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Pension demand 'to boost inflation-linked swaps'

UK - Pension fund demand is set to triple the size of the inflation-linked swaps market in the UK, according to Watson Wyatt.

The consulting firm said that, based on the size of inflation-linked swap executions it has already completed this year, the market could exceed £9bn (€13.5bn) by year-end - up from an estimated £3bn last year.

In the UK, the company says it has advised on more than 20 swap and related executions in the last three years - with around £14bn in total nominal exposure.

"As pension funds and their sponsors search for more effective ways to manage risk, they are realising that derivatives can alter the nature of that risk in ways that are not possible in the cash markets," said Kevin Carter, European head of investment consulting.

"In addition, there is a broad realisation that there is a variety of derivative instruments that can provide pension funds with protection, enhanced performance and a better match for liabilities."

Carter added: "While interest and activity has certainly increased among our clients, probably of more importance is the greater number of clients we have advised against execution of inappropriate swap and other structured product transactions."

Carter said: "Institutional investors have been using swaps and options for many years but now they have become more attractive for certain pension funds. However, there are some very important questions funds need to answer before entering these strategies.

“These include legality for use by the fund, pricing transparency in the product, whether the entity selling the solution has the appropriate product and can manage the collateral and will the product do what is expected of it. Subject to answering these satisfactorily, pension funds can confidently consider entering a structured product strategy."

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