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!!!!!!!!!"#$%&!(!)*+,&+,-!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !./0!1%*$#%!2#345+6!7+8&9!:!./0!13&&+;*<-&!7+8&9!:!./0!/%<...
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Weather derivatives                 The weather derivatives market continues to gain end-user, hedge                 fund ...
weather hedges to manage that   risk. That compares to 29% of                                                             ...
Weather derivatives                           counterparties. “Weather is becoming a             of millions of dollars, w...
Weather derivatives   “The auction might come from one country                                     Investors may be poised...
Weather derivatives       “The good news is that there is new                                                       to Cel...
SolutionsGetting a grip on climate riskA new index lets investors express their views on how fast the planet is warming   ...
SolutionsInconvenient truth: now you can hedge against it with the UBS Greenhouse IndexTurning up the heatNew index broade...
SolutionsThe sea may be calm but the freight rates are volatileBlue Sea thinkingA new index on sea-freight derivatives hel...
!""""""""""""""""""""""""""""""""""""!!!!!!!!!!!!!!!
WEATHER Derivatives                          Weather Derivatives                                                          ...
WEATHER Derivativessuggest that the number of contracts traded will be      more in the market. It is difficult to quantif...
WEATHER Derivatives                                 Investment buyers of weather derivatives will tend     ingful performa...
Panorama – 17-Jul-08
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, ...
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Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, Carbon, Freight, Shipping

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Ilija Murisic - Alternative Asset Markets

Articles Financial Times, Wall Street Journal, Reuters, Risk Magazine, Carbon Emission, Freight, Shipping


Keywords: Weather, Weather Derivatives, Carbon Finance, Carbon Emission, C02, HDD, CDD, CME, EUA, CER, FFA, futures, climate change, Index, Kyoto, UBS, derivatives, hybrids, trading, structured products, china, commodities, port congestion, capital markets, freight, shipping

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Alternative Asset Markets - Ilija Murisic - UBS Global Warming Index, UBS Greenhouse Index, UBS Blue Sea Index - Weather, Carbon, Freight, Shipping

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  5. 5. Weather derivatives The weather derivatives market continues to gain end-user, hedge fund and investor interest. Roderick Bruce examines the forecast and finds a silver lining on the current Wall Street cloud Every cloud... After a barren year in 2006/7, the weather tion to the headline numbers in the PwC derivatives market has come storming back. survey, which have grown quite a lot over the Notional value of over-the-counter (OTC) years, perhaps an even better barometer of the and exchange-based weather trades on the market’s health is that end-user hedging trans- Chicago Mercantile Exchange (CME) rose actions have been growing at a steady pace 76% between April 2007 and March 2008 since the inception of the market,” says Martin to reach $32 billion, while contracts traded Malinow, CEO of Galileo Weather Risk rose by 35% to 985,000 over the same period, Management and president of the Weather according to a survey by Pricewaterhouse- Risk Management Association (WRMA). Coopers (PwC). The weather markets look ripe for further The market had reached a high of $45 billion growth. End-users are coming from a variety in 2005/2006, and its decline the subsequent of new sectors, with increasingly advanced year led many to question its longevity. “Since structured deals making risk transfer more its inception, the weather markets have faced effective, and innovative origination compa- challenges, but they continue to be resilient,” nies such as Storm Exchange and Weather- says Felix Carabello, director of alternative Bill are offering improved access to derivatives investments at CME Group. for small businesses. Most significantly, as the Carabello says the 2006/2007 drop in trading winds of change sweep away investment banks volume came from a period of staff reorgani- and insurance companies on Wall Street, hedge sation within market participants. He noted funds and reinsurers are turning to the market that traders’ risk appetite was reduced as in increasing numbers, as are investors seeking they settled into their new roles. “Because a uncorrelated assets to diversify portfolios. number of traders were changing jobs, we saw a decrease in volumes,” he says. “The moves Energetic growth were caused by market evolution and organic Market participants say that around 90–95% of growth. It was like a kid losing its milk teeth global weather derivatives volumes come from before it matures.” the US, with Europe supplying the bulk of the End-user hedging business – particularly remainder, with some trades occurring else- within the energy sector – remains the pillar where, particularly Japan, Australia and India. that the weather market is built on. “In addi- The US energy sector, which pioneered the weather derivatives market in 1998 with a deal between Koch Industries and Enron, remains “A barometer of the market’s health the biggest end-user, according to brokers. is that end-user hedging transactions A CME Group / Storm Exchange survey carried out in April, which polled 205 risk have been growing at a steady pace and finance mangers across the US, found that 74% of respondents in the energy sector had since the inception of the market” attempted to quantify the impact of weather on Martin Malinow, Galileo Weather Risk Management & WRMA their business, and 35% had actually employed26 energy risk energyrisk.com
