Remarks before the 2019 AICPA Conference on Current SEC and PCAOB Developments
Jamie N. Davis,
Professional Accounting Fellow, Office of the Chief Accountant
Dec. 9, 2019
The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
Good morning. It is an honor to speak with you today. This morning I would like to share some thoughts on the expected discontinuation of LIBOR.
Discontinuation of LIBOR
In July, SEC Staff from the Division of Corporation Finance, Division of Trading and Markets, Division of Investment Management, and the Office of the Chief Accountant released a staff statement on LIBOR transition. I encourage you to read that statement if you are not already familiar with it. Among other topics, the statement discussed how we, in the Office of the Chief Accountant, have been following the issues in this developing area.
Cash flow hedges
Last year at this conference, an OCA staff member discussed the impact of the anticipated cessation of LIBOR on existing cash flow hedge accounting relationships. More specifically, he shared staff views on whether an entity could still assert that LIBOR based interest payments identified in a cash flow hedge are probable of occurring, despite the anticipated LIBOR cessation. He also shared staff views on whether or how to consider prospective hedge effectiveness assessments for cash flow hedges. Prior to the implementation of the FASB’s pending accounting standards update relating to reference rate reform,  stakeholders may continue to find these views helpful as they evaluate cash flow hedges that involve LIBOR-based interest payments.
Financial Accounting Standards Board (FASB) standard setting
The SEC staff statement also highlights the proactive efforts of the FASB to address accounting considerations relating to reference rate reform. Since the issuance of the statement, the FASB issued a proposed accounting standards update. OCA is supportive of the FASB’s efforts in this area, and we especially commend their efficient and thorough work on this project.
Amendments to equity-classified preferred stock instruments
OCA recently addressed a consultation on how to account for amendments to preferred stock instruments that are expected to be made as a result of the anticipated cessation of LIBOR.
The fact pattern provided involved perpetual preferred stock instruments that are equity in legal form and classified in permanent equity by the issuer. For at least a portion of the life of the instrument, periodic dividend payments by the issuer are based on a LIBOR rate. The sole business purpose of the amendments will be to designate a replacement dividend rate index for LIBOR (in this case, the Secured Overnight Financing Rate – “SOFR”) upon the cessation of LIBOR. No cash will be exchanged in connection with the amendment agreement.
Modification vs. extinguishment
There is currently no explicit guidance in U.S. GAAP on how to account for amendments to preferred stock. OCA staff has previously observed that there are various acceptable approaches for analyzing these changes to determine whether they represent a modification or extinguishment. As part of the issuer’s historical analysis of amendments to preferred stock, they elected an accounting policy to apply a qualitative approach, which is one of the models that the staff has previously accepted.
In continuing to apply this accounting policy to evaluate the amendments to the preferred stock described in the illustrative fact pattern, the entity considered the business purpose for the changes and how the changes may influence the economic decisions of the investor. Since they concluded such changes were not significant, they believed the amendments would be treated as a modification to the preferred stock. OCA staff did not object to that view.
Recognition of the modification
The second question addressed the determination of any accounting recognition on the modification date. OCA staff has previously observed that when accounting for a preferred stock modification, it would be acceptable to analogize to the modification guidance contained in Subtopic 718-20, which addresses changes to equity-classified share-based payment awards. Application of this guidance would result in recognition of the increase in fair value of the modified instrument upon modification.
In the fact pattern provided, the entity performed a qualitative assessment and determined that the sole business purpose of enacting the modification was to identify a permanent replacement rate for LIBOR. They drew a distinction between this type of modification and other modifications that may be structured to transfer value. For example, the staff has observed preferred stock modifications done in contemplation of the issuance of a new series of preferred stock where the business purpose of the modification may be to transfer value to the holders of the preferred stock.
In the case of the modification enacted in contemplation of the cessation of LIBOR, the entity asserted that there is a presumption that the modification will be negotiated at fair value.
There will likely be a change in fair value of a LIBOR-linked preferred stock instrument leading up to the anticipated cessation of LIBOR. Given that this is widely known in the market, the entity asserted that market participants will increasingly consider this when pricing LIBOR-linked contracts. In accounting for a modification of preferred stock, only incremental fair value is recognized. The fair value immediately prior to the modification would already consider the impact of the anticipated LIBOR cessation, minimizing any potential increase in fair value as a result of the modification whose sole business purpose was to add or amend fallback language.
OCA staff therefore did not object to the conclusion that there is no recognition of any change in fair value as a result of the modification in the fact pattern presented.
I encourage stakeholders to continue to evaluate their exposure to LIBOR-based contracts. As you continue that work, OCA encourages you to raise accounting considerations. As always, OCA is available for consultation on accounting issues.
Thank you for the opportunity to share my views with you today. I look forward to the continued dialogue.
 Formerly an acronym for London Interbank Offered Rate, LIBOR is common parlance for its current official name ICE LIBOR.
 See Staff Statement on LIBOR Transition from the Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant (July 12, 2019), available at: https://www.sec.gov/news/public-statement/libor-transition.
 See Rahim M. Ismail, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 2018 AICPA Conference on Current SEC and PCAOB Developments (Dec. 10, 2018), available at: https://www.sec.gov/news/speech/speech-ismail-121018.
 FASB Proposed Accounting Standards Update, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Sept. 5, 2019) (“FASB’s Proposed Accounting Standards Update”), available at: https://fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176173289025&acceptedDisclaimer=true.
 The Alternative Reference Rate Committee is publishing optional fallback language to be used in contracts that currently reference LIBOR. This language describes the triggers that indicate that LIBOR should no longer be used as the contract’s reference rate. For more information see:
 See T. Kirk Crews, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 2014 AICPA Conference on Current SEC and PCAOB Developments (Dec. 8, 2014), available at: https://www.sec.gov/news/speech/2014-spch120814tkc.
 ASC 718-20, Compensation – Stock Compensation: Awards Classified as Equity (“Subtopic 718-20”).
 See supra note 7.