ECB published a report that presents recommendations, from an accounting perspective, on the transition to new risk-free rates. This report by the private-sector working group on euro risk-free rates focuses on the implications, for IFRS and IAS, of the transition from the current euro overnight index average (EONIA) to euro short-term rate (€STR). It also focuses on the inclusion of fallback rates for EURIBOR based on a €STR-based term structure methodology. The recommendations cover three areas: the impact of the transition from EONIA to the €STR on the modification of contracts and hedge accounting, fallbacks for EURIBOR and hedge accounting, and general accounting and financial reporting.
While the report primarily focuses on the EU Benchmarks Regulation implications for hedge accounting related topics, it also touches on challenges for non-hedge related topics. Implications for national generally accepted accounting principles (GAAP) do not fall within the scope of the report. The key recommendations of the working group include the following:
- Preparers of financial statements should qualitatively and quantitatively assess whether changes to contracts resulting from the transition from EONIA to the €STR are substantial or non-substantial modifications.
- IASB should address the issue of modifications of contracts and the potential risk of derecognition owing to the benchmark regulation and provide preparers of financial statements with specific guidance on how to treat changes of contracts driven by the reforms in the light of the existing IASB guidance on modifications of floating rate instruments.
- Preparers of financial statements should assess whether EONIA component designated in hedge relationships is still reliably measurable throughout the transition.
- Preparers of financial statements should evaluate whether the change in hedged risk from the transition from EONIA to the €STR will lead to the discontinuation of existing hedging relationships.
- Preparers of financial statements should analyze the effect that a potential timing mismatch between the transition of the hedged item and the transition of the hedging instrument—as regards the switching of either the floating rate option or the discounting curve from EONIA to the €STR—would have on the effectiveness of the hedge relationship affected by the transition.
- From a financial accounting perspective, market participants should try to reduce variability in fallbacks between different product classes (including derivatives) to a minimum as this would reduce technical implementation challenges and accounting complexity.
- Preparers of financial statements should analyze if there are fallback scenarios under which hedge relationships need to be discontinued. They should also consider incorporating a provision for replacing benchmark interest rates in their hedge documentations for new contracts, and also, the risk of inconsistency when developing fallback provision triggers. This should be taken into account when amending existing contracts and setting up new contracts.
- Where EONIA or EURIBOR-based valuation curves are replaced by the €STR curve or a curve based on a €STR-based term structure methodology, the preparers of financial statements should assess the potential impact of a change in value for financial instruments measured at fair value on the day of transition.
- Preparers of financial statements should closely monitor the IASB project on IBOR reforms and any amendments or clarifications to the standards resulting from it.
To ensure that these recommendations are adopted by all market participants, the working group has created a financial accounting and risk management sub-group that comprises representatives from European and international credit institutions, consulting and accounting firms, clearing houses, and investment management firms and associations. ECB, ESMA, EC, and Financial Services and Markets Authority (FSMA) all act as observers in the sub-group. The recommendations of the working group are not legally binding. They nevertheless provide guidance for market participants preparing for the transition to risk-free rates.
Keywords: Europe, EU, Accounting, Banking, Securities, €STR, EONIA, Risk-free Rates, Benchmark Fallbacks, EURIBOR, Hedge Accounting, Interest Rate Benchmarks, Benchmarks Regulation, IFRS, IASB, ECB
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