UKRAINIAN AGRICULTURAL WEATHER RISK MANAGEMENT WORLD BANK COMMODITY RISK MANAGEMENT GROUP

1. UKRAINIAN AGRICULTURAL WEATHER RISK MANAGEMENT WORLD BANK COMMODITY RISK MANAGEMENT GROUP Ulrich Hess Joanna Syroka PhD January 20 2004 UKRAINIAN AGRICULTURAL WEATHER RISK MANAGEMENT WORLD BANK COMMODITY RISK MANAGEMENT GROUP IFC PEP Ukraine Ulrich Hess Joanna Syroka PhD January 22 2004 WFP’S PILOT ETHIOPIA DROUGHT INSURANCE PROJECT Joanna Syroka Commodity Risk Management Group, World Bank WRMA Annual Meeting, Chicago June 25-27 2006

2. CHALLENGE To secure timely and reliable funds to finance WFP response to drought in severe years. Effective response requires contingency funds, which weather risk management instruments can provide.

3. AID FUNDING Example: Ethiopia’s Agricultural Areas PRESENT APPROACH EVENT ASSESS APPEAL FUNDING AID time Aug/Sept Nov/Dec Jan/Feb Mar/Apr Jan CONTINGENCY FUNDING APPROACH ASSESS / APPEAL EVENT AID time Oct/Nov Dec Aug/Sept Timing gains critical to saving lives and livelihoods

4. PILOT OBJECTIVES • The objectives of this small pilot were: • Quantify Ethiopia’s drought risk and develop appropriate rainfall index; • Demonstrate the possibility of transferring LDC weather risk to the market; • Enable price discovery for Ethiopian weather risk; • Set in motion a process for ex-ante risk management in Ethiopia and other developing countries.

5. NECESSARY STEPS To satisfy these objectives: • Design an index and contract structure • Generate support internally, donors, Government, market • Raise premium funds from WFP donors • Clean historical and real-time data • Capacity building to Ethiopian Met Service to ensure data flow • Engage the services of EarthSat • Educate all stakeholders • Design contingency plans: How will a payout be spent? • Secure WFP Executive Board approval for a transaction • Adapt WFP’s procurement process for a weather derivative • Negotiate legal terms for a UN agency • Mark-to-Model methodology

6. Ethiopia Drought Index for Pilot: Crop water balance model, FAO’S WRSI Variable input is daily rainfall data only 26 primary weather stations tracking staple crop yields Indexed yield calibrated to the income losses of “At-Risk” farmers Thought Experiment: “If WFP could transfer value to a farmer at harvest time, to stop him selling his productive assets, how much would they need to give?” Location: 26 Weather Stations (Agricultural Areas Only) Start Date: 11th March 2006 End Date 31st October 2006 Premium: Around $2,000,000 Max Payout: $20,000,000 ETHIOPIA PILOT FOR WFP Drought derivative to demonstrate feasibility of establishing contingency funding for an effective aid response

7. ETHIOPIA DROUGHT INDEX

8. THE ETHIOPIA TRANSACTION • Risk Transfer Structure: • Derivative based on Master ISDA documentation • Counterparty (buyer of option): UN World Food Programme • Executive Board approval November 2005 • Significant (pro bono) legal investment to structure contract • Weil, Gotshal & Manges LLC • Historical Data cleaned by EarthSat • Data Requirements for Transaction: • 26 weather stations reporting in real-time • Substantial capacity building required with Ethiopian Met Office • Now report to the WMO’s GTS for the first time in 4 years • Settlement Data Provider: EarthSat

9. THE ETHIOPIA TRANSACTION • Competitive Tender Process: • Official UN WFP procurement process • 9 companies invited to tender, 5 participate • 3 trigger levels priced • Tender Winner (seller of option): AXA Re, Paris • Final Transaction: • Trigger Level: $55,000,000 • Premium: $930,000, paid by USAID mainly • Payout Rate: 0.35c per $1 index • Maximum Payout: $7,100,000 • Rate-on-Line: 13% • Contingency Plans for Payout: • Cash Transfers to 63,000 households of $103 each if maximum payoutoccurs • Additional households chosen through existing safety net structure at local level

10. LESSONS LEARNED SO FAR • We can transfers weather risk from an LDC to the international risk markets • But…. takes time, work and a wide range of skills • Piloting is essential, to test internal processes and engage stakeholders • Weather data is critical, need to work closely with National Met Services and data cleaners • We are monitoring the index as the data comes in: • So far the index mirrors events on the ground • Planting has occurred as predicted • Index itself has many advantages/uses, contingency planning • Moving forward contingency funding should be linked to effective contingency plans and internal financing arrangements • WFP preparing a second year pilot for Ethiopia, to be approved by the November 2006 Executive Board • Procurement process will be significantly easier second time around! • Will finance pre-defined contingency plans • Index will be refined

11. CONCLUSIONS A weather risk management instrument can provide timely and guaranteed funds in the event of contractually specified shortfalls in rainfall. Additional benefits include: Effective Contingency Planning & Interventions Price discovery so that donors and Governments can build effective, comprehensive investment portfolios for countries and regions Ethiopia pilot is a first step (of many!) towards a risk management approach to humanitarian aid