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New regulation such as Basel III has compelled banks to get inflation swaps signed with utility companies off their books, as uncollateralised derivatives exposure requires much greater capital. John Towner, director at Redington, said: "Because they are regulated and because their revenue stream is linked to RPI, utility companies have a more predictable cash-flow profile, and issuing inflation-linked bonds often makes sense in terms of their capital structure." However, as Towner stressed, these stable cash flows have led many utility companies to establish what are known as whole business securitisation (WBS) programmes, which enable them to issue debt more efficiently.
Towner went on to say that acquiring these kinds of swaps from banks, looking to reduce assets in light of new capital requirements, made sense for pension funds, particularly because the swaps delivered long-dated, inflation-linked cash flows that matched well with pension liabilities. He conceded that a number of implementation issues remained, such as bridging the valuation gap, as well as making pension funds comfortable enough to take the assets onto their books at all, given the credit exposure to utility companies.
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