Sebi starts fresh talks on weather derivatives after NCDEX proposal

Market regulator has asked exchange to deliver foolproof product that suitably maps temperature and rainfall, besides addressing a host of other issues

Sebi head office

Weather disturbances during the past few years have again revived the debate on the need for launching derivatives based on atmospheric changes, as these products allow traders, farmers and companies to hedge the incumbent risks. A Sebi official said, “Weather derivatives are a work in progress. The issue has been debated from time to time. We took up the matter at the commodity advisory committee level and need to look at it again.”

The rise and fall in temperatures beyond a range, or abnormal monsoon trends are risky for farmers as well as many industries and weather derivatives or weather futures can hedge such uncertainties. The National Commodities and Derivatives Exchange (NCDEX) has applied to Sebi to allow it to launch this product.

Sources close to the development said the proposal is still at the discussion stage and some inputs have been sought from the exchange. Sebi is understood to have forwarded the proposal to its advisory committee for commodity derivatives, which has asked the exchange for provide some more clarity about the product.

Sources also said, “The issue about exchange-traded weather derivatives is that product has to be standard while country’s the requirements are varied. Secondly, these derivatives give signals about the weather based on participants perception and there is a danger that farmers will use them to claim crop insurance and other benefits, instead of using them to take sowing decisions.” Hence, Sebi’s advisory committee has asked the exchange to submit a foolproof product.

Sebi starts fresh talks on weather derivatives after NCDEX proposal

The exchange is said to be working on various parameters to evolve a standard product. The issues under consideration include adoption of a suitable average for temperature and rainfall, among other weather elements, and the demarcation of regions. The expert advice is to fix a range for temperature and arrive at standard norms for monsoon level.

Since rainfall differs from area to area, what should be considered for the futures? Another issue before the exchange is to settle the price of futures without having any spot market. Globally, weather drivatices are largely over-the-counter products decided between both parties, which makes standardisation an issue.

For data provision, India Meteorological Department and private sector Skymet are widely followed for monsoon progress, temperature and hailstorms. Companies such as NCML also collect data on these metrics, but cater largely to insurance companies. Weather prediction isn't a key function for them.

If an acceptable product is developed, sources said there are users wanting to hedge risk. For instance, fertiliser sales increase when there is good monsoon and decline in drought conditions. To hedge this risk, fertiliser companies can bet on deficient rainfall.

Similarly, in winter, if temperature drops late during the wheat crop season, the yield would rise, resulting in higher production and reasonable prices.