  6. 6. weather hedges to manage that risk. That compares to 29% of The weather retailers – none of whom had derivatives market employed derivatives. has come storming “Energy companies are still back after a barren the number one participant,” year in 2006/7 says Bill Windle, who began trading weather derivatives at Enron in 1999 and is now managing director at RenRe Investment Managers, a weather risk management company. “More and more unregulated energy providers are seeking our services because they do not benefit from regulatory mecha- nisms that limit their exposures – they’re in a truly free market, so volumetric and price expo- sure is significant.” More energy compa- nies – producers, marketers and consumers – are getting involved in the market as product offerings advance. ©iStockphoto.com/Tobias Helbig Significant new volumes are coming from cross-commodity deals that allow hedgers to offset both volumetric risk with tradi- tional derivatives and price risk with more complex structures. For example, a deregulated natural gas provider depends on cold weather “There’s quite a bit of appetite for these to drive sales. While the company can esti- products,” says Windle. mate sales based on temperature predictions That appetite is not limited to the US. (using heating or cooling degree day – HDD Whereas energy companies in Europe tradi- /CDD – indexes) and create a supply port- tionally hedge volumetric risk from warm folio accordingly, if the winter is colder than winters, many gas distribution companies expected then the company will be forced to in the UK now hedge price risk from colder enter the market to buy more gas when prices than expected winters. “If it’s much colder are at their highest. than normal, short-term natural gas prices in To hedge this risk, the company can buy a the UK tend to spike more than they do on natural gas-linked weather derivative. “If the the European continent,” says Jens Boening, temperatures are over a certain strike we’ll sell managing director Europe & Asia at Weath- the company natural gas at a fixed or indexed erBill, which provides customised products to price, allowing them some comfort that they end-users from utilities to small businesses. won’t have to purchase in a high price envi- Boening points out that end-user demand ronment,” says Windle. in Europe is not met efficiently in the traded Should the winter be warmer than expected, market, as standardised products (such as those Nicholas Ernst, Evolution a put position then allows the company to sell based on HDDs at London Heathrow) leave Markets: “Weather is becoming any excess inventory at the end of the season significant basis risk. a cross-commodity market, and at a predetermined or indexed price, allowing Cross-commodity products are therefore around 20% of our business the company to better match their volumetric attracting new end-users to the market, now comes from these deals, up and price exposures in one combined product. and increased volumes from established from about 10% a year ago”October 2008 energy risk 27
  7. 7. Weather derivatives counterparties. “Weather is becoming a of millions of dollars, whereas only a year cross-commodity market, and around 20% ago we were dealing with more middle- of our business now comes from these deals, market clients.” up from about 10% a year ago,” says Nicholas Brian O’Hearne, managing director, finan- Ernst, head of the weather derivatives group cial products at Swiss Re, says that agriculture at broker Evolution Markets. “The growth in is clearly the fastest growing end-user sector, the market is not just coming from new end- as awareness of weather’s impact on crop users, but also increased risk transfer from the yield – and how to hedge this risk – improves natural gas, power and heating oil markets.” across North and South America. “We’ve seen interest from Australia, South Africa – anywhere with an agricultural economy has a need for weather derivatives,” he says. “WeatherBill will de nitely give the One such economy is India’s, where 55% of end-user market a boost” the population (around 621 million people) depend on agriculture for their livelihood. The Jens Boening, WeatherBill sector contributes 18% of India’s GDP, equiva- lent to $748 billion. Weather risk is concen- Harvesting new business trated in precipitation: 75% of the country’s Advances in deal structuring, combined with annual rainfall of 110 centimetres occurs during soaring grain prices, have drawn significant the summer monsoon season between June and interest in weather risk hedging from the agri- September. In addition, 26% of India’s power culture sector. “There is weather risk in the generation comes from hydropower. entire agricultural value chain, only a portion “Higher or lower than normal rainfall can of which is covered by Federal crop insur- create a huge problem for the economy, partic- ance,” says the WRMA’s Malinow. “At these ularly large sections of the rural population,” unprecedented price levels, there is more abso- says Kolli Rao, chief manager of the Agri- lute value to lose than ever before.” cultural Insurance Company of India (AICI). Weather risk manager and information “Weather derivatives and insurance could provider Storm Exchange has seen its busi- therefore be a huge market here.” ness grow dramatically, thanks in no small part Janani Akhilandeswari, a consultant at The to the agricultural sector. The company has Centre for Insurance and Risk Management tripled its staff in the past 12 months, hiring (CIRM), estimates that India’s OTC weather experts in agronomy and agricultural mete- derivatives market is worth around $1 billion. orology to meet growing demand. Storm At the moment, exchange-traded weather Exchange has developed crop-specific indexes, derivatives are not permitted under Indian law based on how weather impacts yield and crop as they are “intangible assets”, but a bill being growth, and offers structured derivative prod- considered by the government is likely to ucts around them. allow trading in commodity options, weather “The convergence of energy risk and agri- derivatives and index futures within the next cultural risk is now more prevalent than ever, 12 months. Index-based weather insurance given the effect of yield and price volatility products currently meet the demands of the on many of the largest ethanol producers,” agriculture sector. says David Riker, president and CEO of “We are currently working with the National Storm Exchange. “The deals we’re doing Commodity and Derivatives Exchange now are multi-year contracts worth hundreds [NCDEX] in designing and pricing exchange- traded weather derivative products to be traded once the regulatory barriers are lifted,” says “Since its inception, the weather markets CIRM consultant Rupalee Ruchismita. “We see huge potential in this market.” The Multi have faced challenges, but they continue Commodity Exchange of India (MCX) is to be resilient” also said to be considering launching weather derivatives, according to AICI’s Rao. Felix Carabello, CME Group Kendall Johnson, managing director and global head of weather derivatives at broker28 energy risk energyrisk.com
