Sebi plans trading in weather derivatives

Panel meets this week to further discuss issues in this regard

The Securities and Exchange Board of India (Sebi) plans to allow trading in weather derivatives, a financial instrument for managing this risk in the agricultural sector.

Sources say a Sebi panel is analysing pricing models on such derivatives and working on the infrastructure needed. Unlike other financial derivatives, those on the weather do not have a definite pricing model.

“Some conclusion is likely at a meeting scheduled for this week,” a Sebi source told this newspaper.

The idea was in the works for a while and gained momentum following the finance minister's Union Budget speech, where the aim was stated. This was discussed at the first meeting of the Commodity Derivatives Market Advisory Committee in the first week of March. Representatives from Sebi, commodity exchange officials and of the Agricultural and Processed Food Products Export Development Authority were present.

“There is endless scope for the product. It would prove immensely beneficial, typically for the agriculture sector and farmers,” said Ajay Kedia of Kedia Commodities. Once Sebi introduces it, it is felt, a number of trading entities would offer a customised version. And, more sectors would be covered. Hotels, insiurance, financial institutions, sports, soft drinks and confectionery, engineering and construction are among those where revenue is affected by the weather.

How weather derivatives would work could be illustrated in this example. A grower of maize is worried about the monsoon. Against normal production of 100 quintals, the farmer estimates production at only 80 qtls. If the minimum support price is Rs 1,000 a qtl, he'll lose around Rs 20,000 if there's less rain. This is where weather derivatives come in. If he accesses this tool, he could have bought or sold (on the basis of the outlook on rain), a rain day futures contract today, entering into an equal but opposite contract at a later date, making a profit on the transaction by offsetting the losses due to the low volumes produced.

“The most interesting part of the product is that one cannot manipulate it by any means, as one cannot control rain patterns,” said another commodity expert.

There are challenges. “It is difficult to collect reliable weather data for sustainability of the product. There are also regulatory issues needing to be sorted. And, it involves a high risk cost,” said an ex-Sebi official, on condition of anonymity.

Internationally, weather derivatives are structured as swaps, options and futures, based on different underlying weather indices. The Chicago Mercantile Exchange and London International Financial Futures and Options Exchange offer standardised weather contracts on their trading floors. Around 95 per cent of global weather derivatives volumes come from the US, with Europe supplying most of the rest.

KEY TAKEAWAYS

• Weather derivatives can act as a tool to hedge against poor monsoon
   
• Sebi currently working on product infrastructure and pricing model
   
• Move to help farmers offset losses arising out of drop in produce
   
• FM had announced launch of new products in commodity derivatives in Budget