The Upcoming Impacts of Reference Rate Reform

One of the most commonly used reference rates for debt agreements, hedging arrangements, and other instruments across global financial markets has been the London Interbank Offered Rate (LIBOR). However, concerns about LIBOR and other interbank offered rates have created a shift to identify other reference rates. In December 2020, the ICE Benchmark Administration (the administrator to LIBOR) announced its intention to cease the publication of the one week and two-month US dollar (USD) LIBOR settings as well as all foreign currency, non-USD LIBOR settings immediately following the LIBOR publication on December 31, 2021. All remaining USD LIBOR settings will be ceased immediately following the publication on June 30, 2023.

In response, the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve identified the Secured Overnight Financing Rate (SOFR) as the preferred alternative reference rate to the US dollar LIBOR. This change in reference rates has the potential to cause several accounting challenges especially as it relates to accounting for hedging relationships and contract modifications. As a result, the Financial Accounting Standards Board (FASB) issued ASU 2020-04 and ASU 2021-01 to provide accounting relief from contract modifications and hedge accounting relationships associated with the transition away from LIBOR.

While FASB provided some relief with the aforementioned ASUs, there are several steps that business leaders and accounting personnel can take to make sure they are prepared for the transition.

• Take a complete inventory of the LIBOR exposure in your contracts.
• Review derivative agreements, loan contracts, preferred stock coupons, lease agreements, etc. and determine which contracts utilize a LIBOR rate and if these contracts have any fallback language regarding alternative rates if LIBOR ceases.
• Once the exposure is determined, develop an action plan to address the LIBOR contracts, such as determining if they need to be modified to add robust fallback language.
• Then, evaluate the operational exposures, such as third-party vendor systems which utilize LIBOR and if they are currently set up to handle an alternative benchmark rate.
• Finally, evaluate the accounting exposure. Are there areas where LIBOR is currently used to support accounting estimates such as the use of LIBOR as a discount rate for goodwill or intangible impairment analysis, and what is the impact of the use of the alternative rate most likely to be used?

Determining the levels of exposure throughout and developing a plan of action will allow companies to navigate the transition as smoothly as possible.

09/01/2021