IFRS and Weather Risks: Now is the Time
by Jean-Louis Bertrand, Professor of Finance, ESSCA
Member of the “Climate and Financial Innovations” working group, Paris-Europlace and weather risk management consultant at Metnext
Wall Street has put a lot of pressure on corporates to meet the numbers and forced treasurers to tackle sales and earnings volatility through the use of rigorous hedging programmes. Most companies have dedicated resources to implement and manage IFRS compliant programmes to cover foreign exchange, interest rate and sometimes commodity exposures. To date, weather risks have not been on the radar screen, yet many studies confirm they can have financial consequences on the business and profits that can be far in excess of what currencies or interest rates can generate.
Treasurers have foreign exchange, interest rates or commodity risks under control, but is this the case for their most significant risk?
We all know that extreme weather events can cost companies a lot of money, but they might just be the tip of the iceberg. Day to day changes in temperature, precipitation or sun hours too can considerably affect business activity and more importantly the bottom line. The recent consequences of the high snowfall in London would be a good illustration.
Over the last thirty years, corporate treasurers have learnt to successfully deal with all sorts of financial risks using derivative instruments. However, their ability to do so is not simply about the availability of financial products. They are able to manage their risk because they are able to identify and understand the risks they are facing and the consequences for the business. In addition, the International Accounting Standards Board (IASB) provides a structured framework to report and evaluate these risks and their associated hedging programmes. Finance professionals and investors know where to look in annual reports if they wonder what FX, interest rate or commodity price movements could do to EBITDA. The same cannot be said about weather risks. Yet weather may well be the next crisis companies have to deal with, especially if they are completely unprepared.
1. Financial impact of weather risks
Weather risks are defined as non-catastrophic weather events which have a financial impact on company sales or profit. They relate to any measurable and tradable variation to a definable benchmark such as changes in temperature, rainfall, snowfall or even wind speed, but exclude extreme events such as tornadoes, hurricanes, flooding or long lasting droughts. Evaluating globally, the financial impact of weather risks on the economy, is not an easy task because methods differ from one study to another.
In August 2008, WeatherBill published the weather-sensitivity rating of 68 countries (Table 1). The higher the rating, the higher the exposure to weather risks. Brazil may be the most weather-sensitive country in the world, but in dollar terms, the US ranks top of the list. Their weather sensitivity amounts to $2.6tr or 23% of their GDP. The total world exposure is estimated to be $5.8tr. In 2005, ABN AMRO published a study showing that weather risks affect between 20 and 30% of industrial production in Europe and 35% in the US, a fact confirmed by the US Department of Commerce, which also stated that the weather impacts 80% of US companies.