ARC progresses climate cat bond facility XCF, signs up UN support

The African Risk Capacity (ARC) is continuing to make progress towards the launch of its Extreme Climate Facility (XCF), a proposed multi-year funding mechanism that will issue climate change catastrophe bonds to help African nations transfer climate change related exposure to the capital markets.

The African Risk Capacity (ARC) first launched its XCF initiative back in 2014, as it sought to provide African nations with tools to help them transfer some of their risks associated with climate change to sources of reinsurance capacity including the capital markets.

Climate change cat bonds would provide a much-needed source of risk financing to those most exposed to the weather and climate related threats created by the currently climate crisis, which threaten severe financial losses as a result of a changing climate and weather variability.

Now, ARC has held a two-day technical workshop in Germany focused on the XCF, where feedback and input was sought from technical experts and engagement with leading multi-lateral organisations helped to raise the profile of this initiative once again.

At the event, ARC has signed a memorandum of understanding with the United Nations Convention to Combat Desertification (UNCCD), with the two organisations set to collaborate to support the development of new financial tools such as the XCF.

The goal is to help Africa to adapt and become more resilient to future drought and other extreme weather events, leveraging resilience measures alongside financial risk transfer tools (such as insurance and reinsurance) to ensure countries are able to respond to the changing climate and resulting weather extremes that may occur.

The capital markets has always been seen as a viable source of additional capacity able to bear climate change physical and transition related risks, particularly weather related.

As a result, ARC has been exploring the potential for creation of a climate linked index that could be used to structure a parametric climate risk catastrophe bond, which would provide the mechanism to secure capital market financing to back the XCF.

The new partnership with the United Nations (UNCCD) unit will also look to leverage private sector resource and expertise, to assist in the development of new financial instruments that can provide the necessary climate linked insurance protection and other funding to mitigate these risks, ARC explained.

The workshop held this week in Bonn, Germany explored the proposed principles and work of the eXtreme Climate Facility (XCF).

XCF is proposed as a new financial vehicle designed to tap into capital market investor appetite to provide funding to support countries affected by extreme, climate change related, weather events.

The work has been exploring the robustness of the XCF, including the proposed financial products and their underlying index, as well as establishing what is and isn’t a viable alternative market-based solution, plus building partner relationships that will be critical to deliver a successful XCF and supporting climate cat bonds.

Mohamed Beavogui, Director-General of the African Risk Capacity (ARC), explained, “Since the inception of the XCF programme in 2014, this is the first Technical Review Forum where the overall end-to-end framework is considered and reviewed. Our guiding principle since the creation of ARC is to interrogate our concepts by subjecting our models to the best available experts in that field. We did this with our drought tool, the African RiskView, which remains the best-in-class to-date for Africa. We are grateful to all our partners and industry experts that have joined us in this process.”

“The World Bank supports countries with climate adaptation measures and is committed to working with countries to strengthen financial resilience against climate and disaster shocks,” added Miguel Navarro-Martin, Manager of Banking Products, World Bank Treasury. “Our focus is on helping countries to protect their fiscal accounts against external risks. The XCF concept being developed by ARC provides an opportunity for African countries to access financial solutions to manage disaster risk and to fund a portfolio of climate resilient investments.”

Dr. Astrid Zwick, Head of the InsuResilience Secretariat, also , “The centrality of our collaboration with countries is to enable a more timely and reliable post-disaster response. Critical to this are preparedness and readiness using climate disaster risk finance and insurance solutions. The XCF promises to be one of those instruments that can complement ongoing efforts in countries to avert, minimize and address climate disaster risks by strengthening local adaptive capacity and resilience. We are glad to be part of this process.”

Ibrahim Thiaw, Executive Secretary, United Nations Convention to Combat Desertification, also said, “The message is clear. We will see an increasing number of droughts with unprecedented severity, which are exacerbated by climate change. No country or region, rich or poor, is immune to the vagaries of drought. The ARC-led XCF will become an important tool to help African countries to cope effectively with the impacts of drought.

“Currently, through the Drought Initiative, the UNCCD is helping 35 of Africa’s 57 countries to create the mechanisms they need to take early action to avert drought disasters. Today, Africa is ramping up pre- emptive actions as a unified front against future drought and climate-induced disasters in the region.

“Today marks the beginning of a unified front against drought and climate-induced disasters in the African region. We currently manage programmes closely related to climate adaptation and natural disaster risk, including the Drought Initiative. Our key aims are to support the establishment and implementation of national drought plans and mobilise innovative financial instruments to better mitigate the risks of extreme climate situations.”

Beavogui, Director-General of ARC, added, “The mandate of the UNCCD resonates with ARC’s mission. Reducing the impacts of drought and other natural disasters by helping Member States’ improve climate resilience through innovative mitigation and risk financing instruments are key to our mandate. The Agreement will create a functional synergy in our efforts to help countries better understand their risk profiles, improve knowledge and strengthen capacities for climate adaptation and food security.”

The XCF is among the most innovative of initiatives currently underway that aims to tap into the capital markets appetite for insurance linked catastrophe and weather risks as a way to secure contingent financing for nations most exposed to a changing climate.

The work to establish the XCF, create an index robust enough to support climate catastrophe bond issuance, structure the transactions and get them to market will be significant.

But through the convening of multi-lateral organisations, alongside industry experts, ARC perhaps has the best chance of making climate change cat bonds a reality.

Beavogui of ARC stated, “Reducing the impacts of drought and other natural disasters by helping Member States’ improve climate resilience through innovative mitigation and risk financing instruments are key to our mandate.

“The Agreement signed today with UNCCD will create a functional synergy in our efforts to help countries better understand their risk profiles, improve knowledge and strengthen capacities for climate adaptation and food security.”

If successful in getting the XCF and climate linked cat bonds to market, ARC may set a precedent for other developing and developed regions of the world, where communities are exposed to the effects of climate change.

The use of catastrophe bonds as a financing vehicle for climate resilience is one of the promises of the structure and it is encouraging to see it being pushed as a potential solution.