UK interest-rate hedging activity increased by 13% in the final quarter of 2015, according to the latest liability-driven investment (LDI) survey by BMO Global Asset Management.

The level is the second highest in the seven-year history of the survey.

Total interest rate hedging activity amounted to £28.8bn (€39bn) in Q4.

Inflation hedging grew by 8%, to around £19.7bn.

The LDI survey polls the derivatives trading desks of investment banks on volumes of hedging transactions, and has been carried out since the first quarter of 2009.

It covers UK/sterling hedging.

Simon Bentley, head of LDI client portfolio management at BMO Global Asset Management, told IPE the figures include other institutional investors besides pension schemes, as banks do not differentiate between investor types when aggregating the data.

But he said the asset manager expects pension scheme investors to represent the large majority of the data “given the overall make-up of the market”.

The highest level of quarterly interest-rate hedging activity was in Q2 of 2015, a spokesperson told IPE.

The activity over the fourth quarter of last year coincided with some structural changes in the Gilt repo market, the asset manager noted.

According to BMO, recent changes to banking regulations have made it more capital-intensive for banks to hold Gilts on their balance sheets, increasing Gilt repo pricing, and these changes have also “initiated a general shift towards cash collateral rather than Gilt or cash and Gilt collateral”.

Bentley added: “Longer-term concerns around Gilt repo liquidity, combined with a short-term seasonal increase in Gilt repo pricing, led to a bias towards swap-based hedging at the expense of Gilts in Q4,” said Bentley. “This further exacerbated the relative cheapness of Gilts compared with swaps.”

The headline figure for hedging activity last quarter is unrelated to the seasonal increase in repo pricing, he told IPE.

“Anecdotally,” he said, “it appears many schemes set targets to initiate or increase hedges earlier in the year and were simply keen to complete this activity before year-end, resulting in a significant amount of activity during Q4.”

Respondents to the survey had predicted a rise in nominal, inflation and real rates in the first quarter of 2016, but, said Bentley, “there is a reasonable probability that the first UK rate hike won’t now occur until 2017”. 

This is due to unfavourable economic data releases and uncertainty over the referendum on whether the UK should remain in the European Union.

Still, there will probably be some volatility around market expectations for a rate rise, “which could create opportunities for nimble investors”.

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