Inflation derivatives
Produced in partnership with Nick May of Herbert Smith Freehills

The following Banking & Finance practice note produced in partnership with Nick May of Herbert Smith Freehills provides comprehensive and up to date legal information covering:

  • Inflation derivatives
  • What are inflation derivatives?
  • Who uses them?
  • Documentation
  • Types of product
  • Future developments

Inflation derivatives

Inflation derivatives perform an important risk management tool by providing participants with an effective hedge against the risk of changes in rates of inflation. The market for inflation derivatives is large and well established and has existed since its earliest forms, from the early 1980s. The size of the global non-cleared inflation derivatives market was estimated by the International Swaps and Derivatives Association (ISDA) in 2014 at $US 3trn.

This Practice Note provides a summary of:

  1. what inflation derivatives are

  2. who uses inflation derivatives

  3. product types

  4. documentation; and

  5. future developments

What are inflation derivatives?

An inflation derivative is a financial instrument that is used to transfer inflation risk from one counterparty to another. Inflation derivatives are traded on the over-the-counter (OTC) as well as the exchange-traded derivative markets. This Practice Note focuses on the OTC derivative market.

The inflation-linked payments to be made under an inflation derivative are calculated by reference to an inflation index. An inflation index measures changes in the rate of inflation within a country by reference to the changes in price of a representative basket of benchmark goods and services. A significant number of developed economies produce inflation indices, with examples including the Harmonised Index of Consumer Prices excluding tobacco (HICPxT) published by Eurostat for the euro area. In the UK, the primary inflation indices are the Retail Price Index (RPI) and the

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