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ABN Amro working on weather derivatives plan

Hemangi Balse in Mumbai | July 21, 2003 10:31 IST

ABN Amro Bank is exploring sales of weather derivatives and catastrophe bonds for the first time in the country.

The bank is talking to companies in the beverage and cement sectors, to airlines and oil majors to get them interested in the product.

With the recent amendments to the Securities Contract Regulation Act, derivatives trading is allowed in commodities. It was banned till last year.

But trading in weather derivatives is yet to receive a formal nod from the government.

The bank is selling weather derivatives as an over-the-counter product to companies whose operations are significantly dependent on weather conditions.

Beverages companies, for instance, are prime customers because their sales are heavily weather-dependent.

Similarly, integrated beverage companies -- which also own plantations -- need to control their risks both on the production side and the sales side.

The bank is also introducing catastrophe bonds to corporates which are designed to protect them from unforseeable events that can cause enormous damage.

A catastrophe bond -- which basically is a means to transfer risk -- is a security that is offered on high interest rates and provides insurance companies with a form of reinsurance to pay losses arising out of a disaster.

This means greater amount of funds are available to offset catastrophe losses.

These bonds sold by banks to their clients act as a deposit. Should a disaster strike, the entire principal amount can get wiped out.

In the event that it does not, the corporate stands to gain hefty returns, said ICICI Lombard's head of risk & reinsurance, Ritesh Kumar.

This, thus, allows insurance risk to be sold to institutional investors in the form of bonds.

ICICI Lombard recently concluded the first reinsurance-driven sale of weather derivatives when it sold the product to Malana Power Company for a coverage of Rs 10 crore (Rs 100 million).

The cover puts a floor on the uncertainties, in the event that adequate rainfall or melted snow is not available.

Should the power generation fall below 90 per cent, the insurance company will bear the loss of profit to the extent of Rs 10 crore, said Kumar.

Said a senior executive with ABN Amro Bank: "Weather derivatives are a risk mitigation exercise to overcome uncertainty at the time of product sales on account of vagaries of weather."

Weather derivatives are a cheaper alternative to insurance and can tide over the cyclical weather-related risks.

In the US and in Europe, weather derivatives are a booming market as farmers, agri-companies and utilities alike buy these contracts to protect themselves from the fickle weather.

ABN Amro Bank has received enquiries from cement companies across the country. These companies stand to benefit immensely if the monsoon is good within the range of 60-70 days considered normal.

A normal monsoon boosts the economy which translates into higher cement sales later, but if the monsoon is prolonged, cement sales go into a prolonged slump.

"Such non-linear risk relationships are typically addressed with the use of derivatives," the bank official said.


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