  8. 8. Weather derivatives “The auction might come from one country Investors may be poised to play a major role in and place the risk in two di erent countries the weather market’s expansion, but there is a consensus among participants that growing or time zones. It’s becoming a truly end-user business is the key to assuring long- term market integrity. “From the beginning global market and the auction format people thought our markets would be revolu- helps us to cover that” tionary, but they have been evolutionary,” says Kendall Johnson, TFS Energy RenRe’s Windle. “There is no next big thing that will come in and double market volumes, funds were reportedly keen to trade as the but I’m confident that there will be continued index was a counterparty of unprecedented double digit year on year growth in the trading size in the market. of weather-related products.” Some participants aren’t so enthusiastic though. “When UBS enters the market it Bright forecast creates a ripple effect,” says one weather One platform seeking to harness the global market participant. “It’s a problem for the potential of weather risk management is market when someone puts out an auction, WeatherBill, by offering a service that allows instead of taking a more calculated approach to businesses to customise, price and buy weather execution. When someone comes in and shows coverage online. Since being founded in 2006 their entire hand it pretty much paralyses the it has protected a diverse range of clients, from market for a lengthy period of time.” travel companies to car washes and hair salons. Another participant observes that, as the The company itself does not actively trade index is weighted for locational liquidity the market, but rather develops a portfolio of rather than seasonal liquidity, the exposures offsetting – negatively correlated or uncorre- are greater in October to April, instead of lated – weather derivative contracts. being weighted towards the more liquid mid- WeatherBill offers online access to around 20 season. “Conceptually it’s great, but I ques- different contract types combining tempera- tion the longevity of it, given the way it’s being ture, precipitation, snow and frost across seven executed,” he says. countries including the US, UK and Germany. However, the majority of feedback from “We are the first to offer this level of custom- the market on the UBS index is positive. isability in terms of the indices available and “There’s now plenty of liquidity in the market weather stations being offered – we will defi- to absorb structures like this,” says Swiss Re’s nitely give the end-user market a boost,” says O’Hearne. “Investors are looking for diver- WeatherBill’s Boening, formerly of Merrill sification, and weather derivatives offer very Lynch and vice-president of the WRMA. “Our good non-correlated returns.” mission is to democratise the weather market.” Murisic told Energy Risk that he is now WeatherBill is currently seeking registration developing an investor index based on poten- with the UK’s Financial Services Authority, tial Indian precipitation contracts, to be which will allow it to offer its products to listed on the NCDEX. “The Indian monsoon every UK business. The level of granularity derivatives market could be one of the world’s offered is very different to the standard- largest in terms of volume,” he says. He ised CME contracts that have so far been the is also hoping to develop an index for the market driver. “Companies like WeatherBill burgeoning hurricane derivatives market (see and Storm Exchange provide an invaluable ‘Hurricane derivatives’ box). service, a different kind of risk transfer tool “Higher or lower than normal rainfall can create a huge problem for the economy, particularly large sections of the rural population [in India]. Weather derivatives and insurance could therefore be a huge market here” Kolli Rao, AICI30 energy risk energyrisk.com
  9. 9. Weather derivatives “The good news is that there is new to CelsiusPro, a Europe-focused platform similar to WeatherBill, as a signal that online appreciation that falling asset prices don’t origination could be the way forward. With end-user and investor interest on the change the temperature in London” rise, the forecast looks bright for continued Martin Malinow, Galileo Weather Risk Management & WRMA growth in weather derivatives trading, despite the testing times currently being experienced from us,” says CME Group’s Carabello. “It’s in the global markets. Indeed, the very nature more customised, less commoditised.” of the weather market means it may benefit as Market veterans Brian O’Hearne and Bill institutions seek diversification. Windle view WeatherBill’s emergence as the Malinow is cautiously optimistic. “We haven’t next step for the market. Windle feels the seen much impact on weather markets so far, increased liquidity will benefit all market but it would be naive to think there won’t be players. “The tide will rise, and as it rises it will some fallout given the general credit contraction lift all boats,” says Windle. “I wish WeatherBill and deleveraging we have been facing,” he says. success, because it will be beneficial to all of us.” “The good news is that there is new apprecia- O’Hearne meanwhile points to Swiss tion that falling asset prices don’t change the Re’s agreement to provide risk capacity temperature in London.” Hurricane derivatives Index-based hurricane futures and options, launched on the CME mph winds would score 2.5 on the index. Hurricane Katrina would in March 