Forecast meets futures with NCDEX to tap real-time IMD weather data

In a step towards the formal launch of India’s first weather derivatives, the country’s leading commodity exchange, the National Commodity & Derivatives Exchange (NCDEX), and premier state-run weather forecaster, the India Meteorological Department (IMD), on Thursday signed a memorandum of understanding (MoU) that will give the former access to IMD’s historical and real-time weather data.

 

This would help NCDEX develop statistically validated weather indices that form the foundation of weather-linked futures contracts.

 

The agreement is after weather derivatives were included in the Securities Contracts (Regulation) Act, 1956 (SCRA), in 2024, paving the way for commodity exchanges to offer them as market products for risk management by stakeholders.

 

SCRA is the legislation that governs securities and stock exchanges.

 

“This partnership combines NCDEX’s market infrastructure and innovation with IMD’s scientific excellence and data precision and is a critical step towards the launch of India’s first weather derivatives,” NCDEX Managing Director and Chief Executive Officer Arun Raste said.

 

The weather product to be developed under this collaboration will enable seasonal and location-specific derivative contracts.

 

It will also advance expertise on weather-related risks across agriculture, transportation, and allied industries, Raste added.

 

Earlier in 2023, NCDEX signed an MoU with private weather forecasting agency Skymet to deepen its understanding of the impact weather has on agricultural commodities and to launch two rainfall-based indices on an experimental basis.

 

The indices were called the Indian Monsoon Index and the Indian Rain Index.

 

Senior executives said the existing weather indices of NCDEX are more focused on providing information on actual rainfall and decision-making. But the MoU with IMD will now pave the way for developing more robust instruments for trading in multiple weather parameters like temperature, rainfall, precipitation, etc.

 

The concept of robust weather derivatives is not new — around the world, some countries are already running successful weather derivatives markets.  ALSO READ: NCDEX looking to develop commodity derivatives ecosystem in Iran, Nepal

  In India, too, there has long been discussion and work on comprehensive weather derivatives, but nothing has materialised on the ground yet.

 

Senior NCDEX executives said a major reason for the delay is that weather derivatives, as a tradable instrument, have only recently been permitted by the Securities and Exchange Board of India.

 

“And secondly, only a few countries or exchanges have weather derivatives as tradable instruments, and therefore a deeper study is required to delve into various facets of derivatives as tradable instruments before their launch,” a senior executive commented.

 

Indian agriculture, like in other places of the world, is increasingly becoming prone to uncertain weather.

 

In fact, not only agriculture, even sectors which are dependent on farming, have been increasingly susceptible to uncertain weather.

 

All about weather derivatives

 

A weather derivative is a financial instrument that offers payouts based on the occurrence and magnitude of predetermined weather events. This helps hedge against weather-related risks or losses. For example, a farmer who faces weather-related risks such as rainfall can buy a weather derivative, pay a premium to the seller, and hedge against rainfall risk. If there is excessive rainfall, the seller pays the farmer, allowing him to cover his loss. If rainfall is favourable and there’s no loss, the seller retains the premium.

 

Financial institutions and insurance companies typically sell weather derivatives.

 

According to National Commodity & Derivatives Exchange Managing Director and Chief Executive Officer Arun Raste, globally, the Chicago Mercantile Exchange offers both futures and over-the-counter (directly between two parties) contracts on weather. Unlike commodity derivatives, which are volume-based, weather deriva­tives contracts are based on indi­ces like heating degree days or cooling degree days — essentially measuring deviations from expe­ct­ed temperature levels.