ASU 2020-04: Reference Rate Reform

March 16, 2020

On March 12, 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) 2020-04, Reference Rate Reform (“ASC 848”): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASC 848 contains optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform.

Financial institutions that utilize hedge accounting should consider the impact this new standard has on their respective cash flow, fair value, or net investment hedges. Customer hedging programs are not subject to stringent hedge accounting rules, and, therefore, will not require updated documentation as a result of this new guidance.

The relief granted in ASC 848 is applicable only to legacy contracts if the amendments made to the agreements are solely for reference rate reform activities. The provisions of ASC 848 must be applied at a Topic, Subtopic, or Industry Subtopic for all transactions other than derivatives, which may be applied at a hedging relationship level. Entities may apply the provisions as of the beginning of the reporting period when the election is made (i.e. as early as the first quarter 2020). Unlike other topics, the provisions of this update are only available until December 31, 2022, when the reference rate replacement activity is expected to have completed.

Highlights of available optional expedients and exceptions for Cash Flow hedges:

  • Hedged forecasted transactions may be considered probable to occur;
  • The hedged risk may change so long as the hedging relationship remains highly effective;
  • Effectiveness assessments may be changed multiple times throughout the transition process;
  • Same risk analyses may be disregarded;
  • Option products receive relief on changes to excluded component values upon transition to a new reference rate (i.e. entities may choose to either recognize in earnings or amortize the total change in excluded component values);
  • If shortcut is being used as the method of assessing hedging effectiveness, changes as a result of reference rate replacement that would otherwise disqualify its use may be disregarded for the life of the hedging relationship.

Highlights of available optional expedients and exceptions for Fair Value hedges:

  • Most relief available is contingent upon adoption of ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities;
  • Changes to designation proportions of the swap or hedged item and combining two or more derivatives or proportions thereof as the hedging instrument is allowed;
  • Allows the designated benchmark interest rate in active hedging relationships to be changed without de-designation;
  • If shortcut is being used as the method of assessing hedging effectiveness, changes as a result of reference rate replacement that would otherwise disqualify its use may be disregarded for the life of the hedging relationship.

Chatham representatives will reach out to clients' accounting groups with the necessary documentation for applicable elections as of this quarter ending on March 31, 2020.

Links to other Chatham publications on the topic including Understanding ASC 848 as well as the LIBOR Transition Update are accessible on our resource center.

For more information you can contact the Financial Institutions Accounting team at AcctgFI@chathamfinancial.com.


Disclosures

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal/notices/.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 20-0073

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