On July 17, 2013, the FASB issued ASU No. 2013-10, which permits an entity to designate the Fed Funds Effective Swap Rate ("Fed Funds rate"), also referred to as the overnight index swap rate ("OIS"), as a benchmark interest rate. In addition, the ASU removes the restriction on using different benchmark interest rates for similar hedges. The ASU is effective immediately. This In brief article provides an overview of the final standard.
On July 17, 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force)1 ("the ASU").
The new guidance permits an entity to designate the Fed Funds Effective Swap Rate ("Fed Funds rate"), also referred to as the overnight index swap rate ("OIS"), as a benchmark interest rate. In addition, the ASU removes the restriction on using different benchmark interest rates for similar hedges.
The ASU is effective immediately, and can be applied prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. Hedge accounting is optional, and this guidance is elective.
Guidance on accounting for derivatives and hedging instruments2 allows an entity to designate the risk of changes in fair value or cash flows of financial assets and financial liabilities due to changes in the benchmark interest rate as the risk being hedged in fair value or cash flow hedges. The derivatives guidance defines a benchmark interest rate as "a widely recognized and quoted rate in an active financial market that is broadly indicative of the overall level of interest rates attributable to high-credit-quality obligors in that market."
Until the ASU, only interest rates on direct treasury obligations of the U.S. government and the London Interbank Offered Rate (LIBOR) swap rate were considered benchmark interest rates in the U.S. In fact, prior guidance3 had explicitly prohibited use of the Fed Funds rate (the interest rate at which depository institutions lend balances to each other overnight) as a benchmark rate.
Since the financial crisis in 2008, the demand for hedging products incorporating the Fed Funds rate has increased, driven largely by increased focus on banks’ sources of funding, widening of spreads between LIBOR and the Fed Funds rate, increased collateralization of derivatives, and new legislative requirements to transact derivative trades through clearing houses.
In addition, the ASU eliminates the need to designate the same benchmark interest rate for similar hedges. It also removes the prior language indicating that the use of different benchmark interest rates for similar hedges “shall be rare and shall be justified.”
The new guidance is relevant for U.S. GAAP only. Under IFRS, a hedge of the risk free or benchmark interest rate is not explicitly limited to a specified interest rate. Rather, it is described in terms of a rate that is both a separately-identifiable component of a financial instrument and reliably measurable.
The new guidance can be applied by all companies that enter into hedging arrangements.
The new guidance is effective immediately and may be applied prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013.
PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the Financial Instruments team in the National Professional Services Group (1-973-236-7803).
1Refer to PwCs EITF Observer for more information.
2ASC 815-20-25-12(f)(2) for fair value hedges and 815-20-25-15(j)(2) for cash flow hedges