large volumes of hedging relationships transition from IBOR to RFRs. Entities will, therefore, have until the end of the reporting period during which the uncertainty for a particular hedging relationship is resolved, to update the hedge documentation.

The Board agreed to

clarify the treatment for derivatives that may be replaced rather than modified as a result of IBOR reform, such as those transacted via central clearing houses. Provided the transition from IBOR to RFR satisfies the 'required as a direct consequence of' and 'economically equivalent' principles described above, any corresponding hedging relationships may continue. 3.

Designation of risk components and portions

The ED proposed that upon designation of a hedge, provided the entity reasonably expects the RFR risk component to become separately identifiable within the next 24
-months, the separately identifiable requirement is deemed to be met.

Some respondents

to the ED observed that 24-months may not be sufficient time for an RFR to become established. The Board decided to retain the 24-month period as the relief is intended to be temporary and requires a clear end-date to maintain the overall integrity of the hedge accounting requirements.

The Board considered the example

where an entity designates an RFR as the hedged risk in two separate hedging relationships; the first designated on 31 March

2021 and the second on 30 June 2021. As proposed in the ED, the 24-month

IBOR reform:

IASB responds to comments on phase two exposure draft 3 period for each hedge would begin and end at different dates, even though the designated hedged risk is the same. If an entity concludes for one hedging relationship that it no longer has a reasonable expectation that the RFR will become separately identifiable at the end of 24-months, it will more likely than not reach the same conclusion for all other hedging relationships in which the RFR is designated. The Board therefore agreed that the 24-month period shall apply to the individual RFR and begin from the date an entity first designates the RFR as the hedged risk, rather than the

24-month relief being applied on a hedge-by-hedge basis. The

earliest start date for the 24-month relief will be when an entity first applies the amendments. 4.

Effective date and transition

The proposed effective date for the phase two amendments is for annual periods beginning on or after 1 January 2021, but earlier application is permitted. Application of the phase two amendments is retrospective and hedging relationships must be reinstated if: Ź The hedging relationship was discontinued solely due to changes required by

IBOR reform

And Ź The hedging relationship would not have been discontinued if the phase two reliefs had been available To avoid practical problems where hedging instruments have been discontinued or designated in new hedging relationships, the Board agreed that discontinued hedging relationship will only be reinstated if: Ź They were discontinued solely due to changes required by IBOR reform And Ź On initially applying the amendments, the discontinued hedging relationship still meets the risk management objective on the basis of which it qualified for hedge accounting and continues to meet all other qualifying criteria. 5.

Disclosures

The ED proposed to amend IFRS 7 Financial Instruments: Disclosures to include additional disclosures for how the entity is managing the transition to RFRs, its progress and the risks arising from the transition. Concern was raised that the extent of quantitative information would involve undue cost and effort and that some requirements were unclear. The Board agreed to amend the proposal to disclose the carrying amount of non- derivative financial assets and liabilities, and the nominal value of derivatives that continue to reference IBORs subject to reform, disaggregated by each significant IBOR benchmark. The disclosure should show the progress made by entities in transitioning to RFRs. Entities will choose a representative basis for disclosing the quantitative information and explain the basis applied.

The Board

also agreed to remove the requirement to disclose, for each RFR, an explanation of how the entity has determined whether derecognition is required.

How we see it

The changes made at the IASB's June meeting to the proposed phase two amendments were limited to minor adjustments and clarifications. These changes should address the key concerns of respondents to the ED and make the amendments easier for entities to understand and apply, whilst continuing to ensure the IASB's objectives are met. While the June discussions indicate the main areas of amendment, we will need to wait to see the final wording to understand fully the requirements and guidance. At its meeting in June, the IASB made good progress towards completing its response to the comments received on the ED. Given the high priority the IASB continues to place on its response to IBOR reform, no delay is currently envisaged to publication of the final phase two amendments by the end of Q3 or in Q4 2020. Since the phase two amendments will soon be finalised, it is important for entities to carefully assess how they will apply them. This is especially the case if they are considering early adopting them for the year ending 31 December 2020. Entities should consider how they will make the judgements necessary to apply the reliefs, and gather the information needed for the additional disclosures.

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