2007, stand at the crossroads between the insurance / have scored 19. “The Carvill index is a more precise proxy for reinsurance industry and the capital markets. The products were storm damage and intensity than the Saffir-Simpson scale [which formulated in a joint-venture between specialist reinsurance rates hurricanes in categories 1 to 5]” says Martin Malinow of company Carvill, the index provider, and CME Group as a result Galileo Weather Risk Management. “It’s a purely parametric index, of the devastating 2005 hurricane season, which caused an so it’s effectively a weather derivative and seems to be a product estimated $79 billion worth of damage. Such was the hit on that’s here to stay.” the insurance market that some claims from Hurricane Katrina Nicholas Ernst of Evolution Markets, which recently set up a remain unsettled. desk to broker cat bonds, ILW derivatives and the CME’s hurricane “The problem that the reinsurance companies faced was a futures, says that hedge funds prefer to trade the CME/Carvill futures concentration risk – companies had been warehousing risk so it as the index format is ideal for algorithmic trading. “The problem was concentrated too much in one space,” says CME Group’s Felix is that it doesn’t fully cover all insurances risks – it leaves significant Carabello. “Some reinsurance companies believe that warehous- basis risk,” he says. “Right now it’s maybe too big a leap from the way ing of risk was an unsustainable business model and they realize business is traditionally done, but the market is two or three years that they have to shed their risk through different types of coun- away from really exploding.” terparties accessible through CME Clearing.” After little interest in 2007, an active 2008 storm season has seen Insurance companies previously insured their risk through a 32,600 hurricane contracts traded on the CME up to August this reinsurance contract called an Insurance Loss Warranty (ILW), year; notional value has yet to be calculated, according to the CME. brokered by companies such as Aon or Guy Carpenter. Now prod- Swiss Re’s Brian O’Hearne says that more point-specific and ucts such as catastrophe bonds, which pay out to investors based location-specific products have helped to encourage insurance on large weather events, or ILW-based insurance futures (traded companies to trade on exchanges. “Insurance derivatives are on London-based Insurance Futures Exchange, IFEX) are allowing poised for significant growth,” he says. hedge funds, investors and energy companies to hedge hurricane One participant who wished to remain anonymous says that risk, at the same time diversifying the insurance market. many insurance hedge funds are up 10-15% for the year, because The CME contracts have increased accessibility to the market, as they are uncorrelated to floundering financial markets. “With AIG they do not feature an indemnity piece; no receipt for loss needs having gone belly up there will be more reinsurance opportuni- to be shown to guarantee a payout (unlike ILWs). “With these ties,” he says. “The fact these assets have done well when every- futures you can parametrically calculate the risk and infer statistical thing else has performed poorly means there will be significant losses, and it settles immediately,” says Ilija Murisc of UBS. “For a capital inflows.” utility company that’s very useful.” And of course, institutional and retail investors are on the The underlying index measures hurricane size and maximum lookout for uncorrelated assets. “There are opportunities to wind speed. Contracts trade at $100 for each 0.1 points on the create an index in the catastrophe markets, just as UBS has done in index. A relatively small hurricane with a 60-mile radius and 74 the weather markets,” says Kendall Johnson of TFS Energy.32 energy risk energyrisk.com
  10. 10. SolutionsGetting a grip on climate riskA new index lets investors express their views on how fast the planet is warming cities – including New York, Chicago, Atlanta, and Las Vegas – that are most actively traded on the CME’s weather derivatives exchange. Between May 2 and September 3 this year, an excess temper- ature of 0.68ºF on these contracts caused the index to climb by almost 35%. This performance showed minimal correlation with any other investible asset class, a fact that could make the climate an interesting candidate for inclusion in otherwise tra- ditional portfolios. Access to the index would be via structured products, perhaps in combination with other types of asset. More cities could potentially be included in the index. The CME currently trades weather derivative contracts for 18 US and nine European cities, as well as six Cana- dian and two Japanese locations. To be eligible for inclusion in the GWI, however, the volume of futures traded for any given city must represent 1% or more of the total weather derivatives contracts tradedA broader swathe of investors can now give climate derivatives a whirl on the CME. Provided they meet this con- dition, European and Asian cities are likely to be included in the GWI over the me-Weather derivatives have been traded Bank to come up with the world’s first dium term. A UBS-GWI governance com-for the best part of a decade. In theory, ski index that tracks temperatures on a mittee will meet annually to determineresorts could use them to hedge against national and regional rather than a local the composition and the weighting of thewarm winters or brewers to protect them- basis. Launched in April this year, the UBS UGWI index and its family of sub-indices,selves against cool summers. In practice, Global Warming Index (UBS-GWI) is a trad- which currently covers four US regions: thethough, most users are in the energy sec- able benchmark for global investments in Northeast, Midwest, West and South.tor. The Chicago Mercantile Exchange the weather derivatives market. It provides Although there has been a dramatic in-(CME) established a weather derivatives a rational and simple way to obtain finan- crease in weather derivatives volumes overexchange for temperature contracts ref- cial exposure to large-scale trends in the the course of the last few years, tradederenced to certain US cities in September