New hedging standard - Benchmark Interest Rates

Under the current guidance [ASC 815], companies are limited to hedging the following benchmark interest rates only:

·         Interest rates on direct Treasury obligations of the U.S. government (the U.S. Treasury Rate)

·         London Interbank Offered Rate (LIBOR) Swap Rate

·         Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate or OIS)

The new hedging standard will newly allow i) any contractually specified interest rates and ii) Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate to be designated as the hedged interest rate risk.

i) Cash flow hedges of variable-rate financial instruments

·         The concept of benchmark interest rate will be eliminated.

·         An entity may designate any contractually specified interest rate as the hedged risk in cash flow hedges of interest rate risk. For example, a bank could hedge the variability in cash flows of a variable-rate loan based on its own prime rate as long as the rate is contractually specified in the loan.

·         An entity may designate as the hedged risk only the change in cash flows of the contractually specified interest rate index, not an implied rate embedded in the interest rate index. For example, if an entity issues variable-rate debt based on its own prime rate, it cannot designate the change in cash flows of the Fed Funds Target rate or the Wall Street Journal prime rate as the hedged risk.

ii) Fair value hedges of fixed-rate financial instruments

·         The concept and definition of the term benchmark interest rate and list of the current eligible benchmark interest rates (see above) is retained.

·         The SIFMA Municipal Swap Rate is added to the list of permissible benchmark rates, which would allow an entity that issues or invests in fixed-rate tax-exempt financial instruments to designate as the hedged risk changes in fair value attributable to interest rate risk related to the SIFMA Municipal Swap Rate rather than overall changes in fair value.

·         SIFMA is the average rate at which high-credit-quality U.S. municipalities may obtain short-term financing and currently is the predominant rate referenced in issuances of variable-rate municipal bonds. For that reason, the FASB believes that it should be considered a benchmark rate.

·         If an entity modifies a tax-exempt financial instrument’s hedged risk from total price risk to interest rate risk related to the SIFMA Municipal Swap Rate, the modification would be considered a dedesignation and immediate redesignation of the hedging relationship. In this situation, the cumulative basis adjustment of the hedged item from the dedesignated hedging relationship would be amortized to earnings over the remaining life of the hedged item on a level-yield basis.