A growing number of sovereigns issuing inflation-linked bonds is expected to kick-start the nascent market for over-the-counter inflation-linked derivatives, according to bankers at the 17th Annual General Meeting of the International Swaps and Derivatives Association in Berlin last week. France last year joined the club of sovereign inflation-linked bond issuers and Italy and Germany are reportedly planning their first issue.
"This is hot," said Frédéric Janbon, ISDA board member and senior managing director and global head of interest rates at BNP Paribas. Even though inflation-linked derivatives have existed for several years the market has not taken off as there has not been a liquid underlying market or sufficient demand, he explained.
Kevin Chattwell, managing director of debt markets and head of European derivatives at Merrill Lynch in London, agreed that activity will pick up. "The increase in the cash issuance of inflation-linked bonds will provide liquidity and with this will come growth."
The most basic form of inflation-linked derivative is a swap in which one entity pays the percentage change in an inflation index plus 3% and in return receives Euribor flat, said Thomas Roeder, managing director and head of interest rates and treasury at Dresdner Kleinwort Wasserstein in Frankfurt. This market could be bigger than weather derivatives, he added. At the moment the firm sees a couple of trades a month, however he predicts this could grow to a couple of trades a week in the next 12 months.
Pension funds hedging defined benefit schemes and real estate owners are expected to be the two main users of these products. The typical maturity is five years, but there is also a market in the 25-30 year product for real estate owners that want to hedge long leases.
