Weather Derivatives: A New Dawn In Risk Management

THE allure of weather derivatives financial instruments that allow businesses to hedge against the whims of Mother Nature is undeniable.

- SRIRAM VENKATAVARADAN

They are tradable instruments that usually employ observed weather data to create an index on which a pay-out is based. Weather phenomenons such as precipitation, tempests, cyclones and tsunamis pose significant risks to businesses, with one estimate suggesting more than 80 percent of business activities in the world are weather-dependent.

These instruments offer a way to manage uncertainties. With the increasing unpredictability of weather patterns due to climate change, the demand for financial instruments to manage weather-related risks is only likely to grow.

With the Indian economy being largely agrarian, the agricultural sector and industries such as tourism, travel and energy have always been at the mercy of weather.

The recent notification of the finance ministry allowing derivatives trading in weather marks a significant milestone in India's financial landscape. But the success of this initiative hinges on effective regulation of weather derivatives trading.