Inflation derivatives house of the year: Natixis

Risk Awards 2025: French bank’s hedge fund push boosts its flow standing and creates repack risk offsets

Left to right: Yvon Pilchen, Aurélien Lecaillon, Jean François Partouche, Jean Philippe Foeillet, Robin Lenfant

Photo: Fabrice Vallon

After two years of volatile markets, 2024 saw a normalisation of European inflation, and with it decreasing activity in the market. 

But in the midst of this downturn, Natixis’s corporate and investment banking arm managed to increase its European inflation trading volume by 6.5 times through a concentrated push on the flow business coupled with a standout year for repack solutions products at the bank. 

In all, European inflation derivatives notionals traded at Natixis jumped from €5.6 billion in 2023 to €36.5 billion in 2024.

The record increase in trading volumes came from significant investment in staff hires and increased risk limits, as well as a push with hedge funds whose flows they tapped to recycle structured product risk.

“We developed the hedge fund coverage globally. With these hedge funds, we have the opportunity to risk recycle the book and since the volume of repacks was really big this year, this new franchise of hedge funds was really helpful to us,” says Yvon Pilchen, head of interest rate swaps and inflation derivatives at Natixis.

The push by the French bank has been noticed in the market, with one interdealer broker source saying Natixis has jumped from fourteenth to fifth with them for European inflation in the past year.

For more than a decade Europe struggled to generate inflation until 2021, when the market started to show signs of life in the aftermath of the outbreak of the Covid pandemic. European inflation reached its peak in October 2022 when the Harmonised Index of Consumer Prices for the European Union reached 11.5%.

Despite the fact that inflation is going down, we see more and more people focused on their inflation risk

Yvon Pilchen, Natixis

Since then, inflation has been declining and has sat around 2% in 2024, but concerns about a possible future spike have pushed many to reconsider their positioning.

“Despite the fact that inflation is going down, we see more and more people focused on their inflation risk,” says Pilchen. “Covid helped people to realise that the risk is really important and needs to be hedged.”

Understanding the dynamics at play, the bank set about hiring more talent to meet that demand. For example, in November 2023, the bank hired Aurelien Lecaillon as an inflation trader from Societe Generale.

Natixis also increased its value-at-risk limits across the bank, which directly impacted the inflation business, allowing it to warehouse more illiquid risk.

“It’s a permanent discussion with the risk management team to increase [risk] limits temporarily, but we also had a permanent increase because of new activity,” says Pilchen.

A key component driving the increase in flows at Natixis has been the effort the bank has put into engaging with hedge fund clients. Part of the drive meant going to meet prospective clients from New York or Singapore in-person.

“I think meeting physically between trader and hedge fund was very important because some traders will have a very negative outlook about what the value of the hedge fund flows are, and these tend to disappear when they meet in person, knowing that the person fronting them is not trying to do a tricky trade,” says Jean Francois Partouche Ceyrac, global head of fixed income structuring at Natixis.

That drive has translated into the bank doubling the number of portfolio manager clients it trades European and French inflation with to 20, and a fivefold increase in trading revenues with these players.

Hedge fund boost

Increasing hedge fund coverage was a critical component of building out Natixis’s repack business, which sees it package up inflation-linked bonds and inflation swaps into a special-purpose vehicle (SPV) to give investors a pick-up over holding the bonds.

Not only did the swaps component give the bank an axe that it would take to the hedge funds, but it could also use the channel to de-risk the book with the funds instead of paying fees to use the interdealer market – and ultimately allowed it to do more repack business.

“[The increase in hedge fund activity] gave us confidence that if we were pushing some solution on inflation, like the multi-tranche repacks, that trading would have the capacity to handle it,” says Ceyrac.

As the franchise built, the bank moved from using the hedge fund flows primarily as a means of recycling repack risk, to being able to be aggressive on pricing for a range of products. Clients interviewed during the research process also agreed that they have noticed an improvement in the bank’s inflation pricing this year.

Creative solutions

The actual repack structures on offer had some novel features designed to help life insurance clients, who found themselves competing for cash against short-term deposits and Livret A accounts – a French state regulated, tax-free, instant access savings account that has inflation linkages.

