8/7/2019 News for Bank- UBS Global Warming Index - Ilija Murisic - Oct 07

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14 UBS News for Banks / Winter 2007

Bank to come up with the worlds first

index that tracks temperatures on a

national and regional rather than a local

basis. Launched in April this year, the UBS

Global Warming Index (UBS-GWI) is a trad-

able benchmark for global investments in

the weather derivatives market. It provides

a rational and simple way to obtain finan-

cial exposure to large-scale trends in theclimate. The index should also prove useful

to industries that need to hedge against

damaging climatic trends. Potential users

could include many branches of agricul-

ture, tourism and construction.

How it works

The UBS-GWI is based on existing CME

weather futures contracts that settle on

the difference between the average daily

temperature and a base temperature of

65F. These are Heating Degree Day (HDD)

and Cooling Degree Day (CDD) contracts,so-called because they measure how far it

is necessary to heat or cool buildings in the

prevailing weather conditions. At present,

the index comprises contracts on the 15 US

A broader swathe of investors can now give climate derivatives a whirl

Weather derivatives have been traded

for the best part of a decade. In theory, ski

resorts could use them to hedge against

warm winters or brewers to protect them-

selves against cool summers. In practice,

though, most users are in the energy sec-

tor. The Chicago Mercantile Exchange

(CME) established a weather derivatives

exchange for temperature contracts ref-erenced to certain US cities in September

1999, later adding European and Asian

references. More recently, the CME has

added contracts on snowfall, frost and

hurricanes. These innovations helped lift

total CME turnover in weather contracts

to some $45 billion in 20052006. This

success has attracted attention elsewhere.

In mid-2006, Chinas Dalian Commodities

Exchange announced that it planned to

start trading weather futures, with the aim

of helping Chinese farmers hedge their

exposure to bad weather.Weather, though, is not climate. As cli-

matologists like to say, weather is what

you get while climate is what you expect.

This insight prompted UBS Investment

Getting a grip on climate riskA new index lets investors express their views on how fast the planet is warming

Solutions

cities including New York, Chicago,

Atlanta, and Las Vegas that are most

actively traded on the CMEs weather

derivatives exchange. Between May 2 and

September 3 this year, an excess temper-

ature of 0.68F on these contracts caused

the index to climb by almost 35%. This

performance showed minimal correlation

with any other investible asset class, a factthat could make the climate an interesting

candidate for inclusion in otherwise tra-

ditional portfolios. Access to the index

would be via structured products, perhaps

in combination with other types of asset.

More cities could potentially be included

in the index. The CME currently trades

weather derivative contracts for 18 US and

nine European cities, as well as six Cana-

dian and two Japanese locations. To be

eligible for inclusion in the GWI, however,

the volume of futures traded for any given

city must represent 1% or more of thetotal weather derivatives contracts traded

on the CME. Provided they meet this con-

dition, European and Asian cities are likely

to be included in the GWI over the me-

dium term. A UBS-GWI governance com-

mittee will meet annually to determine

the composition and the weighting of the

UGWI index and its family of sub-indices,

which currently covers four US regions: the

Northeast, Midwest, West and South.

Although there has been a dramatic in-

crease in weather derivatives volumes over

the course of the last few years, tradedproducts using weather remain inacces-

sible to the vast majority of the financial

community. Used mainly as a hedging in-

strument by energy, insurance and com-

modity professionals, weather derivatives

remain largely untouched as an asset

class in their own right. UBSs new Global

Warming Index could change that by pro-

viding a simpler way for a broader range

of institutional and private investors to

gain financial exposure to global tempera-

ture trends.

Ilija Murisic UBS Investment Bank,Non-standard derivative productsilija.murisic@ubs.com