IAS 39 Financial Instruments: Recognition and Measurement—Separation of an embedded interest rate floor from a floating rate host contract in a negative interest rate environment
The Interpretations Committee received a request to clarify the application of the embedded derivative requirements of IAS 39 Financial Instruments: Recognition and Measurement in a negative interest rate environment. Specifically, the Interpretations Committee considered:
- whether paragraph AG33(b) of IAS 39 should apply to an embedded interest rate floor in a floating rate host debt contract in a negative interest rate environment; and
- how to determine the ‘market rate of interest’ referred to in that paragraph.
The Interpretations Committee observed that:
- paragraph AG33(b) of IAS 39 should be applied to an interest rate floor in a negative interest rate environment in the same way as it would be applied in a positive interest rate environment;
- when applying paragraph AG33(b) of IAS 39, in a positive or negative interest rate environment, an entity should compare the overall interest rate floor (ie the benchmark interest rate referenced in the contract plus contractual spreads and if applicable any premiums, discounts or other elements that would be relevant to the calculation of the effective interest rate) for the hybrid contract to the market rate of interest for a similar contract without the interest rate floor (ie the host contract); and
- in order to determine the appropriate market rate of interest for the host contract, an entity is required to consider the specific terms of the host contract and the relevant spreads (including credit spreads) appropriate for the transaction.