The Chicago Mercantile Exchange (CME), which has always been an exchange location where weather futures and derivatives have been traded, is set to use weather data for settlement and valuation of its contracts from specialist provider Speedwell.
It’s an important move as it puts a recognised third-party provider of global weather risk transfer settlement data and information at the heart of what is still the most important trading venue for weather risk management contracts.
The CME has always been an important location for weather risk trades, even though the market shifted to one where private and OTC transactions became more prevalent, as those seeking weather hedging protection looked for increasingly tailored and bespoke hedges.
But in the last year or so trading activity in the CME’s weather products picked up dramatically, with September 2020 marking the highest volume month for the CME weather products in over two years and then as of December 2020, open interest in weather contracts was over 29,000, a 175 percent increase year-over-year.
It’s no surprise interest has been growing, given the increasing focus on climate change, climate risk and finding tools that can help to manage it.
In fact derivatives markets have been highlighted as key to managing climate-related risks from climate change by regulators and trading entities alike, which along with a growing level of interest in the weather space, as well as some more activity from hedge funds and asset managers, has helped to propel demand.
Speedwell Settlement Services Ltd. will now provide the data to settle CME weather contracts, and Speedwell forward curves will also be used to assist with the day-to-day valuation, as the official supplier of verified weather observations for the settlement of CME weather contracts from this month.
The Forward Curves will be used for daily contract margining and both settlement and curves will be rolled-out across the full suite of CME weather contracts.
David Whitehead, CEO of Speedwell Settlement Services commented on the news, “We are excited to be working with the CME on their weather contracts. Global energy market uncertainty coupled with increasing extreme weather linked to climate change is creating demand for these products. It is a partnership that makes sense; Speedwell has spent the past 20+ years developing environmental indices designed for the risk transfer. Our products incorporate historical data for structuring and pricing, forecasts, and forward curves for managing ongoing risk, and then verified observations for settlement. The CME has a long history in this market, a well established infrastructure, and a product specification that has been developed per user needs and fine-tuned over time. Between the two companies we have what is needed to make this a success.”
The CME’s weather product range remains relatively limited, with CME Weather Futures and Options still based on temperature indices for twelve global locations, covering stations in nine US cities, two European cities, and one Japanese city.
This has always been viewed as a limiting factor, as many entities that would like to trade their weather risk find the stations too far from their own locations, resulting in an element of basis risk in the product.
However, Speedwell is a specialist in this area of weather risk transfer and also installs weather stations around the world, for use in weather hedging and parametric risk transfer triggers.
Which means that expanding the range of CME traded weather contract locations could be a far easier task with the assistance of Speedwell, as too could finding ways to leverage data analytics to reduce basis risk.
Weather contracts are available for those twelve global locations for trading across monthly periods as well as seasonal strips.
It will be interesting, going forwards, to see how Speedwell can help the CME to rebuild its relevance as a global marketplace for weather and also climate risk, with a wider range of products and indices available for trading and settling weather hedges against.
Speedwell also said it will offer a number of data, forecast, and service packages specifically designed for companies trading weather on the CME.
CME’s weather products have always been of interest to some in the insurance-linked securities (ILS) market, both as a hedging tool and for those investing in weather risk as an opportunity to put more capacity to work as hedging counterparty, for their investors.
Others in the insurance and reinsurance market may also find weather derivatives an increasingly interesting market to play a role in, especially if volumes pick up considerably with the increasing global focus on managing climate change and climate related risks.