Equity slump sees upsurge in long-dated hedging

The European interest rate swaps market has seen a return of the long-dated hedging programmes that first surfaced at the end of last year, according to traders at investment banks.

Traders reported a substantial increase in swap flows at the long-end of the swaps curve during the past three to four weeks. Three banks – UBS Warburg, Morgan Stanley and Merrill Lynch – were identified as the main players in the market, increasing their swaps activity to meet the demands of their clients. Despite the increased flows, many claim this is still only the start of the swaps activity, as more European pension funds look to hedge their long-dated liabilities.According to Robert Pearson, managing director of the interest rates derivatives division at UBS Warburg, the past few weeks have seen a massive increase in institutions receiving fixed on long-dated swaps: “We’ve seen average daily flows between €1 billion and €1.5 billion on the long-end in the past few weeks. This compares with the usual daily average of a few hundred million euros.”

The increase in swaps volumes comes as a result of the equity markets downturn that has led to an increased move out of the equity markets. “End-users are switching out of equity into fixed income using swaps as a proxy for the fixed-income element,” Pearson added.

The 10-year to 30-year part of the swaps curve has flattened significantly from its levels earlier this year, due to the increased volumes. 30-year swaps continue to offer good pickup for investors looking to move out of equities, and have been at 5.30% over the past three weeks. But the increase in activity has now caused rates to fall to around 5.17%.

Market participants expect the swaps activity to continue as the equity markets continue to drop. Pearson pointed out that several European institutions have yet to complete their swapping programmes and, as a result, expects to see a lot more activity in the market.