Growing demand, whatever the weather

Channels: Investors, Markets, Policy

Companies: Tullet Prebon, Endurance Global Weather, Willis, CQ Partners, Risk Solutions, Speedwell, Reed Smith

People: Marty Malinow, Claire Wilkinson, Claude Brown, Stephen Doherty,

The weather risk management market continues to grow, and is extending its reach into new regions. Mark Nicholls reports

It is one of those ironies of our changing climate: while 2014 is likely to have been the warmest since records began, it began with an icy blast over North America that saw hundreds of precipitation, snowfall and temperature records broken. This weakening of the 'polar vortex' led to widespread economic disruption and was blamed for an unexpected contraction in first-quarter US GDP.

But the bad weather wasn't bad news for everyone. "Weather continues to be our best marketer," says Marty Malinow, the New York-based president of Endurance Global Weather, which once again was voted Best Weather Risk Dealer/Structurer across all four geographic regions.

Utilities, which still account for the majority of demand for weather risk management products, tend to be exposed to mild winters reducing overall demand for heating. However, their fingers are burnt by extreme cold, too. "The majority of utilities don't have the generating reserves on hand to meet demand on extremely cold days, so they need to go into the market at the same time as everyone else," he says. "It's not great for margins."

Meanwhile, the winter of 2013-14 in Western Europe was particularly warm, crimping revenues at energy companies. "Both of the market's two largest risks got pinged. It's not terrific for dealers' books, but it has created stronger demand," says Malinow.

This year, US utilities have come knocking for weather hedges that combine seasonal protection with 'peak-cold day' cover, while European utilities have hedged a higher proportion of their weather exposure for this winter than in previous years, he says.

"Last year's bitter North American winter has triggered demand from those who saw their revenues reduced, or costs increased," says Claire Wilkinson, a UKbased partner at Willis, and co-head of the insurance broker's global weather risk practice. Her firm was voted Best Broker, Europe in the rankings. "Enquiries have come from a wide variety of end-users, ranging from transportation companies to municipalities and snow-removal companies," she says.

Claire Wilkinson, WillisBut it can be a long process between a client acknowledging its risk, and buying protection. "Most industries realise they have exposure to adverse weather – but it can be very hard to articulate that particular risk in terms of a precise index against which a weather-index product can be referenced," Wilkinson says. "For example, a leisure firm might be vulnerable to high levels of rainfall, but in very specific locations, times and quantities. You have to do a lot of analysis to make sure that the index is relevant for the particular client."

The next challenge is finding the budget. "The most difficult thing is getting the client to buy in the first place," she says. "In subsequent years, it's a much easier decision."

Nonetheless, dealers report higher levels of business this year. Interest is building in Latin America for weather risk products, while Europe, in particular, is seeing new demand from German utilities.

"The Weather Risk Management Association has got a big outreach programme underway," says Claude Brown, who is on the board of the market's trade body. He is also a partner at Reed Smith, which was ranked Best Law Firm this year for the second time. "We're seeing new faces at the meetings, and new members signing up," he says, citing Dutch utility trading arm Eneco Energy Trade and technology and analytics company Sapient.

Wilkinson at Willis says interest in hedging weather risk is broadening out from the market's traditional base in the energy sector. "Agriculture, construction, leisure – we're seeing a very diverse range of new buyers, partly because we've deliberately gone out to spread the message, but partly because companies are witnessing the impact of adverse weather on their business," she says.

"We're seeing enquiries from all over the world" Wilkinson adds. "One of our higher profile transactions this year was the reinsurance placement for ARC Insurance Company" in which Willis brokered $55 million of capacity from the international weather markets for Africa's first catastrophe insurance pool.

The transaction allowed the pool to underwrite insurance policies against drought in an initial group of five African countries, Kenya, Mauritania, Mozambique, Niger and Senegal. Because the contracts are based on satellite rainfall data linked to the specific needs of the countries' staple crops, they can pay out promptly – reducing the countries' reliance on international emergency aid and helping them anticipate, rather than react to, any likely crop failure.

"We're seeing enquiries from all over the world" - Claire Wilkinson, Willis

The availability of an increasingly wide range of weather data is allowing the market to expand into areas historically poorly served by weather observations, such as Latin America, says Stephen Doherty, CEO at Speedwell Weather, the UK-based weather data company that has been voted Best Data Provider/Advisory firm for the seventh year running. "We are also seeing an increased usage of gridded products, allowing expansion into Africa and the high seas," he says. Gridded products are referenced to a combination of satellite information and so-called 'reanalysis' data, or re-processed historical data.

"There's interest in marine weather risk management – you can't easily sate that appetite with observations," he notes.

In a deal this year for Irish developer Mainstream Renewable Power, Endurance wrote what is believed to be the first hedge for construction risk for offshore wind farms.

Marty Malinow, Endurance Global WeatherGridded data can also provide useful back-up for onshore wind energy deals, which are linked to very localised conditions. "If the primary instruments used for a parametric wind deal fail, it can be very difficult to find an alternative [weather station]," says Doherty. Using gridded data may be part of the mix of inputs used to ensure settlement can be made. And the fact that gridded data sets can help improve the quality of data used to settle weather trades is likely to reassure regulators who, in the wake of the Liborrigging scandal, are turning their attention to all manner of index-providers.

"All weather trades have an index at their base, and the risk is that an index compiler could be considered its sponsor," says Brown. That would mean index providers such as government meteorological offices could face the same level of regulation as a financial institution, he notes.

"Our view is: bring it on," says Doherty, who says that his business has been built with the necessary approach to quality, audit trails and Chinese walls that regulators are likely to insist upon. It's not only the index-providers who are shouldering a greater regulatory burden – dealers are also feeling the heat. "Our clients have three concerns when it comes to their weather risk businesses: regulation, regulation and regulation," says Brown at Reed Smith.

The main concern is ensuring that non- US firms writing weather risk contracts in the US are compliant with the Dodd- Frank legislation, which is designed to discourage excessive risk taking. That legislation was passed in 2010, "but its extraterritoriality rules are now becoming clearer," says Brown. "We're also doing a lot of work the other way," looking at the impact on market participants in Europe of EU legislation such as the Markets in Financial Instruments Directive and the European Market Infrastructure Regulation.

He adds that, by and large, the regulatory burden falls predominantly on firms' back-office and legal functions, and is not overly weighing on the volume of market activity. "The market is accruing gradual, steady, sober growth, predicated on the availability of data and the growing awareness of the product," agrees Doherty at Speedwell. EF

For all the results from Environmental Finance's Annual Market Rankings, see A survivors' market