climate. The index should also prove useful products using weather remain inacces-1999, later adding European and Asian to industries that need to hedge against sible to the vast majority of the financialreferences. More recently, the CME has damaging climatic trends. Potential users community. Used mainly as a hedging in-added contracts on snowfall, frost and could include many branches of agricul- strument by energy, insurance and com-hurricanes. These innovations helped lift ture, tourism and construction. modity professionals, weather derivativestotal CME turnover in weather contracts remain largely untouched as an assetto some $45 billion in 2005 –2006. This How it works class in their own right. UBS’s new Globalsuccess has attracted attention elsewhere. The UBS-GWI is based on existing CME Warming Index could change that by pro-In mid-2006, China’s Dalian Commodities weather futures contracts that settle on viding a simpler way for a broader rangeExchange announced that it planned to the difference between the average daily of institutional and private investors tostart trading weather futures, with the aim temperature and a base temperature of gain financial exposure to global tempera-of helping Chinese farmers hedge their 65ºF. These are Heating Degree Day (HDD) ture trends.exposure to bad weather. and Cooling Degree Day (CDD) contracts, Weather, though, is not climate. As cli- so-called because they measure how far it Ilija Murisic UBS Investment Bank,matologists like to say, weather is what is necessary to heat or cool buildings in the Non-standard derivative productsyou get while climate is what you expect. prevailing weather conditions. At present, ilija.murisic@ubs.comThis insight prompted UBS Investment the index comprises contracts on the 15 US14 UBS News for Banks / Winter 2007
  11. 11. SolutionsInconvenient truth: now you can hedge against it with the UBS Greenhouse IndexTurning up the heatNew index broadens the choices for investors concerned withclimate changeUnless you are a dairy farmer in Green- If it chooses, this clientele can now focus four-fifths of the combined emissions in-land, climate change is an inconvenient even more selectively on the human- dex by value, reflecting its greater underly-truth. For most such inconveniences, induced element in climate change. The ing market volumes. As index componentsthough, there is a convenient tool for recently launched UBS Greenhouse Index are weighted according to the volume ofhedging their effects. Climate change was (UBS-GHI) is a play on both temperature underlying transactions, new weather con-the exception until April last year, when trends and, indirectly, on the amount of tracts or carbon reduction schemes couldUBS launched its Global Warming Index carbon dioxide in the air, an important be added to the GHI in future, if justified(UBS-GWI). Rolling into a single instrument cause of global warming. Half the index by their popularity.a selection of intensively traded weather by value is based on the existing Global As the existence and pricing of carbonderivatives, the index offers investors a Warming Index, while the other half reduction schemes depend wholly onnew and handy way of expressing views tracks futures contracts on two princi- human agency, the GHI is a more complexon regional or national climate trends in pal markets for carbon emissions, the EU instrument than its predecessor. It shouldthe US. (See News for Banks, Winter 2007 Emission Trading Scheme (40% of the appeal to institutional investors looking foredition for more details.) index) and the Kyoto Clean Development additional portfolio diversification, reckon This invitation was taken up with enthu- Mechanism (10%). Thus the index delivers the product’s designers within UBS Invest-siasm. Since inception, the Global Warm- exposure to temperatures across a selec- ment Bank’s hybrid derivatives tradinging Index has attracted some $100 million tion of US cities, as well as prices for unit. Other users could include businessesin contracts. Even more significantly, it has carbon dioxide in the EU and for carbon exposed to the risk of adverse climatebuilt a new user base for weather deriv- dioxide reductions sold by developing change and those that need to hedgeatives. While traditional weather futures nations to developed ones. against the risk of legislation designed totend to be patronized mainly by energy For investors preferring to concen- curb carbon dioxide emissions. You couldprofessionals and a few specialized hedge trate solely on greenhouse gas emissions, even sell the index short to hedge againstfunds, the GWI has pulled in insurers, pen- a family of sub-indices is available that the unlikely risk of global warming goingsion funds, and even retail investors. GWI track either the European emissions trad- into reverse.investors have been rewarded by a 53% ing scheme or the Kyoto Clean Develop-rate of return since inception (as at mid- ment Mechanism or both in combination. Ilija Murisic UBS Investment Bank,February), as well as minimal correlation As in the emissions part of the parent in- Hybrid Derivatives Tradingwith other asset classes. dex, the European scheme accounts for ilija.murisic@ubs.com UBS News for Banks / Summer 2008 19
  12. 12. SolutionsThe sea may be calm but the freight rates are volatileBlue Sea thinkingA new index on sea-freight derivatives helps investors tap into the China storyIn the same week that UBS launched on time. The upshot is a rising trend in also incorporates a “Port Congestion Fac-its Blue Sea index on freight derivatives, freight rates, coupled with spectacular vol- tor” that takes into account the effect onthe 203,512-tonne bulk carrier China atility; the benchmark Baltic Exchange sea freight derivative prices of loading or un-Steel Team was booked to carry iron ore freight index for dry commodities sagged loading delays in more than 60 iron orefrom Brazil to China. At a record-break- by more than a third between November and coal ports worldwide.ing $303,000 per day, the freight rate last year and mid-January 2008 on fears The index is aimed primarily at investorswas more than three times higher than of a US recession, although it has since who are interested in freight