Three Argentinian enterprises have joined forces to develop climate index futures to help agricultural producers to better protect themselves against the impacts of severe or inclement weather, with drought the first targeted product launch.
The three partners are Rofex, a futures exchange in the Argentine city of Rosario, the Argentina Clearing companies and agricultural data and technology start-up S4 Agtech.
The initial goal is to create a tradable weather derivative or futures contract, which agricultural producers can use to protect themselves against drought. By transferring the risk of drought using an index, producers can receive payouts when index levels hit pre-defined triggers, providing a form of insurance capital.
Hedging drought risk is becoming essential for farmers and agricultural producers in many parts of the world, with the changing climate extremes resulting in severe droughts in increasingly large areas of the world.
By leveraging technology to create the index, which is based on S4’s green index, alongside electronic trading to provide transactional liquidity, cost-effective execution and settlement, the hope is that the weather derivative will prove a more efficient risk transfer tool, enabling smaller producers to benefit from it as well.
The S4Index, as it is known, has been created using satellite data and statistical algorithms. It is not the first use of greenness as a measure of drought, using satellite imagery of the colour of ground cover and foliage to define availability of water and therefore potential for drought.
The climate index future product itself works like a call option, with premiums calculated statistically and then payouts made when the index value is below the strike point or trigger, with payments made automatically thanks to the electronic trading and clearing platform.
Agricultural producers should be able to assess the risk of drought using S4’s index and tools, price a contract based on where the index would define a drought that would negatively affect their crop production, acquire the contract on the exchange and immediately benefit from the risk transfer and protection.
It’s essentially a climate index on an exchange, tailored to measure the effects of drought through the greenness of the surface of the earth. By putting the index on an exchange the risk transfer efficiency rises and the value of this weather derivative tool increases for the producers that need it.
A greenness index has been used for drought measurement for weather index microinsurance before. It’s encouraging to see microinsurance technology being scaled up to offer drought risk transfer tools at a commercial level.
So many of the micro and weather index insurance schemes around the globe have their roots in data and indices making them ideal for translation to exchange based risk transfer products. It’s a prime example of new technology and ideas starting at the lowest level in insurance markets and successfully transitioning into much larger market areas.