SOFR Interest Rate for Hedge Accounting Due By End of the Year
The Financial Accounting Standards Board (“FASB”) plans to publish a U.S. GAAP update that adds a new benchmark interest rate for hedge accounting. Set to be released by year’s end, the planned update will use the Secured Overnight Financing Rate (“SOFR”) as a benchmark rate for labeling hedges of interest rate risk. If the update is finalized, the SOFR will be added to Topic 815, Derivatives and Hedging.
Introduced by the Federal Reserve earlier this year to replace the controversial London Interbank Offered Rate (“LIBOR”), the SOFR is founded on the interest rates banks charge each other in the overnight market for loans made to one another, also known as repurchase agreements. The SOFR is also based on open market transactions and more reflective of market conditions than LIBOR, which is more dependent on a judgment call.
Adding the SOFR to Topic 815 is considered necessary in replacing LIBOR, a one-time international benchmark that became the focus of price-rigging scandals in 2012. In a letter to the FASB, the American Bankers Association said using derivative instruments to manage financial risks is essential to business operations. The organization also stressed transitioning away from LIBOR to reflect ongoing industry changes and the needs of developing markets.
The update will be based on Proposed Accounting Standards Update No. 2018-220, Derivatives and Hedging (Topic 815) — Inclusion of the Overnight Index Swap (OIS) Rate Based on the Secured Overnight Financing Rate (SOFR) as a Benchmark Interest Rate for Hedge Accounting Purposes. Most feedback on the proposal agreed with the FASB’s plan, but several respondents recommended that the board consider a wider principle to quickly implement new benchmark rates. The FASB rejected the plan on August 29.