Financial Adaptation to Climate Change via Public Interest Weather Derivatives and Catastrophe Bonds in the Wake of the Financial Meltdown

Abstract

Anthropogenic climate change is rapidly becoming one of the most pressing and troublesome sources for systemic risk in the global economy. The potential impacts on developed and especially developing economies necessitates the employment of cutting edge and specifically tailored financial solutions to transfer various climatic risks to those in the capital markets who could bear them most economically. In the wake of the recent financial meltdown, however, risk transferring financial technology faces increased skepticism and suspicion with respect to its capability to reduce systemic risks. Rather, financial engineering is blamed for increasing systemic risks, as evidenced by the contribution of collateralized debt obligations (CDOs) and credit default swaps (CDS) to the evolution of the subprime crisis and the collapse of major financial institutions. Given the structuring similarities between catastrophe bonds and CDOs on the one hand, and between Over-The-Counter (OTC) weather derivatives and CDS on the other, two main questions must urgently be addressed: (1) whether the root causes for the recent financial crisis also apply to and call into question climatic risk shifting technology, and (2) what inherent drawbacks, if any, in Cat bonds and OTC weather derivatives should be addressed in order to lower the likelihood of a “climate bubble.” Shedding light on these key questions will contribute to the debate surrounding the future regulatory landscape of risk shifting financial technology in general, and that of climatic risk transfer in particular.