Climate Change and Financial Market: The Case of CAT Bond Jie Zheng Finance PhD Candidate, CentER Graduate School Tilburg University, The Netherlands Erasmus Mundus Conference: Higher Education and Climate Change 26 th - 27 th February, 2009 Budapest, Hungary

Brief Contents 1. Introduction and Problem Statement 2. Climate Change and Financial Market 3. Conclusions

1.1 Increasing Climate Change Risks General Warming of the earth ’ s atmosphere is almost certain (IPCC, 2007) 1 The Intergovernmental Panel on Climate Change (IPCC) compiles the search findings on climate change from various scientific disciplines and publishes them n a report-the latest in 2007

Blair on Climate Change (2006) “The Scientific evidence of global warming caused by greenhouse gas emissions is now overwhelming. It is not in doubt that if the science is right, the consequences for our planet are literally disastrous.”

1.2 Economic Repercussions of Climate Change Customers and investors will be increasingly sensitive to climate issues; firms will be challenged to respond. A rise in extreme weather events will cause increasing wealth destruction and earnings fluctuation; financing costs for corporations and governments are likely to rise. A global boom in climate protection and adjustment will be set in motion; corporations and consumers will have to ear the resulting costs

1.3 Empirical Evidence

1.4 Financial Markets and Climate Changes Financial markets suffering from climate change Financial markets fighting against climate change: >Ex-ante approach e.g., carbon credits (clean development mechanism, CDM) >Ex-post approach (main point!!!) e.g.,catastrophic risk insurance contracts(CAT bond)

Brief Contents 1. Introduction and Problem Statement 2. Climate Change and Financial Market 3. Conclusions

2.1 Ex-ante: carbon markets (1) Developing countries participate through the clean development mechanism (CDM) Industrial countries own and trade property rights on the use of emission limits for OECD Correcting missing property rights and trading privately produced public goods

2.2 Ex-ante: carbon markets (2) Carbon market traded USD 30 billion in 2006 (world bank,2007); USD 8 billion in CDN projects in developing countries (61% in China) Increasing investment & clean technologies in developing countries HOWERVER: US does not participate Carbon market accounts for 40% of global emissions Carbon market and Kyoto Protocol expire in 2012

2.3 Ex-post: securitization of catastrophe risks

2.4 Catastrophe bond

2.5 Brief description of catastrophe bond (CAT) First issued in the mid-1990s; worth USD 4.69 billion in 2006 Designed to protect sponsors from the risk of financial loss associated with large natural catastrophes, e.g.,hurricanes and earthquakes. Relatively short-term, most commonly having maturities of between two and four years Advantages: >Sponsors’ access to capital market >Reducing counterparty risk >Diversity of investment portfolio

2.6 Transaction structure of CAT bond

2.7 Current problems with CAT bond Basis risk Underwriting and marketing costs Legal and regulatory issues

Brief Contents 1. Introduction and Problem Statement 2. Climate Change and Financial Market 3. Conclusions

3.1 Conclusions Financial markets play an important role today in fighting against climate change New financial instruments are emerging in response to the mounting climate changes. The market for catastrophe risks enables previously uninsurable risks to be insured against and the hedging costs to be minimized.

Questions?? THANK YOU!!!