as a genericthe ship’s last fixture, just one month pre- bounced back. asset class. In addition, shipowners andviously. China Steel Team is one of fewer That volatility, of course, has already charterers could use the index to hedgethan 600 Capesize bulk carriers in the attracted banks, hedge funds, and other their total exposure to freight rates. Forworld. And as the name of this particu- financial institutions. So far, would-be this purpose, sub-indices are also available.lar one suggests, China’s prodigious appe- investors have looked to the existing mar- These are based on the three categories oftite for raw materials is keeping all of them kets for sea-freight derivatives, which are bulk carriers that comprise the main index,busy. That’s not surprising, when you con- based mainly on futures and forwards on namely the Capesize giants and the hand-sider that Baosteel, China’s leading steel the principal reference indices. What was ier-sized Panamax and Supramax types.producer, needs 150 ship-loads of ore lacking, however, was a packaged instru- It’s too early to say which types ofevery year to feed its blast furnaces. ment that offered a balanced exposure to investor will make the most intensive use Statistics like these explain why sea a representative spectrum of the dry-bulk of the new index. But Blue Sea has cer-freight rates are rocketing, particularly for freight market. It was this gap that UBS tainly captured the attention of industrydry bulk cargoes such as iron ore or coal. sought to fill when it launched its Blue Sea experts. Lloyds List, the longest-standingAccording to Simpson Spence & Young, a Index on May 22. daily newspaper for the maritime industry,consultancy, average dry bulk freight rates commented as follows: “This new UBSreached almost $220,000 per day in May, Congestion factor initiative deserves to be watched as it mayup from $80,000 or below in January UBS Blue Sea is the first fully integrated in- introduce a new level of sophistication toand a previous long-term average of dex to be benchmarked on the most ac- the freight derivatives market by opening$15,000 – $20,000. Capacity shortage is tively traded dry-bulk forward freight it up to investors who are not necessarilyresponsible for part of this squeeze but agreements. FFAs are non-standardized freight professionals. The Blue Sea Index isa lack of tonnage is not the whole story. over-the-counter forward contracts based indeed blue sky thinking.”Even if the 185 or so Capesizers on order on one of several underlying freight indi-could be delivered tomorrow, ports and ces. They are agreed between two parties Ilija Murisiccargo terminals are too choked with ship- for a specific route, for a specific delivery UBS Investment Bank, Hybrid Derivatives Tradingping to allow them to load and unload rate and a specific vessel type. The index ilija.murisic@ubs.com UBS News for Banks / Autumn 2008 15
  13. 13. !""""""""""""""""""""""""""""""""""""!!!!!!!!!!!!!!!
  14. 14. WEATHER Derivatives Weather Derivatives It was picked up by energy companies who found that fluctuations in weather were hampering their ability to deliver steady earnings to investors. Peter Brewer, chief investment officer of Cumulus Funds, says: “It came down to people would use gas if it was cold to heat things up and electricity if it was hot to cool things down. The contract would pay money out if the temperature changed.” Insurance companies then became involved, who saw it as a means to move risk around. In 1999, the Chicago Mercantile Exchange (CME) began to list temperature futures. These were vanilla contracts based on the temperature in certain cities on certain days. Brewer says that this was an attempt to turn what had been an over-the-counter market into an exchange-traded one, but it generated little interest from any of the market participants at the time. The implosion of Enron in late 2001 caused consid- erable dislocation in this nascent market. It had been the biggest player and the market was left with a dis- parate bunch of investors and traders, which includ- ed some insurers, some banks and some energy companies. But Enron employees started to move into the insurance groups and banks and resume trading there. Brewer says: “It really started to happen post- Enron. There was more focus on counterparty risk. The Chicago Mercantile Exchange removed that credit risk and began to pick up a lot more business. Cherry Reynard reports on the By 2002, it had a 90% share of trading activity in latest hot product to change the weather derivatives.” The weather derivatives market now splits neatly derivative landscape into two main areas: There is the secondary market, According to the Chicago Mercantile Exchange, which trades on the CME and then there is the more weather has an impact on revenues for around 30% esoteric off-exchange market, which allows for more of the US economy. For many companies, this is structured deals. According to statistics from the higher than foreign exchange risk or other types of Weather Risk Management Association (WRMA), risk that are widely hedged. With the impact of cli- around 730,087 derivatives contracts were traded mate change making weather conditions more from April 06 to March 07. This was down on the unpredictable, the business risk from weather looks previous year when hurricanes Katrina and Rita set to rise. Yet, the majority of companies do not increased the appeal of hedging weather risk and hedge against the weather and weather derivatives over one million contracts were traded. Hurricane remain a young and relatively immature market. Is Katrina, in particular, proved one of the most cost- this likely to change as climate change becomes ly in US history, with estimates of damages around more potent? USD65bn. The first widely-known weather derivatives deal was Volumes on weather conditions in the US were completed between fallen energy behemoth Enron largely stable, while European contracts declined. and Koch Energy in 1997. It was structured around However, the WMRA said that it was seeing rapid temperature conditions: Like a spread betting deal, underlying growth in the weather business in other Enron would pay Koch $10,000 for every degree the regions of the world, notably India, which are yet to temperature fell below a set level, while Koch would be captured in the survey. The WRMA says that pay the same for every degree above it. early indications for the 2007/2008 survey period34 ALTERNATIVES
