Prior to the issuance of ASU 2018-16, there were four rates that an entity could use as a U.S. benchmark interest rate for hedge accounting purposes:
- Interest rates on direct Treasury obligations of the US government (UST)
- LIBOR swap rate
- Overnight Index Swap (OIS) Rate which is based on the Federal Funds Effective Rate
- Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate
Upon adoption of ASU No. 2018-16, SOFR OIS Rate is a fifth option that can be used for hedge accounting purposes.
Because of concerns about the sustainability of LIBOR, the Alternative Reference Rates Committee (ARRC) was formed by the Federal Reserve Board to identify an alternative to the US dollar (USD) LIBOR. In 2017, ARRC chose SOFR, which is a volume-weighted median interest rate that is calculated daily based on overnight transactions from the prior day’s trading activity in specified segments of the US Treasury repurchase market as its preferred reference rate. ASU 2018-16 was issued as a result of this transition from LIBOR to SOFR as the best practices reference rate.
IN PRACTICE FOCAL POINT
By including the OIS rate based on SOFR as an acceptable benchmark interest rate during the early stages of the transition, this standard will facilitate the LIBOR to SOFR transition and provide time for companies to prepare for changes related to interest rate risk hedging strategies for both risk management and hedge accounting purposes.
While an entity would have to disclose the implementation of ASU 2018-16 in the year of adoption, this ASU would not require any additional recurring disclosures. The FASB concluded any recurring disclosures regarding the addition of a new benchmark rate would be unnecessary. This approach is consistent with past additions of new benchmark rates in the US.
The ASU does not address changes to existing hedging relationships upon a transition to the SOFR OIS from LIBOR, but the FASB is currently assessing the need for a project to consider certain transition relief provisions for existing hedging relationships, as additional time will likely be needed to fully consider the impact of transitioning away from LIBOR financial instruments to SOFR.