Awareness of the benefits of weather risk transfer is growing in Australia and transactions like the recent long-term GrainCorp weather hedge is challenging the perceptions of agriculture-focused public companies, according to brokerage, Risk Solutions International Pty Ltd (RSI).
Formed in Melbourne, Australia in 1997, Risk Solutions International Pty Ltd (RSI) is a specialist alternative risk transfer broker.
Before entering the Australian weather risk transfer market in 2003, the firm had a key focus on credit enhancement and residual value risk transfers. In 2003, RSI completed what is widely regarded as the first multi-year weather contract, and from this moment onwards has conducted innovative work in the weather risk transfer market, which was solidified in 2008 through a joint venture with CQ Energy.
“In that time we have been working to raise the profile of weather risk transfer beyond its origins in energy. It has been a long road but what is encouraging is that there seems to be an increasing awareness over the last year or so of the ability and benefits of transferring weather risk in Australia at a time when there is abundant capacity,” said Roger Currie, Director of RSI, in an interview with Artemis.
Earlier this year, large Australian agribusiness, GrainCorp, secured a 10-year risk transfer arrangement designed to protect it against the impacts of grain production variability, particularly from drought events.
RSI brokered the long-term weather hedge, and Currie provided some insight into why the deal was unique and the importance of it having a long tenure.
“As far as we are aware, the transaction was a first in Australia. It is important to bear in mind GrainCorp’s core business of storing and transporting east coast grain. GrainCorp is not a grower but is highly exposed to growing conditions year to year.
“One important element we would highlight is that the GrainCorp transaction challenges the perception that a public company involved in agriculture must simply accept the highs and lows of the seasons, and, as part of that, just wait for the best years to make up for the worst years,” said Currie.
It’s a valid point. Transactions such as this provide the company with protection against the risk of fluctuations in production volumes as a result of weather events, such as droughts. The long-term weather hedge mitigates the financial impact of adverse conditions for growing crops and is designed to help smooth earnings cashflow for the firm
“The 10 year term was important for when we were thinking about GrainCorp’s receivals over time or “through the cycle”. Beyond GrainCorp, the 10 year term also shows that risk carriers are able to offer longer terms for weather related risks, thereby tackling short term volatility and long term trends.
“For us these elements speak to the real purpose and excitement behind our work. That is, using weather risk transfer at the opportune time to unlock new opportunities for our clients,” said Currie.
The success of the GrainCorp transaction and the efforts of RSI to educate on the benefits of weather risk transfer has, in recent times, been supported by the growing awareness of climate change.
Currie told Artemis that climate change, or the increased awareness of climate change is the main driver of new opportunities for the specialist brokerage.
“Importantly, regulatory bodies in Australia such as the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission have put companies on notice that climate change must form part of rigorous risk assessment and that the disclosure of associated risks must not be merely formulaic.
“These developments will expand beyond just those with exposure to coal and other fossil fuels. Moreover, beyond disclosure, regulators and investors will start questioning what active steps are being taken to manage climate change. For businesses that can’t simply cease a particular activity, weather risk transfer can provide answers,” said Currie.
Today, RSI focuses on particular industries and needs. Currie explained that in order to minimise basis risk without overcomplicating the discussion with clients, in terms of structure, the firm begins with weather indexes that replicate what is important to a client.
“In addition, where a commodity price is relevant to the risk then ideally the structure should include a price component, particularly when it comes to determining settlements. Combining that approach with publicly available data provided by a credible source, at the same time we are able to play to the strengths of risk carriers.
“Using derivatives also allows us to explore structures such as collars and swaps, where unlike single-sided transactions, the parties can truly share risks and costs,” he added.
In the areas where RSI operates, Currie explained that the capacity still comes from offshore jurisdictions such as Bermuda, the U.S., London, and Europe. Risk carriers, he added, continue to be global insurance and reinsurance firms, as well as ILS fund managers.
“We have seen some recent mergers and acquisitions but this has not changed things for us or our clients. We find risk carriers vary in their appetite from one risk or product to the next and even one year to the next so we pride ourselves on maintaining a strong working relationship with all the major participants,” he said.
As noted by Currie, capacity in the Australian weather risk transfer market is abundant and is supported by continued appetite from the insurance-linked securities (ILS) space.
“The main way we currently see ILS intersecting with our work is allowing risk carriers to manage risk ever more efficiently. The same risk carriers we work with are also major participants in global ILS markets. This then flows into the products and terms that can be offered to our clients.
“We are also following developments where ILS is expected to branch out into new perils, particularly those that maintain the weather element (eg. flooding and wild/bush fires). That can be expected to foster innovation for products targeted at the “end consumer”, being the feedstock for ILS,” said Currie.
Ending the discussion, Currie underlined that to RSI’s thinking, “weather risk transfer does not have the sole claim on parametric structures,” adding that “beyond weather, we are looking forward to developing solutions where there is a need and where the data and capacity is available.”