On April 2, 2020, the Governmental Accounting Standards Board (GASB) issued Statement No. 93, Replacement of Interbank Offered Rates.

The statement provides exceptions to the existing provisions for hedge accounting termination and lease modifications to ease the accounting requirements related to the transition away from interbank offered rates (IBORs). It also identifies appropriate benchmark interest rates for hedging derivative instruments.

Background

The London Interbank Offered Rate (LIBOR) is the most commonly used reference rate in the global financial market. LIBOR is used as a reference rate in state and local government contracts, including interest rate swaps and other derivatives, floating rate bonds, loans, and other instruments.

However, it’s expected that many private sector banks currently reporting information used to set LIBOR will stop doing so after 2021 when their current reporting commitment ends.

Key Provisions

As a result of reference rate reform, governments will need to amend or replace agreements in which variable payments made or received are dependent on an IBOR. The exceptions in Statement No. 93 are intended to preserve the consistency and comparability of reporting derivative instruments and leases.

This means agreements with the same economic substance before and after the replacement of a reference rate should be accounted for in the same manner as before the replacement of a reference rate.

Hedging Derivative Instruments

Under Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, a government that amends a critical term of a hedging derivative instrument, such as the reference rate of a hedging derivative instrument’s variable payment, would be required to terminate hedge accounting.

Statement No. 93 provides an exception to the termination provision to allow hedge accounting to continue when the reference rate of the original hedging derivative instrument’s variable payment is an IBOR, if all of the following criteria are met:

• The hedging derivative instrument is effective as of the end of the reporting period.

• The hedging derivative instrument is amended or replaced to change the reference rate of the hedging derivative instrument’s variable payment, or to add or change fallback provisions related to the reference rate.
• If the reference rate of the amended or replacement hedging derivative instrument’s variable payment is multiplied by a coefficient or adjusted by addition or subtraction of a constant, the coefficient or constant is limited to what’s necessary to equate the replacement rate and the original rate.
• If an up-front payment is made between the parties, the amount of the payment is limited to what is necessary to equate the replacement rate and the original rate.
• If the replacement of the reference rate is effectuated by ending the original hedging derivative instrument and entering into a replacement hedging derivative instrument, those transactions occur on the same date.
• The terms that affect changes in fair values and cash flows in the original and replacement hedging derivative instruments are identical, except for the term changes that may be necessary for the replacement of the reference rate.

The statement also clarifies that the term changes that may be necessary for the replacement of the reference rate are limited to the following:

• The frequency with which the rate of the variable payment resets
• The dates on which the rate resets
• The methodology for resetting the rate
• The dates on which periodic payments are made

Up-Front Payments

If an up-front payment is made to equate the replacement rate and the original rate, that payment should be reported as an asset for a payment made or a liability for a payment received and amortized using the interest method over the duration of the related hedging derivative instrument.  

For the purposes of determining effectiveness of the hedging derivative instrument in accordance with paragraphs 40 to 48 of Statement No. 53, the up-front payment should be considered a cash flow over the duration of the related hedging derivative instrument.

Benchmark Interest Rates

Statement No. 53 is amended to define the term reference rate and to remove LIBOR as an appropriate benchmark interest rate.

Under the amended guidance, the following rates are deemed appropriate benchmark interest rates for derivative instruments:

• Interest rate on direct Treasury obligations of the US government
• Effective Federal Funds Rate
• Secured Overnight Financing Rate (SOFR)

Two-Step Transition

Additionally, a government may choose to transition from an IBOR to an interim reference rate before it transitions to a SOFR when liquidity in the SOFR market grows. Hedge accounting should continue to be applied in the two-step transition if certain criteria are met.

Lease Modifications

Under Statement No. 87, Leases, a government is required to apply the provisions for lease modifications–including remeasurement of the lease liability or lease receivable–when the rate in a contract with variable lease payments is replaced.

Statement No. 93 simplifies the accounting analysis for lease modifications affected by reference rate reform by adding the following exception to Statement No. 87:

• If variable payments of a lease contract depend on an IBOR, an amendment of the contract solely to replace the IBOR with another rate—that’s adjusted, if necessary, to essentially equate the replacement rate and the original rate—by either changing the rate or adding or changing fallback provisions related to the rate, isn’t a lease modification.

Effective Dates

The removal of LIBOR as an appropriate benchmark interest is effective for reporting periods ending after December 31, 2021.

All other requirements of Statement No. 93 are effective for reporting periods beginning after June 15, 2020. Early application is encouraged.

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