Inflation-linked European government bonds (EGBs) have an illiquidity premium over their nominal counterparts, which allow the insurers to offer their clients investments with more competitive payoffs. But Natixis took it further this year by offering leveraged versions of the trade that boosted returns even more.

The structure saw the bank invest, say, €100 million ($105 million) of cash, with Natixis also fronting €100 million to an SPV which gives a note with a face value of €200 million to the client. The proceeds were used to invest 80% in EGB linkers, with the remainder in nominal EGBs.

We’ve done 80% of our new business on inflation when it comes to repack

Jean Francois Partouche Ceyrac, Natixis

The bonds posted to the SPV were used as variation margin for Natixis on the €100 million exposure, and chosen so that they can be on-posted as margin to supranational clients with one-way collateral agreements. This means Natixis can avoid the costs of having to finance the bonds for cash to post as margin on those CSAs.

The principal is not linked to inflation so the SPV keeps the uplift of the linkers. However, the bond coupons are close to zero and accrued inflation is not paid until maturity, but the SPV has to pay investors a regular coupon.

To solve this, the SPV entered an inflation swap where it paid the bond coupons and the accrued inflation at maturity to Natixis, and received regular fixed coupons it could pass to the investors.

Also, as the final bullet inflation payment owed by the SPV increases, Natixis’s counterparty credit risk to the SPV grows. The main risk for the vehicle is if the underlying EGB issuer defaults, so to cover the risk the French bank had to buy sovereign credit default swaps on the issuer to mitigate the risk. This required increasing the limits for the derivatives valuation adjustment (XVA) desk to allow it to manage the exposures properly.

“If you have a small limit, they will have to rebalance every day. The expected cost of that rebalancing strategy will be huge, and that will make you non-profitable from the beginning. So, we do have a very strong XVA desk, very committed to support the business,” says Ceyrac.

The leverage repack solution was executed for clients including life insurers, pension funds and distributors. The bank has executed a total of €3.4 million of inflation repack trades this year, measured by the sensitivity of the value to a 1 basis point move in underlying inflation, with the leverage solution making up more than half of it.

By the middle of the year, the bank was solely responsible for putting 9% of the French Treasury’s entire 2053 linker issuance into repack format.

“The difference this year is that we delivered for size, that was new. I believe clients were maybe surprised that we saw so much size and were still the most aggressive in terms of pricing,” says Ceyrac.

“We decided to switch all our proposals from nominal to linkers in a year, and we’ve done 80% of our new business on inflation when it comes to repack,” he adds.

The bank also offered a multi-tranche version of the inflation repack trades, which saw investors investing a certain amount at the beginning and committing to invest in additional tranches during the lifetime of the product, up to around four times. However, the investor gets the benefit of the full investment amount from the start.

Again, this gave counterparty credit risk to Natixis from non-payment of the additional tranches. The bank needed to have documentation in place that would allow it to claim the future payments from the clients, and it also had to model the correlation of a decline in counterparty credit risk and default risk from the bond collateral. Both had to be taken into account when pricing the trade.

The bank has done €300 million total notional of this multi-tranche structure with three different clients in Germany and France since launching the product in May.

The home front

Outside of flow and repacks, Natixis also provided hedges in a less liquid index to protect retail lenders and social housing borrowers from future rises in their specific borrowing costs.

Normally the Livret A rate, the rate on the tax-free French state-backed savings account, is set every six months, taking into consideration the average euro short-term rate and the average change in French inflation over the past six months.

With the formula, the Livret A rate would have been increased to 4.1% in October 2023. But on July 13 last year, the French government announced that it would freeze the Livret A rate at 3% until February 2025.

Social housing entities get their funding from the Caisse des Dépôts et Consignations, a French state-owned entity, at the Livret A rate, and suffered when the rate rose in 2022. So, with the forward rate higher than spot, Natixis worked with a number of these firms so they could hedge their loans by receiving the relatively illiquid benchmark and paying fixed via forward-starting swaps that began after February next year.

Retail banks also use deposit funding linked to Livret A, so Natixis traded the same forward-starting swaps with some of those banks in its BPCE network.

Altogether, Natixis executed €1.4 billion notional of swaps linked to the Livret A rate with both types of counterparty.