Cash Cow

In finance, as in climate change, sometimes there are tipping points. In 2004, the Chicago Mercantile Exchange (CME) traded a modest $2.2 billion in weather futures — obscure derivatives that are linked to temperatures in 29 cities worldwide and that enable traders to bet on hot or cold spells. But the weather was unusually volatile in 2005: drought and floods in Europe, record heat in Australia and an active storm season capped by Hurricane Katrina in the U.S. By the end of the year, CME had traded $36 billion in weather futures.

Since then, the boom in bets related to climate change has proliferated in other financial markets, too. With amateur and professional investors alike growing more concerned about global warming, financial institutions are finding a myriad of ways to cash in. A whole host of new indices, funds and esoteric instruments have been created to meet their needs. Some, for example, offer ways for investors to ride the long-term growth of sectors such as renewable energy, waste management and Arctic shipping; others bundle and package climate-change risk so it can be traded like platinum or pork bellies by hedge-fund speculators.

Investment-research firm KLD Research & Analytics launched a climate-change index in 2005. This year the big investment banks have piled in, too. JP Morgan introduced an index in February comprised of bonds from firms with limited vulnerability to global warming. ABN Amro launched a Climate Change and Environment Index in March, tracking stocks in businesses like emissions reduction and water filtration. In April, UBS introduced a global-warming futures index based on the weather in 15 U.S. cities. Merrill Lynch launched an energy-efficiency index in July. And in September HSBC unveiled what it claims is the largest climate-change index to date, tracking the share prices of some 300 companies.

As you might expect on Wall Street, money is the prime motivator. So long as cash continues to flood into environmental investment vehicles, new ones will keep being created. “There is a lot of demand for these eco-products,” says Ronald van der Ham, assistant director of equity structuring for ABN Amro, and that is what’s driving “the constant stream of new indices and new funds being launched.” Lipper FERI, a mutual-fund information provider in London, estimates that Europe’s environmental and ecological equity funds alone raised nearly $8 billion in the first three quarters of 2007, almost $4 billion more than in all of 2006.

Until recently, this was a specialized niche. But now it “has gone from being the exclusive domain of some clean-tech funds to being a demand of major investors,” says Nick Robins, head of the HSBC Climate Change Centre of Excellence. Indeed, buyers today have their pick of hedge funds that focus on rapid-fire trading to corporate pension funds that are required to put some portion of their money in socially responsible investments. Meanwhile, a slew of new mutual funds is selling individual investors on the heady growth prospects of companies in areas like cleaner energy or environmentally friendly consumer products. HSBC has tracked back its benchmark climate-change index to 2004, and claims it would have outperformed the MSCI World Index by about 70% — evidence that, so far at least, there has been plenty of opportunity to profit from environmental peril.

Not surprisingly the big banks — many of them still nursing their wounds from the subprime meltdown — are eager to embrace this new money-spinner. Institutions like ABN Amro, Merrill Lynch and HSBC have all created structured products built around their own indices: protected offerings, for example, that track an index but give a minimum guaranteed return, or leveraged offerings that amplify gains and losses. They can be used to hedge risks presented by global warming, or simply to bet on the likelihood that cash will continue to cascade into the sector.

It’s all a sign of how quickly and cannily the investment world reacts to the scent of a new opportunity. An added attraction in this case is that the market for such products is so richly diverse. Not so long ago, traders in weather futures were energy producers, insurance firms and tourism ventures — almost exclusively companies that directly had something to gain or lose from a change in the weather. “Now,” says Renaud Huck, CME Group’s Europe associate director, “we have equity investors, hedge funds, commodity traders and weather traders.” For them — and for the financial firms racing to sell products to them — global warming comes with a silver lining.