Analysis: new financial products are now being used to manage risks and raise funds to implement climate adaptation strategies

In recent years, the world has seen an increase in the frequency of extreme weather events such as hurricanes, record-breaking rises in temperature, excessive rainfall and other consequential natural disasters that include rising sea level and forest fires. These changes are a direct consequence of climate change and there is extensive research that shows changing climatic conditions have a direct impact on the socio-economic wellbeing of the people, in the form of widespread dislocation of the population, lower agricultural income arising from loss of crop and livestock, higher unemployment and poverty.

Such weather events also carry significant negative effects on economic growth and development. The recent disruptions caused by Storm Eunice in Ireland are still fresh in our memories along, with the likes of Ophelia (2017), Darwin (2014) and Katia (2011).

But these extreme weather events pale when compared to the likes of Hurricane Katrina in 2005 which topped $150 billion in damages. In terms of soaring temperatures, deadly summer heatwaves bring severe drought-like conditions that directly influence certain economic activities. For example, certain products like air coolers see an exponential growth in demand while there are human fatalities elsewhere.

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From RTÉ Archives, Robert Shortt reports for RTÉ News on the aftermath of Hurricane Katrina in New Orleans in 2005

Research provides empirical evidence on the impact of these extreme weather conditions on financial markets and corporations. For instance, hurricanes disrupt the smooth functioning of corporations in terms of both production and supply of products and services thus negatively affecting its revenues. Similarly, corporations tend to increase the usage of credit lines during extreme temperature drops, which could result in a sharp decline in their productivity.

Industries like agriculture, transportation, electricity generation and tourism are more sensitive to changing weather patterns. Abnormal precipitation can have a direct impact on agricultural yield, bearing heavily on the profitability of food processing, beverage and agricultural companies. As a result, farmers and financial investors face product pricing risks and this may translate into higher farm credit risk. Similarly, mining and quarrying activities can be disrupted due to insufficient water supply during droughts and excessive damage to infrastructure in the case of flooding during excessive rainfall conditions.

In the auto sector, research shows that the small passenger vehicle segments and agricultural tractors demands can be impacted by extreme rainfall conditions, especially in emerging markets due to its direct link to the rural economy. The sales of convertibles and four-wheel drives are highly influenced by idiosyncratic variations in the weather.

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From RTÉ One Nine News, Met Éireann says extreme weather is evidence of climate change

The negative impact during storms and hurricanes cause physical damage to the urban infrastructure such as road and rail lines, disrupting transport services. Excessive turbulence and other precarious flying conditions also disrupt air transport services leading to the cancellation of flights directly impacting operating costs and profitability of the firms in that sector. Additionally, the adverse impact of transportation disruptions is directly felt by the courier and tourism sector.

As climate change creates conditions of uncertainty and distress across these sensitive industries, studies show a substantial impact on their earnings, costs and operational productivity. Owing to these factors, there can be uncertainty for the future cash flows of these companies.

Stock markets generally reflect the fair value of a firm based on the changing information environment. Disruptions caused to the firm's operations and profits can severely dent investor sentiments. This results in wide fluctuations in stock prices of these firms, while investors in the market await the corporation’s strategic response to address cash flow uncertainty. Studies show firm’s investment strategies of weather sensitive sectors are normally influenced by weather patterns.

Some interesting financial products are now being used to manage both risks and raise funds to implement climate adaptation strategies

How do corporate managers deal with these events? Interestingly, studies have used the salience theory of choice under risk to explain how managers strategise their investment behaviour. The theory is based on the saliencies of past experiences encountered by the managers. The idea is that a manager who is salient to the recurring weather phenomena is better equipped to deal with the uncertainty.

In this regard, they undertake several climate adaptation strategies that involve investments in innovation and technology that can mitigate the risk associated with climate change. For example, the agricultural sector is adopting coping strategies such as using modern agriculture technology to improve yields or use weather derivatives as insurance against price volatility.

Some interesting financial products like catastrophe bonds, water futures, nature-debt swaps and green bonds are now being used to manage both risks and raise funds required to implement the climate adaptation strategies. At EU and UN levels, climate finance funds are established to raise local, national or transnational financing to support alleviation and adaptation strategies that will address climate change. However, more remains to be done in this direction.


The views expressed here are those of the author and do not represent or reflect the views of RTÉ