The ‘sub-LIBOR Issue’ – FAQ | IFRS

The ‘sub-LIBOR issue’

Some financial institutions are able to raise funding at interest rates that are below a benchmark interest rate (e.g., LIBOR minus 15 basis points (bps)). In such a scenario, the entity may wish to remove the variability in future cash flows caused by movements in LIBOR benchmark interest rates. However, IFRS 9, like IAS 39, does not allow the designation of a ‘full’ LIBOR risk component (i.e., LIBOR flat), as a component cannot be more than the total cash flows of the entire item. This is often referred to as the ‘sub-LIBOR issue’.

The reason for this restriction is that a contractual interest rate cannot normally be less than zero. Hence, for a borrowing at, say, LIBOR minus 15bps, if benchmark interest rates fall below 15bps, any further reduction in the benchmark would not cause any cash flow variability for the hedged item.

Consequently, any designated component has to be less than or equal to the cash flows of the entire item.

In the above scenario, where the interest rate is at LIBOR minus 15bps, the entity could instead designate, as the hedged item, the variability in cash flows of the entire liability (or a proportion of it) that is attributable to LIBOR changes. This would result in some ineffectiveness for financial instruments that have an interest rate ‘floor’ of zero in situations in which the forward curve for a part of the remaining hedged term is below 15bps because the hedged item will have less variability in cash flows as a result of interest rate changes than a swap without such a floor.

The sub-LIBOR issue is also applicable to non-financial items where the contract price is linked to a benchmark price minus a differential. This is best demonstrated using an example derived from the application guidance of IFRS 9.

The sub-LIBOR issue is also applicable to non-financial items where the contract price is linked to a benchmark price minus a differential. This is best demonstrated using an example derived from the application guidance of IFRS 9.

The ‘sub-LIBOR issue’

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