  15. 15. WEATHER Derivativessuggest that the number of contracts traded will be more in the market. It is difficult to quantify thenearer the 2005/2006 figures. If catastrophic weath- exact size of the market as there is no centraliseder conditions continue to be a predictor of trading data point, but it is thought that this market is nowvolumes (as they have been in the past), then much larger than the exchange-traded market.2008/2009 is likely to be even stronger, encompass- Catastrophe, or "cat" bonds are also a growinging the earthquake in China, cyclone in Burma and area. These are issued by insurance companies andfurther hurricanes in the mid-West of the US. designed to cover particular risks. Investors will buyFor the exchange-traded market on the CME, the on the assumption that an event wont happen. Ifmain volume is in contracts on heating degree days the event happens, the investors lose their money(HDD) and cooling degree days (CDD) on 18 cities and the insurance company makes enough money toaround the world. Temperature contracts accounted cover a proportion of the money it has to pay out tofor volumes of USD18.9bn in 2006/2007. Although its clients. These bonds are also being picked up bymuch of the trading is in US cities, CME offers hedge funds in a blurring of the lines between insur-futures on temperatures in Amsterdam, Barcelona, ers and weather derivatives investors. TraditionalBerlin, London, Madrid, Paris, Rome and catastrophic events have been seen as the domain ofStockholm. These are well-traded, liquid contracts the insurers alone.and are mostly traded by energy companies, funds The corporate users of these products are dis-(including hedge funds) and insurance companies. parate. For example, the CME launched snowfallThe presence of large energy companies means futures and hurricane futures primarily to help statemost arbitrage opportunities quickly disappear. governments manage their budgets. In addition to The CME has tried to expand its range recently, energy companies, beverage producers are subject tofinding that demand for weather hedging goes the vagaries of the weather - Britvic, for example,beyond temperature. As such, it has introduced made several references to its vulnerability to weath-products focused on frost, snowfall, rainfall and er conditions in its recent results statement.even a hurricane future. However, trading in these Construction projects can be influenced by theareas remains relatively limited with rain and wind weather as can ski resorts and other holiday groups.contracts attracting volumes of just USD142 million Retailers are often affected by high rainfall and poorand USD36 million respectively in 2006/2007. conditions as people dont tend to go out shopping. The key problem for the CME in developing new On the other hand, WH Smith benefited from lastproducts remains access to quality data. Eric Gisiger years terrible weather because people stayed insidea member of the investment committee of Man and read books.ECO says that few companies actually understand San Francisco-based WeatherBill has just pub-the impact the weather has on their bottom line. He lished a study identifying the relationship betweenadds: “They know they might get depressed results weather conditions and flight disruptions. It showeddue to poor weather conditions , but have less of that 14% of the 21 million flights evaluated in thean idea how much is attributable to the weather and study were delayed or cancelled due totherefore how much they need to hedge. Available weather. More than 25% of all flights “This market is stillstandardised weather contracts such as the onestraded on the CME could be used but usually have a studied were cancelled or delayed of which 55% of those disruptions (3 mil- very immature andbasis risk, in other words do not perfectly hedge the lion flights) were weather-related. Thestill very opaque,underlying risk.” He believes that although these contracts are use- survey showed some airports such as San Francisco, Reno and Chicagos OHare thats why hedgeful, they can only ever represent standardised suffered disproportionately from weath-funds like it”hedges. There is therefore a basis risk. The weather er-related delays.in central London is not necessarily the same as in These corporate will use the basic con-Heathrow and therefore the standard products do tracts available to them on the CME and Stephen Doherty,not always reflect the exact market risk. also structure their own deals if they The off-exchange weather derivatives are only need more tailored, specific hedging. chief executive officermarginally captured by the WRMA statistics. They need to make sure that this type of at Speedwell WeatherExamples of this type of contract could be whether hedging is cheaper than insurance.it is going to rain at a sporting event or whether it Doherty says that some of the most complex dealswill snow in Meribel this season. Stephen Doherty, are now within agriculture. This has felt the earlychief executive officer at Speedwell Weather, says: effects of climate change most significantly with“These more exotic structures will be based on the crop destroyed by poor weather conditions. He adds:fair value for the trade plus a profit margin for tak- “There has been an explosion in this area. Weathering the risk. These products are unlikely to trade conditions affect crops - including rain and temper-thereafter.” ature. Timing is also important. You are seeing someThese tend to be smaller volume trades, but there are exotic weather structures in this area.” ALTERNATIVES MAGAZINE 35
