The US Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update (ASU) to add a fifth option to the list of US benchmark interest rates permitted in the application of hedge accounting under FASB Accounting Standards Codification™ Topic 815, Derivatives and Hedging. The comment due date is 30 March 2018.
Topic 815 provides guidance on the risks associated with financial assets or liabilities that are permitted to be hedged. Those risks include the risk of changes in fair values or cash flows of existing or forecasted issuances or purchases of fixed-rate financial assets or liabilities attributable to the designated benchmark interest rate (the interest rate risk).
Currently, in the United States, there are four eligible benchmark interest rates under Topic 815. These include:
- Interest rates on direct Treasury obligations of the U.S. government (UST)
- The London Interbank Offered Rate (LIBOR) swap rate
- The Overnight Index Swap (OIS) Rate based on the Fed Funds Effective Rate
- The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate.
The Federal Reserve Board and the Federal Reserve Bank of New York (Fed) have been leading an effort to introduce an alternative reference rate in the United States due to concerns about the sustainability of LIBOR. They convened a consortium, the Alternative Reference Rates Committee (ARRC), which includes major market participants and financial institutions, to identify a suitable alternative to Libor. The ARRC has identified a broad Treasury repurchase agreement (repo) financing rate referred to as the Secured Overnight Financing Rate (SOFR) as its preferred alternative reference rate. The OIS rate based on SOFR would be a swap rate based on the underlying overnight SOFR rate.
The proposed ASU would add the OIS rate based on SOFR as a fifth U.S. benchmark interest rate to help entities avoid the potential cost and complexity associated with using different cash flows and discount rates to measure the hedged item and the hedging instrument.
The proposed ASU is available here.
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