Poverty, Climate Change and Weather-Indexed Bonds

Abstract

Scientific evidence clearly shows that as a result of greenhouse emissions, the global climate is changing. Poor developing countries are at most risk because they are more dependent on agriculture; more vulnerable to coastal and water resource changes; and have less financial, technical and institutional capacity for adaptation. It is therefore important for these countries to come up with a comprehensive Action Plan on how to mitigate and adapt to climate change. This paper suggests that weather-indexed bonds could provide a potential vehicle for developing countries (LDCs) to raise money on the international capital markets to manage the risks associated to climate change. The issue of this type of bond could provide an opportunity for countries to hedge against the fluctuations in revenues derived from weather dependent assets. Furthermore, weather-linked risk management tools allow countries to examine a new set of risk-contingent structured financial products. This paper also examines a variety of models applicable to agriculture and the sovereign debt of developing agrarian nations including from the corporate side, weather-linked bonds, and from the producer side, weather-linked loans. These weather risk management tools are targeted towards mitigating both business and financial risk by reducing the contractual obligation of debt (principal and/or interest) depending on the intrinsic value of an attached weather option (e.g. excess heat or precipitation), which pays off, if a specific weather event occurs.