  16. 16. WEATHER Derivatives Investment buyers of weather derivatives will tend ingful performance statistics, but Brewer says that it to be standard investors such as pension funds and has been run on a formal paper trading basis for 16 asset managers looking for a non-correlated asset months and delivered annualised returns of over class. This is where UBS has seen most demand com- 15% to end-December despite considerable volatility. ing for its Global Warming index (see box-out). It targets 15-20% returns on 10% volatility. Gisiger says that hedge funds active in the space also The Nimbus fund, based in Bermuda and run by look at the non-exchange traded , insurance market. Nephila has also proved popular. The Nephila spider He says: “This market is still very premature and can apparently predict hurricanes, spinning its web opaque, a key reason why hedge funds like it. The close to the ground when a hurricane is approaching bespoke insurance market is bigger and more attrac- and high up in the shrubs and trees when the weath- tive in terms of potential margins to be earned but er is nice. The group has recently signed an agreement also requires a specific skill set rarely available. to provide risk capacity and collateral to WeatherBill Market participants assume that a lot of the hedge to support weather contracts sold to customers. fund money goes into the bespoke deals, though There are also a number of more mainstream there are hedge funds actively trading through CME weather-related investments launched in the retail contracts. ” market such as the Schroders Climate Change fund There are a number of specific weather funds and the Virgin Climate Change fund. This demon- investing in the derivatives market. Brewer runs the strates that demand is there among retail investors for Cumulus Climate fund, which launched in February, this type of product, but so far these have been and has a technical, quantitative-driven approach. entirely equity-based. The fund is a long-short equity fund which seeks to So how big is the weather derivatives market likely profit from the financial impacts of climate change. to become? Doherty says: “The Enron idea that It has not been running long enough to deliver mean- weather derivatives will be as big as FX is not realis- tic. Weather risk is important, but the market will The UBS Global Warming index grow quietly. It will be resilient but unexciting. There The UBS Global Warming index (UBS-GWI) is the only index that currently is a flexible and deep pool of capital and so far the exists for the weather derivatives markets.The index grew out of demand ability of the market to adapt and step up to the plate from multi-asset clients for new uncorrelated assets. Ilija Murisic, Executive has been surprising.” Hel believes there is ample Director, Hybrid Derivatives Trading at UBS says: “In 2007, the equity and capacity in the market and it wont be constrained by commodity markets had rallied and investors were looking for asset classes a lack of capital. that were truly uncorrelated.We started to look at weather derivatives and Gisiger says that at the moment corporate buyers thought they were a very interesting market.There was empirically no corre- lation with equities.” are restricted by the assumption that weather is sim- The UBS-GWI was launched in May last year and is constructed using the ply a hazard of day-to-day business and therefore Heating Degree Day (HDD) and Cooling Degree Day (CDD) weather does not need to be hedged in the same way as other futures contracts traded on the CME.The index is currently composed of risks, though he believes more companies are becom- weather futures contracts on 15 U.S. cities.To be eligible for inclusion, the ing aware of the options for hedging their weather volume of futures traded for any given city must represent 1% or more of exposures. the total weather derivatives contracts traded on the CME. At the moment, Brewer concludes: “A lot of people said in the early futures on New York weather form the largest part of the index at 31%. days that this could be the biggest business on the Cities from Europe and Asia are expected to become part of the index in the planet. Thats not something we would argue. This is medium term. a specialist market for companies concerned about The UBS-GWI Governance committee meets annually in September to revis- the weather. It will grow, but we are not about to see it the weightings of the index and its sub-indices family (currently composed a doubling of volumes every year. That said, more of four US regions: Northeast, Midwest,West and South). companies are becoming aware of the possibilities Since launching this index, UBS has moved into similar areas, launching carbon and we are seeing more catastrophic weather condi- trading, energy, commodities and freight indices. Murisic believes there is tions.” good potential growth in these markets, pointing out that the weather deriva- For the market to take off, there would have to be tives market has grown from $2.2bn in 2004 to around $40bn in 2007. increased shareholder pressure on corporates to Murisic says that although the underlying instruments are complex, the index hedge out weather risk, plus an increased number of itself is designed to be very simply and trade like the S&P index. Investors dont need to look at seasonal variations.The index performance has moved investment buyers seeking uncorrelated returns. As from around 100 at launch to around 250 today. yet, there is little shareholder pressure, but corporate Investors have been varied. Murisic says: “We have had a lot of interest from are becoming aware of the potential of the weather insurance companies. Many of our investors come from Europe, particularly derivatives market and a growing number of buyers Scandinavia and from Asia. Hedge funds have not been a big buyer, but there are looking for new, alternative asset classes to hedge has been a lot of interest from wealthy private individuals. Asset managers out risk. Increased unpredictability of weather and pension funds use the asset class to diversify - they have an allocation to conditions is also likely to stimulate demand. The alternatives and they put some of it into weather.” In general, he believes that market is unlikely to see the sort of bullish partici- interest has not come from specialist weather funds and weather investors, pants it had in Enron, but should see steady growth but more from normal investors looking for diversification. over the next few years. A36 ALTERNATIVES
  17. 17. Panorama – 17-Jul-08

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