Announcement providing Temporary Exceptions to Hedge Accounting prescribed under Guidance Note on Accounting for Derivative Contracts due to Interest Rate Benchmark Reform
Interest Rate Benchmark Reform such as Interbank Offered Rates (IBORs), e.g., LIBOR, TIBOR, NIBOR, etc. play an important role in global financial markets and index (benchmark) a variety of financial products including derivatives. Market developments have undermined the reliability of some existing benchmarks. Consequently, some major interest rate benchmarks will cease to be published across the globe after December 2021. The ongoing reform in IBOR, will impact the way financial information is accounted for in the financial statements.
With international developments taking place, global financial reporting Standards have been amended to address the issues affecting financial reporting arising from these reforms. Two groups of accounting issues that could affect financial reporting have been identified globally:
• Phase 1- Pre-replacement issues—issues affecting financial reporting in the period during which there is uncertainty about the timing or the amount of interest rate benchmark-based cash flows. To address these issues, the amendments have been made to the relevant IFRS Standards. In India, corresponding changes have been made under Ind AS that are effective from April 1, 2020.
For the entities that do not apply Ind AS, the provisions regarding hedge accounting are prescribed in the Guidance Note on Accounting for Derivative Contracts issued by the Institute of Chartered Accountants of India in year 2015.
This Announcement is issued in order to provide corresponding temporary relief to the entities not following Ind AS having transactions in financial market products, for accounting periods beginning on or after April 1, 2020.
• Phase 2- Replacement issues—issues affecting financial reporting when the uncertainty regarding the timing and the amount of interest rate benchmark-based cash flows is resolved and hedging relationships are affected as a result of the reform. IFRS Standards have been amended to provide practical expedient for modifications of the financial contracts that are affected by IBOR Reform with the view to avoid undue impact on the financial statements where the transactions are economically equivalent to the previous basis (i.e., before and after IBOR reforms). In absence of such practical expedient, due to change in benchmark rate, there could be unintended consequences, such as discontinuation of hedge accounting, etc.
In India, corresponding changes are being made under Ind AS to be effective from accounting periods beginning on or after April 1, 2021. Corresponding amendments to provide additional temporary exceptions to hedge accounting for entities not following Ind AS are under formulation and will be issued in due course.
In the aforementioned background and to address the exigent issue, this Announcement prescribes the temporary relief to the entities not following Ind AS corresponding to that provided in Phase 1 to the entities following Ind AS.
Temporary exceptions from applying specific hedge accounting requirements prescribed in Guidance Note on Accounting for Derivative Contracts
- An entity shall apply paragraphs 4–11 and paragraphs 13-14 to all hedging relationships directly affected by interest rate benchmark reform. These paragraphs apply only to such hedging relationships. A hedging relationship is directly affected by interest rate benchmark reform only if the reform gives rise to uncertainties about:
(a) the interest rate benchmark designated as a hedged risk; and/or
(b) the timing or the amount of interest rate benchmark-based cash flows of the hedged item or of the hedging instrument. - For the purpose of applying paragraphs 4–11, the term ‘interest rate benchmark reform’ refers to the market-wide reform of an interest rate benchmark, including the replacement of an interest rate benchmark with an alternative benchmark rate such as that resulting from the recommendations set out in the Financial Stability Board’s July
2014 report ‘Reforming Major Interest Rate Benchmarks’.*
* The report, ‘Reforming Major Interest Rate Benchmarks’, is available at http://www.fsb.org/wpcontent/uploads/r_140722.pdf. Also refer to Report of the Committee on Financial Benchmarks of RBI dated 7th Feb 2014 at https://m.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=761 - Paragraphs 4–11 provide exceptions only to the requirements specified in these paragraphs. An entity shall continue to apply all other hedge accounting requirements prescribed in the Guidance Note for Accounting for Derivative Contracts for hedging relationships directly affected by interest rate benchmark reform.
Highly probable requirement for cash flow hedges - For the purpose of determining whether a forecast transaction (or a component thereof) is highly probable, an entity shall assume that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
Reclassifying the amount accumulated in the cash flow hedge reserve - For the purpose of applying the requirements in the Guidance Note in order to determine whether the hedged future cash flows are probable to occur, an entity shall assume that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
Assessing the economic relationship between the hedged item and the hedging instrument - For the purpose of applying the requirements in paragraph 44(i) of the Guidance Note, an entity shall assume that the interest rate benchmark on which the hedged cash flows and/or the hedged risk are based, or the interest rate benchmark on which the cash flows of the hedging instrument are based, is not altered as a result of interest rate benchmark reform.
Designating a component of an item as a hedged item
- For a hedge of a non-contractually specified** benchmark component of interest rate risk if any, an entity shall apply the requirement that the risk component shall be separately identifiable only at the inception of the hedging relationship.
**When risk components are designated as hedged items, an entity considers whether the risk components are explicitly specified in a contract (contractually specified risk components) or whether they are implicit in the fair value or the cash flows of an item of which they are a part (non-contractually specified risk components). A risk component to be eligible for hedge designation should be separately identifiable and reliably measurable.
End of application of temporary exceptions from applying specific hedge accounting requirements - An entity shall prospectively cease applying paragraph 4 to a hedged item at the earlier of:
(a) when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmark based cash flows of the hedged item; and
(b) when the hedging relationship that the hedged item is part of is discontinued. - An entity shall prospectively cease applying paragraph 5 at the earlier of:
(a) when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmark based future cash flows of the hedged item; and
(b) when the entire amount accumulated in the cash flow hedge reserve with respect to that discontinued hedging relationship has been reclassified to profit or loss. - An entity shall prospectively cease applying paragraph 6:
(a) to a hedged item, when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the hedged risk or the timing and the amount of the interest rate benchmark-based cash flows of the hedged item; and
(b) to a hedging instrument, when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmark-based cash flows of the hedging instrument.
If the hedging relationship that the hedged item and the hedging instrument are part of is discontinued earlier than the date specified in paragraph 10(a) or the date specified in paragraph 10(b), the entity shall prospectively cease applying paragraph 6 to that hedging relationship at the date of discontinuation. - When designating a group of items as the hedged item, or a combination of financial instruments as the hedging instrument, an entity shall prospectively cease applying paragraphs 4–6 to an individual item or financial instrument in accordance with paragraphs 8, 9, or 10, as relevant, when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the hedged risk and/or the timing and the amount of the interest rate benchmark-based cash flows of that item or financial instrument.
Disclosures -Uncertainty arising from interest rate benchmark reform
- For hedging relationships to which an entity applies the exceptions set out in paragraphs 4–11, an entity shall disclose:
(a) the significant interest rate benchmarks to which the entity’s hedging relationships are exposed;
(b) the extent of the risk exposure the entity manages that is directly affected by the interest rate benchmark reform;
(c) how the entity is managing the process to transition to alternative benchmark rates;
(d) a description of significant assumptions or judgements the entity made in applying these paragraphs (for example, assumptions or judgements about when the uncertainty arising from interest rate benchmark reform is no longer present with respect to the timing and the amount of the interest rate benchmark-based cash flows); and
(e) the nominal amount of the hedging instruments in those hedging relationships.
Effective Date - An entity shall apply the temporary exceptions stated in paragraphs 1-12 and 14 for annual periods beginning on or after 1st April 2020.
- The requirements of this Announcement apply only to those hedging relationships that existed at the beginning of the reporting period in which an entity first applies these requirements or were designated thereafter, and to the amount accumulated in the cash flow hedge reserve that existed at the beginning of the reporting period in which an entity first applies these requirements.
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